Financial Services Royal Commission Final Report: Key recommendations for the insurance industry

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This is the second article in our two-part series, where we provide a more in-depth review of the key recommendations for the insurance industry. To return to our first article, click here.

Key recommendations for the insurance industry

Life insurance commissions flagged for further reduction or elimination (2.5)

The recently enacted LIF reforms that now permit only capped or level commissions for life risk products will be scrutinised by ASIC in 2021. If the restrictions have not led to significant underinsurance then ASIC will be urged to reduce them (ultimately to nil). The Commissioner is confident that relying more heavily on life insurance provided through superannuation will not leave 'large numbers of Australians without an appropriate level of life insurance'.

Our view: Minds may differ about what could be an 'appropriate' level of cover. How much life cover do you have through your superannuation?

General insurance (including CCI) commissions also in the firing line (2.6)

The Final Report recommends a review in 2022 of measures to improve the quality of financial advice and further recommends that review consider extending the conflicted remuneration prohibition to general insurance and consumer credit insurance.

Our view: One of the Commissioner's pet peeves is the proliferation of exceptions in the current financial services legislation. The ACCC recently made a similar recommendation and the industry should start preparing now for the seemingly inevitable. As with life insurance, the real challenge for intermediaries will lie in being able to persuade legislators that not all commission creates conflicts or else persuade retail clients that the fee charged for their service is reasonable and reflects the effort involved in arranging their cover.

No outbound telephone sales of general or life insurance (4.1)

The Final Report notes the potential for consumers to make purchasing decisions based on inadequate information during a cold call. Insurers will still be able to contact existing customers in relation to renewals but will be prohibited from cross-selling other types of insurance products.

Our view: Many areas of the industry have already moved away from outbound telephone sales but the death knell has now been sounded. Insurers should explore more modern communication channels to help with lead generation. How often do your children use a smartphone as a telephone?

Funeral expenses policies will be 'financial products' under the law (4.2)

This will have the effect of subjecting them to the same requirements and prohibitions as other types of insurance, such as the anti-hawking prohibition referred to above.

Our view: No surprises here. Funeral expenses policies have been on the hit list for many years.

Sales of add-on insurance deferred (4.3)

The proposed deferred sales model would apply to all add-on insurance (other than comprehensive motor vehicle insurance). Some exemptions may be justified, and the Final Report recommends that Treasury consult with industry to identify worthy exceptions.

Our view: In many cases, a deferred sale equals no sale. Some may see this as a consumer benefit, but many claims are paid each year on some types of add-on insurance. Not every add-on policy is tyre and rim insurance.

Dealer commissions capped (4.4)

ASIC is encouraged to cap the commission that can be paid to motor vehicle dealers for sales of add-on insurance.

Our view: If recommendation 2.6 is given its full effect, any such cap may be short-lived.

Duty of disclosure watered down for 'consumer insurance contracts' (4.5)

This will apply to both general insurance and life policies. 'Consumer insurance contract' is a UK concept that means a policy taken out by an individual either wholly or mainly for a purpose unrelated to their trade, business or profession. The Final Report recommends the duty of disclosure be watered down for these individuals, so that they need only take reasonable care not to make misrepresentations.

Our view: The Final Report asserts that 'insurers are always better placed than an insured to identify the categories of information that they consider to be relevant' to their underwriting decision. There is no recognition that insureds are always better placed than insurers in relation to the knowledge of their own health (to use life insurance as an example). There is recognition, however, that this change may lead to premium increases but the Commissioner considers this a worthwhile burden for consumers to bear.

The apparent rationale for this change is that, based on UK experience, consumers are unaware of their duty of disclosure and don't understand questions being asked of them. The reform is intended to prevent consumers having to 'guess what information might be important to an insurer'. At this point, insurers who long ago implemented plain English policy documents might collectively bash their keyboards in frustration.

The effect of this recommendation will be to increase the importance of asking direct questions in proposal forms for this new class of insurance contract. The Final Report recognises that this might result in the repeal of the special provisions in the Insurance Contracts Act that currently apply to the duty of disclosure for 'eligible contracts'.

Harder to avoid life policies based on non-disclosure or misrepresentation (4.6)

Currently, a life insurer can avoid a policy within its first three years if the insured innocently failed to comply with their duty of disclosure. This right will revert to the pre-2013 situation where, if the insured had complied with their duty, the insurer can only avoid the policy if it would not have entered into a life policy on any terms.

Our view: Underwriting guidelines will need to be reviewed to ensure they clarify the situations where no policy will be offered to an applicant.

Unfair contract terms will apply to insurance policies (4.7)

There are no new insights to be found in the Final Report on this subject, which recommends that the unfair contract terms provisions relating to insurance:

(a) be contained in the ASIC Act rather than in the Insurance Contracts Act (which is contrary to the approach originally proposed by Government);

(b) adopt a narrower definition of 'the main subject matter of the contract' than the industry would have liked; and

(c) operate independently of the duty of utmost good faith.

