House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Minister for Revenue and Financial Services, the Hon Kelly O'Dwyer MP)

Chapter 1 - Removal of exemption to the ban on conflicted remuneration

Outline of chapter

1.1 Schedule 1 to this Bill amends the Corporations Act 2001 (Corporations Act) to remove the exemption from the conflicted remuneration ban on benefits paid in relation to certain life insurance products.

1.2 Benefits paid in relation to life insurance are permissible under certain circumstances specified by the Australian Securities and Investments Commission (ASIC) in a legislative instrument.

Context of amendments

1.3 Previously, paragraph 963B(1)(b) of the Corporations Act provided a broad exemption from the conflicted remuneration ban for benefits paid in relation to certain life insurance products.

1.4 A life insurance product is defined in paragraph 764A(1)(e) of the Corporations Act as a life policy, or a sinking fund policy within the meaning of the Life Insurance Act 1995 (Life Insurance Act), that is a contract of insurance. The definition excludes payments by employee associations, certain payments under the Life Insurance Act, funeral benefits and employee benefits paid by employers.

1.5 Some common life insurance products include:

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Life insurance - a form of insurance that pays out a lump sum to a beneficiary upon the death of the client.

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Total and Permanent Disability cover - a form of insurance that pays out a lump sum if the client becomes totally and permanently disabled. Different insurers have different definitions of what it means to be totally and permanently disabled.

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Trauma cover - a form of insurance that provides cover if a person is diagnosed with a specified illness or injury. These policies include major illnesses or injuries that will have a significant impact on a person's life, such as cancer or a stroke.

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Income protection insurance - replacing the income lost due to a person's inability to work due to injury or sickness.

1.6 A series of reports have identified a need for reform in the life insurance sector.

1.7 In October 2014 ASIC released Report 413: Review of Retail Life Insurance Advice. The report identified a strong connection between upfront commissions, policy lapse rates and poor consumer outcomes - 45 per cent of advice provided under an upfront commission model failed to comply with the law. The report also found that 82 per cent of the industry utilised upfront commission arrangements and that upfront commissions are generally between 100 and 130 per cent of the premium.

1.8 In response to the ASIC report, the Government called on industry to review remuneration practices in the life insurance industry. Mr John Trowbridge was appointed as independent Chair of the Review of Retail Life Insurance Advice (Trowbridge Review), published on 26 March 2015.

1.9 The Trowbridge Review recommended several reforms, including a significant reduction in upfront commissions.

1.10 The Government also commissioned a review of Australia's financial system, the Financial System Inquiry (FSI), led by Mr David Murray AO.

1.11 The FSI recommended a complete abolition of the current upfront commission model, and a move to level commissions, where any upfront commission does not exceed ongoing commissions.

1.12 In its response to the FSI, the Government announced its support for an industry-developed reform package. The Government announced a revised reform package by media release on 6 November 2015.

Summary of new law

1.13 The Bill removes the exemption from the ban on conflicted remuneration in section 963B(1)(b) of the Corporations Act for benefits paid in relation to certain life insurance products issued after the commencement date. Benefits paid in relation to life insurance products issued after the commencement date are therefore subject to the ban on conflicted remuneration. Level commissions are not affected by this change.

1.14 The Bill also enables the regulations to prescribe circumstances in which benefits paid in relation to life insurance are conflicted remuneration.

1.15 The Bill amends the Corporations Act to give ASIC the power to specify, by instrument, the criteria that must be satisfied for certain life insurance products to be exempt from the ban on conflicted remuneration (ASIC Instrument).

1.16 The criteria ASIC is empowered to specify in the ASIC Instrument are:

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the ratio between the benefit payable to a financial services licensee, or a representative of a financial services licensee, who provides financial product advice in relation to a life insurance product, or products and the amount payable for the product, or products, to which the benefit relates, and

•

the amount, or way of working out the amount, that is an acceptable payment that is to be repaid under clawback.

Comparison of key features of new law and current law

Detailed explanation of new law

Removing the conflicted remuneration exemption

1.17 This Bill removes the exemption from the ban on conflicted remuneration that applies to licensees, or representatives, in relation to certain life insurance products. The effect of the amendment is that all benefits paid in relation to life insurance, whether offered inside or outside superannuation, are subject to be ban on conflicted remuneration. [Schedule 1, item 8, paragraph 963B(1)(b)]

1.18 The Bill does not apply to benefits paid in relation to products issued before the commencement date. This means that the exemption from the ban on conflicted remuneration under paragraph 963B(1)(b) continues to apply to benefits relating to these products (see 'Application and transitional provisions').

