Ethics and insurance in financial advice

In the first article of this ethics series, we examined the broad application of ethics in financial practice. In this second article, the focus is on life insurances and the ethical considerations that are essential when making recommendations to clients. Round five of last year’s Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission) highlighted numerous cases in which ethical conduct in both the provision of risk advice and management of claims was notably lacking. This article, sponsored by GSFM, will examine the adviser’s duty of care under law and the new FASEA standards, as well as good business practice when advising clients about risk products.

According to the Australian Securities and Investments Commission (ASIC)^[1], life insurance advice is of vital importance to the long-term financial wellbeing of Australian consumers. Quality financial advice includes advice on the type, level, structure and affordability of life insurance cover based on the client’s cash flow position and which prioritises the client’s insurance needs and objectives.

Chapter seven of the Corporations Act (2001) imposes a number of obligations on holders of Australian financial services licences, including obligations to “do all things necessary to ensure that they provide financial services efficiently, honestly and fairly, to have adequate arrangements for managing conflicts of interest, to comply with the financial services laws, to take reasonable steps to ensure that their representatives comply with the financial services laws, and to have a dispute resolution system for services to retail clients.”

This should be familiar to all companies and their representatives providing advice to retail clients; after all, it underpins the ethical provision of holistic financial advice – and this includes risk advice.

Unfortunately, as highlighted in last year’s Royal Commission, there remains in some quarters a systemic failure to uphold these obligations. In the world of risk products, this can take many forms. For example, the following instances from the Royal Commission in which a major life company admitted to the following breaches by its authorised representatives:

• recommending customers cancel one life insurance policy issued by the company and replacing it with another also issued by that same company, so the adviser could collect the maximum upfront commission payable
• mis-selling insurance cover, including customers being provided with false or misleading information in relation to the purchase
• customers being coerced into taking out a policy they did not need
• customers being sold a policies they did not understand.

While most people read that list and can immediately identify the problems, some prioritise their income over the needs – and best interests – of their clients.

Ethics and risk advice

As detailed in the first article of this series, ethics can be defined as:

‘moral principles that govern a person’s behaviour or the conducting of an activity’

In financial planning, it can be distilled into acting in the client’s best interests at all times, acting with competence, honesty, integrity and fairness. In short, the way any one of us would like ourselves and our family members and friends to be treated by a professional service provider.

Risk advice can be particularly emotive; people are insuring against the worst – death, disability, being stricken by disease, being unable to work. Threats to the mortality of oneself or family members, talking to clients about providing for their family; these can be difficult conversations to have. It is, however, a critically important conversation and, arguably, an integral component of holistic financial advice.

In 2013, the Future of Financial Advice Reforms (FOFA) enshrined the best interest duty into law, to ensure advisers always act with the best interests of their clients front and centre – this includes strategic advice around life insurances and the selection of specific risk products.

The FOFA reforms introduced a number of changes to the regulation of personal financial advice, including a ban on conflicted remuneration. However, this ban did not extend to life insurance products and as such, commission payments continue to be the predominant remuneration structure in the industry.

Other FOFA requirements did extend to the provision of advice regarding life insurance products. This included the personal advice obligations to act in the best interests of the client, to ensure that the advice is appropriate to the client, to warn the client if the advice is based on incomplete or inaccurate information and to give priority to the interests of the client in the event of a conflict of interest.

Further, section 961B of the Corporations Act 2001 (as amended) lists the steps an adviser must take to satisfy the ‘best interests’ standard. The last of these is a catch all statement encapsulates the spirit of the legislation:

Take any other step that, at the time the advice is provided, would reasonably be regarded as being in the best interests of the client, given the client’s relevant circumstances.

Regardless of the client’s requirements, the advice must be underpinned by knowledge of the client, their circumstances, and any financial product – including insurance – recommended as part of the advice process.

ASIC report 413 – Review of retail life insurance advice

The Royal Commission was not the first review of the risk advice sector to uncover practices that didn’t always put the client first. ASIC’s 2014 and 2016 reviews of the sector uncovered a range of practices that would not comply with FASEA’s new ethical framework.

The most common policy type across the insurance industry is a stepped premium policy; it has a premium that increases, or ‘steps up’, each year according to risk factors, such as age. ASIC found that stepped insurance policies lapse at high rates after the first year. In phase one of its review, ASIC found three drivers for high lapse rates:

1. Product innovation or the redesign of key policy features by insurers
2. Age-based premium increases negatively impacting affordability
3. Incentives for advisers to write new business or rewrite existing business to increase commission income.

Interestingly, ASIC found a correlation between high lapse rates and upfront commission models.

In phase two of the review, ASIC audited 202 advice files from licensees active in providing personal advice to consumers on life insurance products. The review found that 63% of consumers received advice that met the standard for compliance with the law, while 37% of consumers received advice that failed to meet the relevant legal standard that applied when the advice was given.

The way an adviser was paid – by an upfront commission model compared to a hybrid or fee for service model – had a statistically significant impact on the likelihood of their client receiving non-compliant advice. In this sample, 55 percent of risk advice given by financial advisers using an upfront commission model was legally compliant – which, of course, meant that 45 percent was not.

ASIC identified a number of factors that affect the quality of risk advice, including:

• adviser incentives
• inappropriate scaling of advice
• lack of strategic life insurance advice
• weak rationales for product replacement advice
• failure to consider the relationship between life insurance and superannuation.

ASIC also identified some key warning signs of poor advice, including:

• high clawback rates
• high volumes of replacement product advice
• product bundling
• upselling.