Our view: In reality, the debate about unfair contract terms in the insurance context is much ado about nothing. When considering examples of 'unfairness' cited by consumer groups, it is hard to see how existing laws wouldn't provide a remedy in each case. The more interesting question will be whether the law inadvertently creates overlapping and inconsistent grounds for challenging a declined claim.

Claims handling will be a financial service (4.8)

The function of an insurance contract is to provide an indemnity (or an agreed sum) in response to an event. The delivery of that indemnity is a service and there is no compelling reason why the sale (and soon the design) of the underlying product (but not the execution of its primary function) should be regulated as a financial service.

Our view: As with some other recommendations, one might wonder what additional burden this will impose. If an insurer currently handles claims with the utmost good faith, it is difficult to see how being required to handle those claims 'efficiently, honestly and fairly' requires it do to more. By way of comparison, the General Insurance Code of Practice already requires its subscribers to do all those things as well as being 'transparent' when handling claims.

It is possible, though, that ASIC may seek to prescribe training standards for claims staff, so the industry should consider now how it will respond in that event.

Codes of practice to be enforceable (in part) by mid-2021 (4.9)

Any provisions of the General Insurance Code of Practice, the Life Insurance Code of Practice and the Insurance in Superannuation Voluntary Code which relate to the terms of a policy are to be identified and made enforceable by 30 June 2021.

Our view: Since the first General Insurance Code of Practice, there has been debate about the merits of having an enforceable industry code. There is not much in the current forms of each code that could be described as relating to the terms of the policy, other than the sections relating to claims handling (and, in the case of the life and superannuation codes, policy design). However, all codes are currently in the process of review and so the proposed reforms will need to be considered carefully as part of that process.

Breaches of codes should give rise to sanctions (4.10)

The power to impose sanctions is already given to the committees that oversee the life and general insurance codes. However, they apply only where a code breach has not been corrected and the Final Report recommends that the committees be empowered to impose a sanction in response to a breach itself (if appropriate having regard to the matters set out in each code).

Our view: Given the other consequences that may flow from a code breach, especially an enforceable provision, we expect only significant or systemic breaches will result in sanctions from a committee.

Licensees required to co-operate with AFCA as a condition of their licence (4.11)

This recommendation reflects the Commissioner's concern that there is no express obligation for financial services licensees to comply with requests from AFCA for assistance. ASIC will now be able to enforce such compliance.

Our view: This should have little practical effect. Currently, those who fall foul of AFCA run the risk of having their membership of AFCA terminated. Without any alternative external dispute resolution scheme to join, this would have the effect of putting the expelled member in breach of their licence conditions. So, the stick is already there but, in future, both ASIC and AFCA will each hold a stick.

Accountability and FEAR (4.12, 6.8 & 6.12)

The Banking Executive Accountability Regime (BEAR) will be expanded to all APRA-regulated financial services entities. After expanding to all authorised deposit-taking institutions and registrable superannuation entities, the regime will be applied to the largest insurers first and then to all insurers.

If the banking model is applied to insurance, this will require each insurer to identify an executive responsible for all the insurer's products: their design, delivery, maintenance and, where necessary, remediation. Insurers will need to provide accountability statements and maps showing lines of responsibility.

Even the regulators will be held accountable, with ASIC and APRA required to apply these management accountability principles to their functions.

Our view: This is a sensible measure but, clearly, a new acronym is needed. We suggest the Financial Executive Accountability Regime or 'FEAR'.

Review universal key terms in MySuper group life policies (4.13)

This recommendation is intended to explore the practicability of amending the law to require insurance terms within default superannuation products to be standardised, at least in key respects. The hope is that it will make it easier for consumers to compare products. The Final Report encourages the same review to look at the merits of prescribing limits of minimum, maximum and fixed levels of cover.

Our view: It is very difficult (and, in many cases, undesirable) to implement widespread standardised wordings but default superannuation provides a worthy test-bed for the attempt.

Remuneration policies will be prescribed and monitored (5.1 to 5.4)

APRA is encouraged to continue its work expeditiously on revisions to its prudential standards and guidance on remuneration (Prudential Standard CPS 510 currently prescribes insurers' remuneration policies). Consultation is expected to occur this year, even though the latest iteration of CPS 510 has not even commenced yet.

The Commissioner encourages APRA to review remuneration policies to ensure that they are designed to reduce the risk of misconduct and to manage non-financial risks soundly. This includes the ability to claw back remuneration that has already vested.

It should be mandatory for boards to assess their remuneration policies regularly and this includes a review at least annually of remuneration systems for front line staff to ensure it focuses not only on what services staff provide but also how they provide them.

APRA should increase its level of supervision and conduct regular market surveillance to ensure these policies are discouraging misconduct effectively.

Our view: There are almost as many flavours of remuneration schemes in the industry as there are licensees, some of which will withstand scrutiny better than others. These recommendations are key to lifting standards and reducing temptation for wrongdoing within the industry.

Culture to become a focus (5.6 & 5.7)

Insurers and insurance intermediaries, like other financial services entities, should as often as reasonably possible assess their culture and governance in order to identify and deal with any problems that emerge. The Commissioner envisages more than a box-ticking exercise. Instead, the Final Report requires boards and senior managers to recognise that responsibility for culture ultimately rests with them. APRA is encouraged to structure its supervisory program so that it focuses on building culture that reduces the risk of misconduct.

