A vast number of interpretive articles were published on the retail distribution review discussion paper since its publication. Unfortunately, a number of these added to the confusion, rather than provide clarity on this very sensitive issue.
While much has been said about the proposal to ban commission on replacement policies, very little attention was paid to the practice of charging exorbitant early termination charges.
Under the heading “The way forward”, the discussion paper sets out how the Regulator intends to “…reduce the impact of adviser remuneration on reasonable benefit expectations, particularly through eliminating the justification for penal early termination charges and inappropriate product replacements”.
Section 14 transfers between retirement annuity (RA) funds – i.e. the transfer of a member’s accumulated savings from one RA fund to another – may in some cases be motivated by differences in intermediary remuneration for different types of RA funds rather than the best interests of the customer. Specifically, investments in ‘underwritten’ RA funds (where the underlying investment is a long-term insurance investment policy) attract commission for the intermediary, while investments in ‘non-underwritten’ RA funds (where the underlying investment is usually a collective investment scheme) will generally result in the payment of a ‘trail fee’ (i.e. a percentage of assets under management) to the intermediary.
Regulations under the Pension Funds Act have attempted to discourage incentive-driven churn of investments between underwritten RA funds by specifying that no new commission may be earned by an intermediary for a transfer from one underwritten RA fund to another, meaning that any advice in this regard must be remunerated by means of an advice fee only. However, a risk remains that there may be incentive-driven churn between underwritten RAs and non-underwritten RAs, where intermediaries who have already earned up-front commission on the initial sale of the underwritten RA may be driven to earn additional asset trail fees by advising the client to shift to a non-underwritten RA, even if this may not be in the client’s best interest, particularly taking into account the early termination penalties that may be payable when withdrawing from the underwritten RA fund.
Proposal QQ which addresses this issue, reads as follows:
Specific conduct standards will be set to mitigate the risk of poor customer outcomes where an adviser recommends the transfer of accumulated benefits from one retirement annuity fund to another. Standards will include strengthened disclosure requirements to ensure that the cumulative impact of any early termination charges deductible from the transferred value, together with that of advice fees and product charges on the investment value post transfer, are clearly communicated.
Consideration will also be given to placing specific obligations on both the transferring and the receiving funds and / or product suppliers concerned, to take steps to satisfy themselves that the transfer is in the fund member’s interests – particularly in instances of transfers from underwritten RAs (where up-front commission costs will already have been incurred).
Proposal PP aims to reduce early termination values on legacy contractual savings products to reasonable levels within the next few years so as to address excessive penalties on the transfer of retirement annuity savings. Transition measures will be introduced to put this in place.
It is difficult to see this proposal working in practice. The abject failure of the Replacement Policy Advice Record (RPAR) in preventing churn is proof that the solution does not lie in more paperwork. It is the practical and moral application of the system that needs to be addressed. Some of those who were supposed to be custodians of RPAR turned out to be the worst offenders in term of institutionalised churn via sign-on bonuses.
It is also difficult to envisage some receiving funds saying to the adviser: “This switch is not in the client’s interest. We will not accept this new business. Leave it with the current provider.”
While the RDR does make provision for greater provider accountability in ensuring fair outcomes for clients, it may not be enough to discourage malpractices. Even if heavy penalties are incurred, the providers normally have deep pockets, and are quite able to pay such penalties from other undiscovered cases of a similar nature.
Last year, two providers were found to be double-dipping. When the “mistake” was uncovered, the clients were refunded, but there was no mention of an internal audit to establish whether other clients were also over-charged, and refunded.
A “name-and-shame” approach could be the only workable deterrent, coupled with a whistle-blowing facility.
Causal event penalties affect three parties: the client, the adviser and the product house. Reducing adviser fees alone will not have the desired impact. There needs to be an equal sharing of the risk, and cost, of early terminations.
At present, this is mainly borne by the client and the adviser – the two parties least able to afford it.