1.19 Conflicted remuneration is defined in section 963A of the Corporations Act and means any benefit, whether monetary or non-monetary, given to a financial services licensee, or a representative of a financial services licensee, who provides financial product advice to persons as retail clients that, because of the nature of the benefit or the circumstances in which it is given, could reasonably be expected to influence the choice of financial product recommended or the financial produce advice given to retail clients.

1.20 The Bill also enables regulations to prescribe circumstances in which benefits in relation to life insurance products are conflicted remuneration, enabling sales of life insurance that do not involve financial product advice to be captured by the reforms. The intention of this regulation making power is to ensure that all life insurance distribution channels are treated equally under the law and to maintain the integrity of the reforms by providing a flexible mechanism to address avoidance mechanisms in the future. [Schedule 1, item 6, section 963AA]

1.21 The Bill removes the exemption from the ban on conflicted remuneration in paragraph 963B(1)(c) where no financial product advice is provided for life insurance products. The Bill removes this exemption to ensure that the regulations can effectively prescribe the circumstances in which benefits in relation to life insurance are conflicted remuneration even where the circumstances do not involve the provision of financial product advice. [Schedule 1, item 9, paragraph 963B(1)(c)]

1.22 However, consistent with the Future of Financial Advice (FOFA) reforms, benefits that are not considered to be conflicted remuneration or benefits that are expressly excluded from the ban on conflicted remuneration do not need to comply with the requirements of the ASIC Instrument.

1.23 Benefits given in relation to consumer credit insurance are also excluded, in order to ensure that the strict arrangements that apply to commissions paid on these products under the National Credit Code continue to apply. [Schedule 1, item 8, paragraph 963B(1)(ba)]

Enabling certain types of commissions to be paid

1.24 The Bill enables ASIC, via a legislative instrument, to permit benefits in relation to life insurance to be excluded from the definition of conflicted remuneration, provided certain requirements are met (herein referred to as the 'ASIC instrument requirements'). The ASIC instrument requirements relate to:

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the amount of the commissions; and

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clawback arrangements. [Schedule 1, item 13, subsections 963BA(2) and 963BA(4)]

1.25 Both the commission and clawback arrangements must be met to obtain the exemption to the ban on conflicted remuneration. [Schedule 1, item 8, sub-subparagraph 963B(1)(b)(iii)(B)]

1.26 The Bill amends the Corporations Act to introduce a concept of 'policy cost' for life insurance products on which commissions may be paid. [Schedule 1, item 4, section 960]

1.27 The components of the policy cost may be:

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the premiums payable for the product, or products, for that year;

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fees payable to the issuer for the issue of the product, or products, for that year;

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any additional fees payable because the premium for the product, or products, is paid periodically rather than in a lump sum (known as 'frequency loading'); and

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any other amount prescribed by the regulations. [Schedule 1, item 11, subsection 963B(3B)]

1.28 The Bill also provides that regulations may prescribe amounts that are not to be included in the policy cost. [Schedule 1, item 11, subsection 963B(3C)]

Amount of the commissions

1.29 A commission is a benefit generally paid by the issuer of the life insurance product to a licensee or authorised representative of the licensee that provided financial product advice in relation to a life insurance product. It is a payment based on a percentage of the sale price of the product. Depending on the circumstances, a commission may or may not include GST. Where the commission includes a GST component, the GST component is not intended to be a benefit for the purposes of the conflicted remuneration provisions.

1.30 The first requirement to obtain an exemption from the conflicted remuneration ban is to be within the acceptable levels of upfront and ongoing commissions. [Schedule 1, item 13, subsection 963BA(1)]

1.31 ASIC has the power in the ASIC Instrument to set the acceptable amount for both the upfront commission and for ongoing commissions for certain life insurance products. [Schedule 1, item 13, subsection 963BA(2)]

1.32 The acceptable amount is determined by reference to the ratio between the benefit (that is, the commission) and the policy cost. This is referred to as the 'benefit ratio'.

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If the benefit ratio is at or below the acceptable amount, then such benefits are permissible under law (exempt) and are considered to not be conflicted remuneration.

