commission culture: a critical analysis of commission...

COMMISSION CULTURE: A CRITICAL ANALYSIS OF COMMISSION REGULATION IN FINANCIAL SERVICES

GAIL PEARSON*

‘It’s no longer called “sales” but “helping customers”. But everyone knows it is about selling’.1

I INTRODUCTION

A commission culture is deeply embedded in the Australian financial services

landscape. Commissions are a form of labour regulation to increase sales of financial products. Industry worries it cannot ‘incentivise’ sellers without them.2 They are not a gift to employees as they are not freely given, but calculated in relation to performance objectives. They may not be a bribe as ostensibly they are not for an improper or corrupt purpose.3 Yet these incentives propel unnecessary and sometimes illegal risk taking and help create a ‘bad’ corporate culture. They increase sales of financial products that are inappropriate or unsuitable for the buyer.

Remuneration structures are not designed for good consumer outcomes.4 Consumers do not understand how they influence the product they buy. There is no overall suitability requirement for the sale of financial products in Australia and commissions drive the sale and churn of inappropriate products. Commissions create conflicts of interest between the firm and consumers and within the firm. They have been justified as necessary to sell socially desirable products and critical for retaining market share.5 This is for the benefit of the firm and the seller. The market refers to distribution channels, not sales,6 and this obfuscating language is adopted by regulators.7 Perhaps we should refer to sale gutters. There are arguments that commissions benefit consumers. These include greater access to a choice of products from a range of different providers, consideration of beneficial products not otherwise

* University of Sydney Business School. 1 Quote from a bank staff member reproduced in Stephen Sedgwick, ‘Retail Banking

Remuneration Review’ (Issues Paper, 17 January 2017) <http://retailbankingremreview.com.au/>, 6.4, 52.

2 ASIC ‘Response to submissions on CP189 Future of Financial Advice: Conflicted Remuneration’ (Report, No 328, 4 March 2013) 16.

3 Anangel Atlas Compania Naviera v Ishikawagima-Ahrima Heavy Industries [1999] 1 Lloyd’s Rep 167. A bribe includes a commission or other inducement given by a third party to an agent which is secret from his principal: Peninsular and Oriental Steamship Navigation Co v Johnson (1938) 60 CLR 189.

4 ASIC, ‘Review of Mortgage Broker Remuneration’ (Report, No 516 16 March 2017) 182–183. This may change if remuneration is brought under the proposed design and distribution obligations.

5 On commissions as a contribution ‘to the sale and the continued availability of insurance products’, see Gilbert + Tobin, Response to interested party submissions, Motor vehicle add-on insurance reform ACCC A91556 & A91557, 14 November 2016, 3.

6 The growth in ‘sales channels’ occurred as banks wound back their branch networks: ASIC, ‘A Report to ASIC on the Finance and Mortgage Broker Industry’ (Report, No 19, 26 March 2003) 7.

7 ASIC Report 516, above n 4, 5.

156 University of Queensland Law Journal 2017

sought, and lower costs of recommendation and advice services.8 Nevertheless, there is compelling evidence of poor consumer outcomes.

Australia has adopted strategies to disclose, ban, cap, and deemphasise commission payments. Other jurisdictions have banned or are considering banning commissions. Despite disclosure, consumers generally do not know how brokers get paid.9 Despite banning, financial advisers still do not always give appropriate advice. Capping, the new approach, may not lead to optimal insurance outcomes.

This article critically assesses current developments in relation to commission payments. There appears little appetite to return to fixed salaries and relinquish ‘at risk’ (that is commission) remuneration models. There are large numbers of individuals who benefit from incentivised sales which do not necessarily benefit the buyers and may even be detrimental to them. Poor consumer outcomes should concern us all. It is ironic that the initial financial services law reform (FSR), which was designed to create generic regulation for all financial products by removing regulatory arbitrage, has resulted in the opposite for commissions.

