Short-term industry under intense scrutiny

"While no firm decisions have yet been made, a range of possible interventions may be considered to address market conduct issues such as misleading advertising, conflict of interest and unethical remuneration structures," Da Silva said at the Norton Rose Fulbright Insurance Management Forum.

These steps could potentially include pricing interventions, market conduct measures and structural interventions, or a combination of them all.

Da Silva described some broad legislative trends before going into detail about the FSB's concerns over current insurance practices. She added that the intention was to move from a rules based regulatory system to an outcomes based one, underpinned by key principles of fairness.

The global financial crisis had underlined the need for a shift in regulatory approach. "While it is true that we might not have had a short-term insurance failure, the crisis highlighted that the light touch approach is not effective," Da Silva added.

For the sake of fairness to consumers, financial stability and the financial integrity of the short-term insurance industry, it might now be necessary to adopt a more intrusive approach for a while.

"The aim is to end up with a balanced approach based on the principle of fairness from us - the FSB - and to customers," Da Silva said. She added that this would go hand in hand with greater regulatory pressure on product providers to take responsibility for the conduct of their intermediaries.

"This is a deliberate shift in approach. The product supplier will bear the burden of responsibility. If a supplier chooses to distribute its products through intermediaries, it will need to take more responsibility for those intermediaries." This is positive for the broker fraternity.

Misleading advertising on the rise

Da Silva admitted that there were a number of industry practices which were concerning from the regulator's point of view. One of these is the supposed misleading advertising. This includes adverts where companies state that they offer cash-back bonuses to consumers, but fail to mention in their advertising that the customer would have to pay an additional premium to qualify.

Another widespread advertising practice is white labelling, where an insurance product is wrongly portrayed as an insurance company. "It looks like a company and is branded as a company but it's a product," she said. "This is misleading for customers because they don't know who the underwriter is."

Turning to the burning issue of remuneration structures, Da Silva homed in on the on-top approach widely used to compensate brokers and other intermediaries in the short-term insurance sector.

On-top fees, are amounts charged to customers over and above the commission and binder or outsource fees that brokers are entitled to as financial services intermediaries.

"Section 8(5) of the Insurance Act allows for on-top fees, but our concern is that these on-top fees include debit order collection fees, policy administration fees, and even general broker administration fees, all of which are remunerated for under intermediary services or commission and should not be charged to the client as well," says Da Silva, adding that the FSB is uncomfortable with most of these fees.

"Intermediaries argue that it costs money to collect premiums. The reality is that premium collection costs have come down over time," she said, adding that collection now costs a fraction of the 10% currently charged to customers by some intermediaries. "Are these fees in the customer's interest or just aimed at getting additional income to brokers?" Da Silva asked.

However, with regards to on-top fees, there is another side of the coin. Da Silva argues that advice is not always explicitly covered under intermediary services, and there is a good argument that brokers should be allowed to charge for advice over and above commission, especially given the professionalisation of the industry and the duties of advice givers under the Financial Advisory and Intermediary Services (FAIS) Code of Conduct. However, if a business is structured to sell only without providing advice, it would be very hard to justify charging an advice fee to the customer.

Problematic aspect

A more problematic aspect of broker remuneration is fees paid to brokers under the binder or outsource arrangement, and additional remuneration from providers, which includes charges such as royalty fees, profit sharing, premium interest, fees for collection of premiums by collection agencies, etc.

While emphasising that the authorities had  not yet decided what action to take, Da Silva warned that the FSB was keeping a watchful eye on fees. "If fees continue to grow, we may introduce caps in the interest of customers".

Asked to elaborate on this, she said that the FSB could cap fees at a level that would discourage unnecessary outsourcing to intermediaries by insurance companies. The reason is that while the purpose of outsourcing is ostensibly to improve insurance costs and efficiency and provide access to skills, it appeared in some cases to be a means of accessing income and did not provide the efficiency it intended due to duplication of costs. The FSB is in the process of determining the actual cost of binder fees and intends issuing benchmark guidelines within the next month or two.

Other developments that are about to make an impact

In preparation for its future role as market conduct regulator under the Twin Peaks model, the FSB is in the process of looking at a number of other issues which would affect market conduct.

One of these issues is the FSB's review of the third party call captive insurance sector. Da Silva said that phased implementation is envisaged and will include doing away with similar arrangements in the cell captive market and ensuring that all players in this market have dedicated licences by 2016.

Another issue being looked at is the consumer credit insurance review, which is being conducted jointly by National Treasury, the National Credit Regulator and the FSB. "The task team has serious concerns about supply-side and demand-side weaknesses of the consumer credit market. These include a highly interconnected value chain with inherent conflicts of interest. The policy approach to be followed may include a combination of structural interventions to reduce interconnectedness, pricing interventions and market conduct regulatory measures to enhance competition," Da Silva said.

Probably the most important piece of legislation is the Retail Distribution Review (RDR), which will redefine the way in which industry remuneration is structured. The process started in 2006 with National Treasury's discussion document on contractual savings and will continue as the FSB engages with industry role players on the issue.

By implementing these measures, the FSB hopes to bring a sense of accountability in the market. Although this will be positive for the industry, the ramifications for people and companies operating in the industry might be quite significant. Do you believe this is fair, or are there a few things Caroline Da Silva needs to be reminded of? Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts jonathan@fanews.co.za.