Our view: Inevitably, there will be a degree of box-ticking, but each organisation should consider implementing a review of its culture in a meaningful way. While not expressly doing so, the Final Report implicitly commends ANZ's recent focus on organisational culture, which measures the organisation's leadership, middle management, risk environment and transparency.

ASIC to improve its enforcement function or have it taken away (6.2)

Although not recommending any immediate change, the Final Report states that if ASIC cannot adequately reform its enforcement function then consideration should be given to establishing a specialist agency for that purpose. The Commissioner expects this to go beyond issuing more infringement notices (which should rarely be used beyond administrative matters) and that enforceable undertakings should not be used unless the entity acknowledges that it has breached the law.

Our view: There is risk here for ASIC, as well as reward. As evidenced in recent times, litigation risk is real and conduct that appears to fall short of community standards and expectations may not in fact be actionable. Insurers and intermediaries should expect harsher treatment from ASIC but that does not mean they should fall on their sword at the first opportunity. The Federal Government has announced additional funding for the Federal Court. It may well require it.

ASIC and APRA to co-operate and share information (6.9 & 6.10)

This means, for example, that when ASIC considers an insurer has broken a law administered by APRA, it will inform APRA of its concerns and provide background to assist in APRA's investigation and enforcement action. The obligation of co-operation will be set out in a memorandum that is subject to an annual report and a biennial review.

Our view: This already happens to an extent, but the Final Report envisages that the sharing of information will be mandated by law, not just by agreement. This may result in the regulators working together to impose more wide-ranging penalties and remediation measures on non-compliant regulated entities.

A new overseer for ASIC and APRA (6.14)

A new authority will be established to oversee and assess the effectiveness of ASIC and APRA. This authority will report to the Federal Government at least every two years.

Our view: In conjunction with recommendation 6.2, the insurance industry can expect the existing regulators to flex their muscles much more readily than in the past, to satisfy their new master.

Breach reporting requirements will be enhanced and expanded (7.2)

Consistent with recommendations made to the Federal Government in 2017, the mandatory self-reporting of significant breaches of financial services laws will be reformed (and extended to credit licensees). This will include a clarification of what matters are taken to be 'significant' and it will include an express obligation to report misconduct by employees and representatives.

The time for reporting breaches will extend to 30 days from discovery but with increased criminal penalties and new civil penalties for failing to report. The form of breach report will be prescribed, and ASIC is asked to publish breach data annually, not on an aggregated basis but at an individual licensee level.

Our view: A more reasonable timeframe for reporting breaches is welcome but licensees will need to be vigilant in ensuring that they meet the new deadline, for fear of harsher penalties in future for late notification.

But wait … there may be more (7.3)

A key theme of the Final Report is that simplification of financial services laws can be achieved by reducing the number of exceptions that have been granted for particular sectors of the industry or for certain classes of products. The Final Report then goes further and suggests that, in the course of this simplification process, further opportunities may be identified to reduce or eliminate exemptions.

Our view: Any person that currently relies, wholly or partly, on an exemption from a rule relating to disclosure, training, conduct or even licensing itself, should be alive to the potential for that exemption to be scrutinised and eliminated unless they can demonstrate a persuasive reason why the exemption should remain.

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The following comments made in the Final Report did not take the form of a numbered recommendation, but the insurance industry should be alive to the potential for legislative reform that they may bring about.

A breach of the duty utmost good faith should result in a civil penalty

This was recommended by Treasury in December 2017 and accepted by the Federal Government in April 2018.

Our view: In practical terms, this may not mean very much, since a breach of the duty is already actionable and is frequently alleged in complaints lodged with AFCA and its predecessor, FOS.

ASIC's proposed design and distribution powers should extend to all financial product and credit products

ASIC sought this extension of its proposed new powers in a submission to Treasury in August 2018. If granted, it would extend to products that currently fall outside the financial services licensing requirements, such as employer-issued life policies, funeral expense products and credit products. Notably, this would also extend ASIC's powers to a wide range of warranty products for which the issuer does not require a financial services licence on the basis that the warranty is incidental to the sale of a non-financial product.

Our view: While this may seem onerous on its face, in practice, these warranties are largely underwritten by insurers and those insurers will already be required to formulate target market determinations for other products to which ASIC's powers extend.

APRA to prescribe standards for managing non-financial risks

The Commissioner agrees with APRA that there is currently limited prescription by the prudential regulator of the compliance and audit functions of regulated entities.

Our view: Insurers should expect that future prudential standards will more prominently feature requirements relating to the prudent management of non-financial risks.

Increased funding for legal assistance, to help complainants take disputes to AFCA

The method of funding is not prescribed but the Final Report calls for predictable and stable funding (rather than one-off funding) for legal assistance services of the kind used by consumers to pursue complaints through AFCA.

Our view: This is likely to increase the workload on AFCA and may have the effect of increasing the likelihood of complaints being pursued beyond licensees' internal dispute resolution processes.

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