This article outlines recent and current inquiries relevant to commission payments. It then sets out details of commission structures in different parts of the financial services industry, followed by an account of commission-induced consumer detriment. Finally, it assesses strategies to regulate commissions. It does not engage with debates on the meaning of culture nor links between commissions and Board or Executive remuneration. It is sufficient to reveal habits, patterns of behaviour, and beliefs that, in part, constitute a commission culture. The focus is on regulating the commission.

II THE COMMISSION REFORM LANDSCAPE

Public interest in the nexus between commission payments, conflicts of interest, bad sales practices, and unsuitable products has intensified since the inquiries that followed the global financial crisis that began in 2008. Some inquiries involved extensive data collection with detailed information on remuneration structures, which were previously imperfectly understood. Others assessed the impact of commissions. The following is a brief overview of investigations into financial advice, mortgage broking, car finance, life insurance, and retail banking. This is a fast-moving landscape.

A parliamentary Inquiry investigated a major collapse of an investment scheme into which individuals had been advised to invest, partly due to over-market commissions paid to their advisers.10 The subsequent review of commissions in the financial planning industry led to extensive bans on the payment of commissions for

8 On arguments about under insurance see John Trowbridge, Life Insurance and Advice Working

Group, Interim Report on Review of Retail Life Insurance Advice (2014), 7. See the rejection of such arguments in Consumer Action Law Centre, Consumer Action Law Centre et al, Submission on Interim Report on Retail Life Insurance Advice, 30 January 2015.

9 ASIC Report 516, above n 4, 177. 10 Parliamentary Joint Committee on Corporations and Financial Services, Parliament of the

Commonwealth of Australia, Inquiry into Financial Products and Services in Australia (2009) (‘Ripoll’) ch 5; On the role of commissions see also Senate Economics References Committee, Parliament of the Commonwealth of Australia, Performance of the Australian Securities and Investments Commission (2014). On results of the Storm Financial model see Lock v Australian Securities and Investments Commission [2016] FCA 31 (4 February 2016); Australian Securities and Investments Commission v Cassimatis (No 8) [2016] FCA 1023 (26 August 2016).

Vol 36(1) Commission Regulation in Financial Services 157

financial advice and use of what is now a legal term ‘conflicted remuneration’.11 Conflicted remuneration is banned but there are carve-outs. First, certain payments were grandfathered so that some trail commissions are still paid.12 Second, the legislation did not apply to insurance and superannuation. These reforms, known as FOFA,13 after an acronym of the legislation, were strongly resisted and there were attempts to wind back part of the reform. A further result of this activity was the Scrutiny of Financial Advice Parliamentary inquiry whose report is long delayed. Due to developments in life insurance it will no longer examine this sector. 14

The Interim Report on the Australian Financial System commented on insurance and the mortgage broking industry.15 The Final Report specifically addressed conflicted remuneration. It recommended no upfront commissions in life insurance, and monitoring mortgage brokers’ lack of independence.16 To reduce the numbers of consumers buying products that do not match their needs, it recommended distributor accountability.17 Since then, there have been both industry and regulator initiated reviews of remuneration practices in different parts of the finance industry.

First off the block were the insurers. The recommendations of the Trowbridge inquiry into commissions18 have been modified in legislation that has now passed and that caps life insurance commissions.19

The Issues Paper of the Australian Bankers’ Association (ABA) report into commissions and retail banking products 20 characterised a central part of its job as looking at how product-based payments and commissions may lead to poor consumer

11 Richard Batten and Gail Pearson, ‘Financial Advice in Australia: Principles to Proscription; Managing to Banning’ (2013) 87(2&3) St John’s Law Review 551; Corporations Act 2001 (Cth) s 963A defines conflicted remuneration.

12 On grandfathered arrangements and Enterprise Bargains see Corporations Act 2001 (Cth) s 1528, Corporations Regulations 2001 (Cth) reg 7.7A.16C.

13 See ASIC Future of Financial Advice reforms, <http://asic.gov.au/regulatory-resources/financial-services/future-of-financial-advice-reforms/> Or the Treasury website on the Future of Financial Advice <https://futureofadvice.treasury.gov.au>.