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If the benefit ratio is paid above the acceptable amount, then such benefits are not permissible under law (exemption unavailable) and are considered to be conflicted remuneration. [Schedule 1, items 4, 11 and 13, section 960, subsection 963B(3A), subsections 963BA(1) and (2)]

1.33 Under the amendments level commissions are still able to be paid. There is no maximum cap on level commissions. [Schedule 1, item 8, sub-subparagraph 963B(1)(b)(iii)(A)]

1.34 The ASIC Instrument can set the acceptable benefit ratio for upfront and ongoing commission amounts. It is anticipated that there will be a three stage transition over a period of two years to allow the industry to adapt to the new regulatory environment.

Clawback Arrangements

1.35 The second requirement to obtain the benefit of an exemption from the conflicted remuneration bans is to comply with the clawback arrangements (the 'clawback requirements'). [Schedule 1, item 13, subsection 963BA(3)]

1.36 'Clawback' is where a certain portion of the upfront commission is paid back to the life insurer, under certain circumstances.

1.37 The legislation specifies that clawback occurs in the first two years of a policy where the product is cancelled or is not continued, other than because a claim is made under the insurance policy or because other prescribed circumstances exist. ASIC has the power in the ASIC instrument requirements to determine how much is clawed back each year. [Schedule 1, item 13, subsections 963BA(3) and (4)]

1.38 The introduction of mandatory clawback arrangements is intended to limit incentives to 'churn' clients through to a new product in order to receive a new upfront commission.

1.39 It is anticipated that the practical application of the clawback requirements will be given effect by insurers, licensees and representatives through relevant commercial and employment agreements as necessary.

1.40 Consistent with FOFA reforms, there are certain benefits that are not considered to be conflicted remuneration (and therefore not required to comply with the conditions of the ASIC Instrument, such as clawback). These types of benefits include education-related non-monetary benefits, fees paid by the consumer to the adviser, and grandfathered benefits.

1.41 ASIC has the power in the ASIC Instrument to determine the amount, or a way of working out the amount, that is an acceptable payment under the clawback arrangements. [Schedule 1, item 13, subsection 963BA(4)]

Reporting Data to ASIC

1.42 The Government has requested that ASIC undertake a review of the sector to assess whether the reforms have better aligned the interests of advisers and consumers, and whether further reforms are required. The review is to be undertaken in 2021 (2021 Review).

1.43 The 2021 Review will consider a range of factors including: the distribution and sale of life insurance, the provision of advice, adviser commissions, policy lapse rates and premiums, and life insurance levels. Related factors (such as the effect of the introduction of a Life Insurance Code of Practice) may also be considered. The specific information to be collected to support the review will be the subject of consultation with industry.

1.44 An existing provision (subsection 912C(1) in the Corporations Act) will be used to facilitate ongoing reporting to ASIC on policy replacement data. This data will assist ASIC to undertake the 2021 Review.

1.45 An amendment is made to ASIC's existing data collection powers under the Corporations Act to clarify that ASIC may require that data be provided to it in electronic form. This change is made to assist ASIC with data collection in relation to the monitoring of the life insurance sector. [Schedule 1, item 1, paragraph 912C(1A)(e)]

1.46 Under this approach, requests for data by ASIC are subject to merits review consistent with other data requests under this provision.

Consequential amendments

1.47 This Bill includes a number of minor and consequential amendments to the Corporations Act. [Schedule 1, items 2, 3, 5, 7, 10, 12, 14, 15, and 16, the definitions of 'benefit ratio' and 'conflicted remuneration' in section 960, the note to section 963A, subsection 963B(1), subparagraph 963B(1)(c)(i), subsections 963B(5), 963C(1), 963C(3), and 963D(4)]

Application and transitional provisions

1.48 These provisions commence on 1 January 2018. [Schedule 1, item 2]

1.49 The amendment applies to benefits given under any arrangement whether made before, on or after the commencement day. [Schedule 1, item 17, section 1549A and subsection 1549B(1)]

1.50 However, the amendment does not apply to products issued before the commencement date or where a life insurance product is applied for before the commencement date and the product is issued within three months of commencement date. [Schedule 1, item 17, subsection 1549B(2)]

1.51 In effect, when considering benefits relating to a product issued before the commencement date, the law continues to apply as though Schedule 1 of the Bill never applied.

1.52 This means that the exemption from the ban on conflicted remuneration that was provided under paragraph 963B(1)(b) before the commencements of the reforms continues to apply to benefits given in relation to products issued before the commencement date.

1.53 Regulations may prescribe particular circumstances under which the amendments do not apply to a benefit. [Schedule 1, item 17, subsection 1549B(3)]

1.54 The amendments do not apply if the operation of the amendments would result in an acquisition of property from a person otherwise than on just terms. [Schedule 1, item 17, subsection 1549B(4)]