Churning and RDR

In the good old days, the Pete Seeger song “Turn, turn, turn” was banned from being aired on the radio because it contained phrases from the Bible.

Many honest advisors have, for a long time, been asking for a ban on the modern version of the song called “Churn, churn, churn.”

I recently received an email from a very irate broker who conveyed his frustration in what can best be described as “non-biblical” terms. He was at the receiving end of one of those mercenaries who previously worked for him, and was then paid an “establishment fee” by a life office to convert his practice to the testament according to his new master.

“Is daar nog niks van die FSB wat churning kan keer nie? ‘n Makelaar wat deur XYZ ‘’GEKOOP” is, churn alles en hy kos my nou al meer as R100 000, en vandag weer R22 000. Dit is nou ‘n sirkus! Die ironie is, hy wen nou al XYZ se pryse!” (“slightly” edited).

The practice of buying advisors by paying them a substantial sum of money in exchange for churning their practice, and thereby earning new commission all over again, was outlawed recently.

This step would have formed part of the retail distribution review, but was implemented before the publication of the discussion document to prevent the practice from escalating prior to it being declared illegal.

The RDR discussion document contains details of how the Regulator aims to put a halt to churning. The requirements contained in current legislation did not achieve the desired effect, and now those, who acted honestly in the past, will bear the brunt with those who did not.

Proposal OO: Product supplier commission prohibited on replacement life risk policies:
Long-term insurers will be prohibited from paying any form of commission or fee to an intermediary in respect of the replacement of life risk policies. Intermediaries will be prohibited from accepting any remuneration other than an advice fee, subject to all applicable requirements for such advice fees, in respect of such replacements. An appropriate definition confirming what type of transaction constitutes a “replacement” for these purposes will be developed, together with specific advice and disclosure standards in relation to replacements.

The rationale for this proposal reads as follows:

Analysis of the current distribution landscape has pointed to concerns about up-front commission on replacement policies contributing to incentive-driven churn of life insurance risk policies. The risk of inappropriate churn is sometimes exacerbated by substantial recruitment incentives offered by long-term insurers for independent intermediaries (using current terminology) to become tied advisers, or for tied advisers to move between insurers – leading to so-called “adviser churn”. This practice is also inconsistent with the principle of “equivalence of reward” between tied or non-tied advisers.

Some commentators have pointed out that “churn” (used here to refer to inappropriate or unnecessary replacement of policies driven by intermediary incentives) should be distinguished from responsible replacement of policies, driven by what is in the policyholder’s best interests. However, it was also acknowledged that it is very difficult in practice to design a framework that will enable this distinction to be consistently achieved. Some suggested placing more emphasis on the replacement process, and enforcement of standards in this regard. Others believed that the only meaningful disincentive for commission-driven churn is to either prohibit commission on replacement policies, or to limit such commission to a full as-and-when basis.

As pointed out above, the view that there is insufficient evidence that up-front commission for life risk policies contributes to mis-selling and churn, is difficult to reconcile with voluminous anecdotal evidence that this is indeed the case and the general view that some level of intervention regarding replacements is warranted.

Having considered the various views expressed, the policy view is that a focus on the replacement process is on its own unlikely to be sufficient to fully mitigate the conflicts of interest created by the opportunity to earn new up-front commission by recommending a policy replacement. Accordingly, the proposal is to prohibit commission on replaced life risk policies. Appropriate replacement of policies may be remunerated by means of an advice fee.

In addition, the exacerbation of policy churn through “adviser churn” is in the process of being addressed by an amendment to the FAIS General Code of Conduct prohibiting “sign-on bonuses”.

If history repeats itself, expect a huge upsurge in churning before the new legislation comes into effect.

Ironically, there is a system in place to prevent unwarranted replacements, but those who are supposed to enforce it, are the main drivers of institution-driven replacements which has become their main thrust to ensure sufficient growth in new business in order to satisfy shareholders.

To avoid a deluge of replacements before the proposals become law, the Regulator could consider applying the current legislation at its disposal more rigidly. Where complaints are received, a call for copies of the required FAIS documentation will soon reveal whether the churner applied his mind to ensure fair treatment of the client, or merely went through the motions to enrich himself at the call of his master’s voice.

A facility where whistle-blowers, like the broker above, can air their frustration, may be the answer.

To everything there is a season. Only time will tell if the intended steps will lead to the abolishment of unwarranted replacements, or whether those who rely on this unethical practice will find ways around the proposals

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