14 The ill-fated Scrutiny of Financial Advice inquiry commenced in 2014 to assess the financial advice reforms, is due to report (again) in mid 2017: Senate Standing Committee on Economics, Parliament of the Commonwealth of Australia, Inquiry into the implications of financial advice reforms (2017) <http://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/SOFA45th>.

15 Financial System Inquiry, Government of the Commonwealth of Australia, Financial System Inquiry – Interim Report (2014) (’Murray Interim’) 2-39; 3-74f.

16 Financial System Inquiry, Government of the Commonwealth of Australia, Financial System Inquiry – Final Report (2014) (‘Murray Final’) 195. On Recommendation 24, see Murray Final, 217, 225, 271.

17 Ibid 198 (Recommendation 21). 18 John Trowbridge, Life Insurance and Advice Working Group, Interim Report on Review of

Retail Life Insurance Advice (2014); John Trowbridge, Life Insurance Advice Working Group, Review of Retail Life Insurance Advice Final Report (2015); ASIC, ‘Review of retail life insurance advice’ (Report, No 413, 9 October 2014).

19 Corporations Amendment (Life Insurance Remuneration Arrangements) Act 2017 (Cth). The legislation was assented to on 22 February 2017.

20 Australian Bankers’ Association, ‘Review into retail banking remuneration begins’ (Media Release, 12 July 2016) <http://www.bankers.asn.au/media/media-releases/media-release-2016/review-into-retail-banking-remuneration-begins>; Sally Rose and Jonathan Shapiro ‘Bankers’ pay to be reviewed by former public service cop Stephen Sedgwick’, Australian Financial Review (online), 12 July 2016, <http://www.afr.com/business/banking-and-finance/bankers-pay-to-be-reviewed-by-former-public-service-cop-stephen-sedgwick-20160712-gq3o1a>.


outcomes.21 It discussed sales metrics and senior manager remuneration, and the differences between a sales and service culture.22 A Final Report is still due.

In September 2016 the House of Representatives Standing Committee on Economics began examining the big four banks’ response to previous inquiries and how to enhance consumer protection.23 It presented the First Report in November24 and the inquiry for the Second Report is taking evidence.25 The First Report recognised the relationship between performance incentives and consumer detriment but attributed this to financial advice commissions and fraud.26

The Parliamentary Joint Committee on Corporations and Financial Services is examining the life insurance industry including sales practices of insurers and brokers and is to report mid 2017. 27 There is a further Senate inquiry into general insurance.28

The Senate Economics References Committee is examining consumer protection in the banking, insurance, and financial sector, including the impact on consumers of both executive and non-executive remuneration and incentive-based commission structures.29 This committee is not expected to report until 2018.

The Australian Securities and Investments Commission (ASIC) has undertaken a number of studies relevant to commission payments. These include reports on insurance and mortgage brokers. It has published reports on consumer credit insurance, add-on insurance and life insurance in conjunction with car sales,30 a review of claims practices in life insurance,31 and an account of lender payments to mortgage brokers and other third parties including comparison sites and referrers. 32

21 Sedgwick, above n 1, 11. 22 Ibid 52–53. 23 House of Representatives Standing Committee on Economics, Parliament of the Commonwealth

of Australia, Review of the Four Major Banks First Report (2016), xv. 24 Ibid. 25 House of Representatives Standing Committee on Economics, Parliament of the Commonwealth

of Australia, Review of the Four Major Banks First Report (2017). 26 Ibid 75. 27 Parliamentary Joint Committee on Corporations and Financial Services, Parliament of the

Commonwealth of Australia, Inquiry into the life insurance industry, Terms of Reference (2017). 28 Senate Standing Committee on Economics, Parliament of the Commonwealth of Australia,

Inquiry into Australia’s general insurance industry (2017). 29 Senate Standing Committee on Economics, Parliament of the Commonwealth of Australia,

Inquiry into consumer protection in the banking, insurance and financial sector, Terms of Reference (2017).