Where the adviser did not receive an upfront commission, 93 percent of recommendations were compliant.

Obligations of licensees

In its recommendations, ASIC’s review clearly stipulated that potential conflicts of interest in the provision of risk advice must be actively managed by AFS licensees. It stipulated that licensees must consider:

• declining to provide advice if they cannot do so in compliance with the best interests duty and related obligations
• structuring remuneration arrangements to minimise the effect of conflicts of interest
• ensuring they provide appropriate levels of training to improve adviser competence
• performing regular file audits.

Irrespective of whether an adviser is giving advice on a specific topic, such as life insurance, or a broader suite of advice topics, the obligation to comply with the best interests duty and related obligations remains unchanged.

Case studies

The following case studies are based on real events; however the names of people and organisations have been changed, and some details altered. The case studies have been drawn from FOS, ASIC’s review of retail life insurance advice and the Royal Commission. For each, potential breaches of FASEA’s Code of Ethics will be identified.

 

Case study one: Look at the big picture

ASIC banned Bob Smith from providing financial services for a period of five years for failing to act in his clients’ best interests when providing advice on life insurance.

ASIC’s surveillance of Bob’s practice found that he had not considered his clients’ circumstances and what life insurance coverage they may need, nor their ability to pay for the insurance he recommended. In ASIC’s view, the adviser failed to make a reasonable assessment of which life insurance products might be best suited to his clients’ needs.

ASIC also found he had made false and misleading statements in his Statements of Advice, claiming to have considered his clients’ circumstances in relation to the waiting periods for income protection policies when he had not.

Breaches of FASEA’s code of ethics

Bob Smith has provided risk advice that is not compliant with the regulatory framework. From the details provided in the case study, Bob potentially breached the following standards in FASEA’s Code of Ethics.

 

Case study two: The churn

Julie and Richard Davis had just had their first child. Becoming parents had them thinking about how they would cope in the event that one partner became ill, was disabled, or worse, died.

Julie was on maternity leave but planned to return to work, Richard worked a four day week. Friends told them they should look at incorporating life insurance as part of their superannuation, but they weren’t really sure. They decided to play it safe and seek advice.

Richard and Julie saw Bethany Green, a risk adviser who worked alone, but was licenced by a large, well-known insurance group. The strong brand behind Bethany gave Richard and Julie comfort that they’d receive the right advice.

Bethany told Julie that because she was on maternity leave, insurance in superannuation wasn’t an option for her. She convinced the pair it was much better to pay for insurance separately as they could be more specific about their requirements. As she said, they were parents now and had to plan for every eventuality.

Although they did not have to pay Bethany for her advice – upfront and trail commission took care of that – the cost of insurance was significantly higher than they had budgeted for and they found it challenging to manage on one salary.

Thirteen months after they had initiated the policy, Bethany got in touch and told them about a new policy that provided better coverage than they had. She convinced them they should change policies. She did not mention the new upfront commission she would receive. The following year they added a second child to their policy, and Bethany used this to suggest yet another change.

An ASIC review of Bethany’s files found a regular program of policy lapses after the first year, followed by the issue of new policies. In the absence of a sound rationale for the vast majority of the cases, it was determined this was a strategy to boost her income. In addition, her recommendations were not always based on the best outcomes for the client and, in some cases, she actively steered clients away from more cost effective and appropriate policies.

Breaches of FASEA’s code of ethics

Bethany Green provided risk advice in which she put herself and her income needs before her clients’ needs. From the details provided in the case study, she potentially breached the following standards in FASEA’s Code of Ethics.

 

Case study three: An ongoing need

A 35 year old mother of two was diagnosed with breast cancer. Coming along only two years after major heart surgery, she was grateful for the TPD cover she had in place. That way, Leanne was able to take ten months away from work to undergo treatment and recover.

Leanne didn’t read the fine print. When the cancer unfortunately returned several years later, Leanne found she was not covered. Her adviser had not reviewed her current policy in light of her illness and had not recognised the policy needed to be upgraded to cover a second bout of the same illness.

Once again, Leeanne had to give up work to have treatment and fight for her life. This time, she did not have the safety net provided by the insurance cover, which put undue stress on her and her family. Not only was she not able to earn an income, there was no cover and medical bills were mounting daily.

Breaches of FASEA’s code of ethics

Although Leanne’s adviser did not act improperly, she was negligent when it came to ensure the products she recommended continued to be appropriate for her client’s changing circumstances. From the details provided in the case study, she potentially breached the following standards in FASEA’s Code of Ethics.

 

Strategic insurance advice

ASIC’s review of the industry and the more recent Royal Commission have both identified the need for strategic insurance advice, tailored for each client’s individual circumstances. The needs analysis is a fundamental building block of the financial advice process; consumers cannot get good advice without it. It ensures the adviser understands the client, their needs and objectives, financial situation and values.

A recurring theme in ASIC’s review was the failure of advisers to give strategic risk advice to their clients. Strategic life insurance advice includes advice on the type, level, structure and affordability of life insurance cover based on the client’s cash flow position and which prioritises their insurance needs.

It is the role of an adviser to engage with the client about the relative value and cost of insurance at a particular sum insured. The adviser has to help the client arrive at the right type of cover and sum insured, one that’s appropriate and affordable to them over time. As with all elements of a financial plan, it should be reviewed regularly to make sure it’s still right for the clients’ circumstances and needs. This is the value add of quality advice.

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[1] ASIC report 413 – Review of retail life insurance advice