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Rule 19 and the replacement advice record

26 January 2021 Gareth Stokes

Compliance professionals working at / for insurers and financial advice practices have their hands full keeping up to date with the changes introduced under South Africa’s twin peaks regulatory framework. They have to monitor both the Financial Sector Conduct Authority (FSCA) and Prudential Authority (PA) for the publication of amendments, regulations and standards that will have an impact on the financial services providers (FSPs) they serve. They must also ensure that their FSPs are aware of the commencement dates for amendments to existing regulations. These dates are usually set out in a schedule accompanying amendments or new regulations, though it is common to allow the responsible minister to determine the date at a later stage.

Compliance versus process optimisation

The Amendment of Policyholder Protection Rules (PPR): Long-Term and Short-Term, published on 28 September 2018, provide a useful backdrop for further discussion. The effective dates for these changes ranged from 1 January 2018 all the way through to 1 January 2020. Some of these commencement dates pre-date the gazetting of the amendments because they dealt with changes introduced by the promulgation of the respective PPRs on 15 December 2017. FSPs must ensure compliance within the authorities’ deadlines; but the process of optimising business practices to ensure compliance often drags on for months afterwards. 

Schalk Malan, CEO of BrightRock, recently observed that the PPR amendments introduced critical changes that affected both insurers and financial advisers. “The change in relation to the replacement or termination of long-term individual risk policies [requires] the inclusion of a replacement advice record (RAR), which applies when policyholders replace specific policies with the support of their broker”. A replacement is described in the regulations as the action or process of substituting an individual risk policy, wholly or in part, with another individual risk policy or the termination or variation of an individual risk policy and the entering into or variation of another individual risk policy. The old policy is referred to as the ‘replaced policy’ and the new policy as the ‘replacement policy’. 

Rule 19 and the replacement advice record

Rule 19.2.1 of the PPR Long-term requires the insurer, “before entering into an individual risk policy in respect of which an intermediary rendered its services as an intermediary, obtain confirmation from that intermediary as to whether or not the policy so entered would constitute a replacement policy”. Insurers, it would seem, expect the intermediary to inform them of this fact from the outset. Upon learning that the policy meets the definition of a replacement policy, the insurer is required to obtain a copy of the RAR from the intermediary. 

The RAR is a financial advice requirement per section 9(1)(d) of the FAIS General Code of Conduct. Malan said that navigating these changes still creates challenges for the industry, despite the rule being in force for more than two years. “The RAR is used to effectively advise a client on the replacement policy and encourages the policyholder to make a decision that will benefit them and their financial future,” explained Malan. To achieve this, the RAR should tabulate differences between the original and replacement policies. The process, which ensures compliance with Rule 19 by all stakeholders to the transaction, places a high administrative burden on the advising broker. 

The replacing insurer is given 14 days following receipt of the RAR to assess it. A senior manager at this insurer must be satisfied that the RAR meets the disclosure requirements under section 8(1)(d) of the FAIS General Code of Conduct; complies with the FSCA’s format; and contains “sufficient information to indicate that the intermediary took reasonable steps to ensure that the replacement policy was more suitable to the policyholder’s needs than modifying or retaining the replaced policy”. The replacing insurer must also provide the insurer of the replaced policy with a copy of the RAR. “In the event the RAR is not completed correctly or has inadequate information for the client to base their decision on, the previous insurer is unable to cancel the policy based on the RAR,” noted Malan. 

Financial advisers beware!

There are significant consequences for brokers and insurers in the event the broker fails to inform the insurer that a new policy meets the ‘replacement’ definition. The replacing insurer is obliged to report the broker to the authority in the event they discover such oversight and could institute a review process and clawback of commission. In the event the omission is discovered within six months of the replacement policy activation, the insurer must offer the policyholder the option to cancel that policy. 

“When a client chooses to change insurers, brokers are required to complete lengthy documentation on why they are changing their policy,” said Malan. BrightRock has developed a template that saves time by part-populating the RAR form. But financial intermediaries who use this tool will still have to double-check the content before submitting the form. “A template like this cannot replace a financial adviser’s knowledge and advice; but if used as intended can save advisers a significant amount of time,” he concluded. 

Writer’s thoughts:
The administrative burden associated with replacing an individual risk policy means that financial advisers will think carefully before going this route. Rule 19 was implemented to protect consumers from poor financial outcomes following a policy replacement. Would you agree Rule 19 has the unintended negative consequence of brokers being dissuaded from replacing low value policies? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts


Added by Tim Jones, 28 Jan 2021
When arguing for as and when commission please remember that on boarding of a new policy it takes a majority of time when compared with ongoing servicing.I.e. The majority of your costs in doing business are incurred upfront. Therefore it is generally accepted business practice that you match your costs to your income flow - otherwise you may not be able to stay in business.
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Added by Peter Dexter, 26 Jan 2021
I agree with Ben and Paul above. The upfront sales commissions incentivise behaviour that is in direct conflict with TCF and the FAIS Code of Conduct. For over 40 years the long term industry has been tinkering with numerous "Replacement agreements" in a half-hearted attempt to stop churning, but they don't have the courage to change the remuneration structures to encourage client-centric, service-focused behaviour. It is just so easy: Pay the APPOINTED broker "as and when commissions" all the way through the life of the policy. That will encourage the building of a book of business, will produce annuity income to fund the servicing of the clients, but most of all, good service will result in client retention and growing revenue streams for brokers. Ultimately resulting in the alignment of client and advisor objectives.
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Added by Nursee Parannath, 26 Jan 2021
1. One of my clients was adamant he has the option of choosing who he wants to deal with and which insurance company he prefers. No one is going to tell him what to do.
2. Does the industry expects the broker to intricately know the products of other insurers?
3. A broker can spend hours on a portfolio only to find the original insurer changing existing the policy to match or better the new quote.
3a. Several insurers publish product comparisons with competing insurers - this in itself is a complicated read.
4. The probable solution lies with the LOA, who can capture brokers and client's info then run a simple program to highlight suspect brokers, Franchises and/or FSP’s.
5. There always will be unethical parties in this practice. Always occurs when Brokers change Franchises or joins other FSP’s.
6. Insurers and their BC's are always chasing sales, manipulating quotes to make it “sellable”
7. Lastly industry bodies like FIA could contribute more to address this issue
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Added by Ben Holtzhausen, 26 Jan 2021
When is this industry going to learn that unethical behaviours are fueled by the perverse incentives to drive up sales of long term risk business?

The up-front commission model is the most significant perverse incentive and the so-called "pond that attracts the crocodiles".

For some reason, the authorities believe it can control the predators' behaviour with all kinds of complicated fences and deterrents.

The answer is so simple: Drain the pond and the crocodiles will go away by themselves.

In other words: STOP this highly outdated, perverse and crazy up-front commission system.

It will not stop replacement of policies completely and it should not, but it will reduce the numbers to those which are truly necessary, sensible and appropriate.

The proof thereof is very clear if one looks at the churning levels of EB-, medical scheme- and LISP business.
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Added by Paul, 26 Jan 2021
Naivety reached new heights when this agreement was introduced. It resulted from institutionalised churning where advisers were bribed by product houses to replace policies on a colossal scale. Now those same institutions are appointed as guardians to ensure that all replacements are kosher. I can just see the “senior manager” (read scapegoat in case something goes wrong) at the replacing company saying: “O dear, we cannot accept this replacement. The replaced product is far better suited to the client’s needs than ours." All of this extra work just adds to the burden of the honest adviser who replaces an old product with one that is really better suited to the client’s needs.
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