30 ASIC, ‘Buying add on insurance in car yards: Why it can be hard to say no’ (Report, No 470, 26 February 2016); ASIC, ‘The sale of life insurance through car dealers: Taking consumers for a ride’ (Report, No 471, 29 February 2016); ASIC, ‘A market that is failing consumers: The sale of add-on insurance through car dealers’ (Report, No 492, 12 September 2016).

31 ASIC, ‘Life Insurance claims: an industry review’ (Report, No 498, 12 October 2016). For background see ABC, ‘Money For Nothing’, Four Corners, 7 March 2016 (Adele Ferguson, Klaus Toft, and Mario Christodoulou); Michael Koziol, ‘“Deeply shocking”: Turnbull government demands urgent ASIC report on life insurance industry’, Sydney Morning Herald (online), 8 March 2016 <http://www.smh.com.au/business/banking-and-finance/deeply-shocking-turnbull-government-demands-urgent-asic-report-on-life-insurance-industry-20160307-gnd0pj.html>.

32 ASIC Report 516, above n 4. Referrers include real estate agents, planners, accountants, and lawyers: above n 4, 7, 21.


III THE STRUCTURE OF COMMISSION PAYMENTS

Commission payments align the seller with the interests of the issuer or provider, not the consumer. As stated in Australian Securities and Investments Commission, in the matter of NSG Services Pty Ltd v NSG Services Pty Ltd [2017] FCA 345, ‘[t]he commission-based salary structures created an incentive for representatives to emphasise sales imperatives over compliance requirements and a culture in which the best interests and appropriate advice duties were more likely to be overlooked’.33 It is important to note that this was after reform to financial advice laws.

The ABA Submission to the Sedgwick retail banking remuneration review states it cannot reveal detailed information about remuneration structures because this is commercially sensitive information.34 This was also a problem for the Four Banks Parliamentary inquiry where certain information has been redacted. The sensitivity around remuneration information appears to come from two sources: competition between banks, and reluctance to reveal this information to a public that no longer trusts banks. Institutions are scared to reveal and relinquish commissions because they view them as a way to incentivise individuals.35 It follows that our information about the structure and amount of commission payments is imperfect. We have mandated information about remuneration for CEOs, but there is limited transparency for management and staff. Indeed, there are suggestions that Boards and senior managers do not receive reports about remuneration structures.36 If this is true, it would mean they are unable to consider connections between commissions and sales practices.

Remuneration practices are significant because of their connection to detrimental outcomes for consumers. There are common threads running through different sectors. Institutions rely on third parties to do their selling, yet nevertheless pay commissions to staff. Payments are based on the quantity or value of what is sold rather than calculation of the skill or time required for the sale. Sales targets are important. There is a clear picture that the number of sales is more important than the seller doing a good job and selling a beneficial product.

A Retail Banking

The Sedgwick report examined commissions to lower level banking staff

(including tellers), managers two levels up, and third parties including brokers, aggregators, and referrers. It included basic banking products (transaction accounts and term deposits), non-cash payments (travel cards), general insurance (but not accident or personal sickness), first home saver accounts, consumer credit products (mortgages, personal loans and credit cards), consumer credit insurance, and small business lending.

Bank staff are remunerated by a two-phase process: fixed pay and variable or ‘at risk’ reward pay. The quantum of ‘at risk’ pay is determined according to formulae that encourage individuals to attain performance targets, or at management discretion. Increases in fixed pay may be linked to performance standards. Tellers, sellers, personal bankers, home lenders, financial advisers and managers all receive a fixed and

33 Australian Securities and Investments Commission, in the matter of NSG Services Pty Ltd v NSG

Services Pty Ltd [2017] FCA 345 (30 March 2017). 34 ASIC Report 516, above n 4, 5, 7, 21. 35 ASIC Report 328, above n 2, 16. 36 ASIC Report 516, above n 4, 188, 189, 190, 193.


variable pay component. Schemes differ from bank to bank.37 There are four general categories of payment schemes: a performance scorecard, variable rewards with performance linked to specific measures or targets, management discretion against individual performance measures or targets, and Enterprise Agreement prescribed variable rewards.38 The remuneration received from variable pay for some employees is breathtaking.

