Latest LIF Changes: More Holes than Swiss Cheese?

As you are undoubtedly aware, the government introduced new Life Insurance Framework (we’ll refer to it as LIF MkII in this update) legislation into Parliament at the end of November 2016.

The Bill has been passed by the Lower House and introduced into the Senate. It’s expected to pass into law when Parliament resumes in early February. New Draft LIF Regulations were also released towards the end of 2016 for comment. We hope, because of some of the issues identified below, that the Regulations are amended before they become law.

What you may not know is that the proposed legislation is still missing some vital details, is different from LIF MKI in some material ways, is uncertain in other areas, and, as currently drafted, appears to have some loopholes and unintended consequences.

First, a look at what the LIF MkII rules are. Then we’ll have a look at some of the ‘issues’ in the current drafting.

THE LIF CHANGES (LIF MKII)

The changes are scheduled to start on 1 January 2018. From that time new policies (pre-existing policies, including those with options to renew after a certain period; new benefits post-LIF under pre-existing policies; and policies applied for pre-LIF but not issued for up to 3 months after commencement of LIF) will be subject to the new rules.

The most material of those changes is the changes to upfront and ongoing commissions. While these thresholds are not detailed in the new Bill or Regulations, ASIC has express power to determine the commission levels.

We understand that first year (i.e. upfront) commissions can be no higher than 80% of the policy cost for the first year post-LIF. This then is reduced to a maximum of 70% of the upfront policy cost in the second year post-LIF and 60% in the third year post-LIF. Ongoing commissions should be no more than 20% of the policy cost. If commissions are within these percentages, these are said to fall within the new ‘benefit ratio’ in the new rules.

But one change to be aware of is that the ‘policy cost’ now will not include stamp duty. Policy cost will include the following elements:

• the policy premiums for the year;
• any fees payable for the year to the issuer for the issue of the product;
• any additional fees attributable to periodic payment instead of lump sum payment; and
• any other amount prescribed by the regulations (none exist at this stage).

Benefits paid must also be subject to the clawback requirements in order not to be banned.

Clawbacks of benefits paid can apply for the first 2 years of a policy if it is cancelled in that period. While the legislation does not contain these details, Minister O’Dwyer has stated that clawbacks will be set at 100% for cancellations within the first year and at 60% for cancellations in the second year. Exceptions where clawbacks won’t apply are where the cancellation is because:

• the insured dies;
• the insured self-harms;
• the insured reaches an age such that the policy is cancelled; or
• an administrative error is made.

THE HOLES ETC

The explanatory memorandum of the Bill states that it removes the exemption from the ban on conflicted remuneration in relation to certain life insurance products and that the Bill has the effect that “all benefits paid in relation to life insurance, whether offered inside or outside superannuation are subject to be [sic] ban on conflicted remuneration”.

But this isn’t strictly true as benefits paid within the prescribed benefit ratio and clawback requirements will still be exempt under s963B.

Pre-existing policies (i.e. those that are in place prior to LIF starting) will effectively be grandfathered, although it must be said that this creates its own conflict as advisers would have an incentive to write new policies to existing clients so they can earn an upfront commission as well as (generally) higher ongoing commissions from the new product. This is a strange outcome for legislation that is supposed to do away with such conflicts.

As we pointed out in our update on LIF MkI, in November 2015, the LIF rules contain clawback provisions but give no regulatory guidance as to how those rules are to apply when, for example, there has been a change of adviser and/or licensee between commencement of a policy and cancellation/clawback. The new rules do allow for ASIC to make rules that could cover such requirements so let’s hope they do spell out the requirements. However, in imac legal’s view, given this is such an integral issue, appropriate rules should have been included in either the Act or Regulations.

Our April 2016 update on LIF MkI identified that it appears possible the clawback provisions may be avoided by merely engaging in an ongoing program of ‘rebates’ to clients, no matter how minimal the rebate so long as the rebate was applied in order to induce the client to acquire or continue to hold, the product. The new LIF rules still allow this as well as where a ‘discount’ is applied to a policy for the same purposes.

But perhaps most troubling of all is the fact that the conflicted remuneration rules which, up until now, have applied only where advice has been provided to a retail client will also now apply even if there has been no advice provided. While this appears to have been intentional so that all insurance providers (e.g. whether an adviser or an online offering) are subject to the conflicted remuneration rules, the current drafting of the draft Regulations is more than a little concerning legally. Under the proposed laws benefits paid could be conflicted remuneration if they are paid in relation to life insurance advice, providing information in relation to life insurance or dealing ‘in relation to’ life insurance. No guidance is given on what ‘in relation to’ means in this context and the wording of the draft regulations doesn’t provide many clues.

And while it appears that benefits paid where advice has been provided and the benefits meet the prescribed ‘benefit ratio’ and ‘clawback requirements’ will not be conflicted remuneration, as per s963B, it appears that any and all benefits paid in relation to life insurance where no advice is provided will be conflicted remuneration regardless of whether such benefits are within the benefit ratio and clawback requirements.

This seems anomalous to us. The only explanation we can think of is that it is intended to prevent another loophole which would exist in the rules if this approach was not adopted. i.e. that without such restrictions, it would be possible under the new rules to pay benefits to multiple parties (e.g. licensee and representative) in relation to the same transaction. But the purpose of the LIF changes was said to be all about doing away with the conflicts when advising (whether personal or general advice) on life insurances. It is therefore not clear to us why the proposed rules even deal with non-advice-related benefits.

And to top it all off the proposed new rules contain a couple of (admittedly minor) typos.

Let’s hope that the draft regulations are amended to deal with some of these issues and that ASIC’s yet-to-be-released legislative instrument plugs any remaining holes.

Ian McDermott is Principal Lawyer with imac legal & compliance pty ltd, a legal and compliance advisory firm helping small-to-medium financial services businesses.