Short-term insurance industry under intense scrutiny from regulator
25 March 2014
Caroline Da Silva, FSB
Caroline Da Silva.
Certain insurance practices perceived as restricting consumers’ freedom of choice or unfairly adding to their costs are under intense scrutiny by financial regulators, according to the Financial Services Board’s Deputy Executive Officer for FAIS, Caroline Da Silva.
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, she said at the Norton Rose Fulbright Insurance Management Forum in Johannesburg on 6 March.
These steps could potentially include pricing interventions, market conduct measures and structural interventions, or a combination.
Da Silva, at the invitation of Norton Rose Fulbright, was giving an update on legislative reforms affecting the short-term insurance sector and the regulatory projects flowing from them.
Describing broad legislative trends before going into the detail of FSB concerns over current insurance practices, she said the intention was to move from a rules-based regulatory system to an outcomes-based one, underpinned by key principles of fairness.
Lessons from the global financial crisis
The global financial crisis had underlined the need for a shift in regulatory approach, she said. "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.”
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, adding that the transition would go hand in hand with greater regulatory pressure on insurance 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.”
Misleading advertising on the rise
Da Silva listed various industry practices that were cause for concern, including misleading advertising, such as where companies 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 is simply a product,” she said. "This is misleading for customers because they don’t know who they are underwritten by.”
Da Silva also expressed misgivings about marketing. Insurance advertising should not make unsubstantiated claims about offering the cheapest premiums or having the best claims-handling record, for example, or should make it clear that their claims are just "puffing” and not fact.
Remuneration structures under scrutiny
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.”
Da Silva made it clear that the FSB was "uncomfortable” with most of these fees.
"Intermediaries argue that it costs money to collect premiums, for example. The reality is that premium collection cost has improved 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.
With regards to on-top fees, however: "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 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.”
Da Silva said advice fees to the customer should be between the customer and the intermediary, fully disclosed and agreed to by the customer and should not form part of remuneration from the product supplier.
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 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 was in the process of determining the actual cost of binder fees and intends issuing benchmark guidelines as soon as March or April 2014, Da Silva said.
Other legislative and regulatory developments highlighted in her presentation were:
• The status of the FSB’s review of the third party call captive insurance sector: Da Silva said 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.
• Consumer credit insurance review, being conducted jointly by the National Treasury, National Credit Regulator and 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 regularly measures to enhance competition, Da Silva said.
• The Retail Distribution Review (RDR) continues: it started in 2006 with the National Treasury’s discussion document on contractual savings. Other milestones include developing the Treating Customers Fairly (TCF) framework and the drafting of the Financial Sector Regulation Bill ("Twin Peaks” architecture).
• The Insurance Laws Amendment Bill: tabled in parliament in June 2013, the bill requires people who sell financial services to register as representatives, whether or not they provide advice. Da Silva said the Bill has been put on hold due to it being an election year but that the FSB will look at alternative means of achieving the objectives in ILAB.
• Financial Services Laws General Amendment Bill: tabled in September 2012, the bill was published on 16 January 2014, with the commencement date of 28 February 2014. Some of the sections will be in force only at a later date. The bill addresses urgent issues in 11 financial sector laws and, among other things, facilitates the Retail Distribution Review.