The performance scorecard approach combines financial and non-financial segments including sales, referrals, cross selling, customer satisfaction, and compliance, all given a different weighting and combined in a score which leads to pay.39 The distribution between financial and non-financial measures differs according to the role of the employee and the particular bank. For tellers, financial measures (primarily referrals) are weighted in the range of 25% - 80% and non-financial measures in the 20% - 70% range. For home lenders (only a small number) the range is 20% - 85% and 10% - 60%. For managers, remembering these are only those two steps away from front line staff, the range is different. Cross selling ranges from 0% - 35%, the team’s financial targets range from 0% - 100% and non- financial measures from 0% - 100%.40 To gain variable pay, individuals may have to meet certain thresholds such as minimum sales, modifiers may increase or decrease the amount, and there may be caps on payable amounts.41 The role of variable pay compared with fixed pay differs across category of employee. Tellers, who receive below average weekly earnings for fixed pay, receive 3% - 16% of fixed pay as additional variable pay, personal bankers 11% - 25% if capped and 20% - 47% if uncapped, home lenders (only a small number) receive 5% while managers receive 12% - 75% if capped and 80% -85% if uncapped.42

The second approach to variable pay is payment against each performance measure, not an overall score. Again, this may include financial and non-financial measures. Few banks reward home lenders on team performance and some home lenders receive their variable pay for mortgages sold only if they also meet cross selling targets.43 Accelerators increase the rate of pay for some individual financial performance measures. Modifiers are related to non-financial measures. Tellers’ pay may be capped; the pay of other roles are unlikely to be capped.44 Tellers, who receive below average weekly earnings, receive between 6% and 14% of their fixed pay from variable payments.45 Personal bankers receive between 23% and 127%, home lenders between 12% and 300% (if capped) and 140% - 597% of fixed pay (if uncapped).46

Few banks base variable pay on management discretion. When they do, the individual’s performance objectives will include a measure related to product sales and referrals. The variable pay under this type of arrangement is reported to be between 6% and 61% of fixed pay.47 Enterprise Agreement sanctioned variable pay is relevant in ‘very few’ banks and is between 1% to 2% of pooled salary costs.48

37 Ranging from two to ten. Sedgwick, above n 1, 22. 38 Ibid 21–22. 39 Ibid 22–23, 62–63. 40 Ibid 63–64. 41 Ibid 63–64. 42 Ibid 21, 65. 43 Ibid 66. 44 Ibid 66–67. 45 Ibid 21, 67. 46 Ibid 67. 47 Ibid 68. 48 Ibid 68.


Despite commissions on advice being banned, financial advisers still receive variable pay via revenue share plans (most common) or a performance scorecard approach. Advisers may generate revenue through upfront and ongoing fees, referrals mortgage lending, personal investments, and ‘grandfathered’ commissions. An individual adviser may be paid a percentage of revenue generated based on a ‘share rate’.49

‘Third-party channels’ include brokers, aggregators, franchises, introducers, referrers and some financial advisers.50 Most third parties receive commissions (mostly upfront, also trailing commissions) on products sold or persons referred. The upfront commission is usually less than 1% of the product and trailing commissions are not more than 0.25%. Commissions can be clawed back to prevent product churning and this may be up to 100% of the commission paid.51 All banks pay upfront commissions. Banks adjust commission rates to increase sales.

It is targets, not amounts, that induce bad selling as they are linked to accelerators and cross sales.52

B Mortgage brokers

The ASIC report on mortgage broker remuneration followed a scoping paper

seeking industry consultation on remuneration types (including commissions, profit share, and rebates), whether commissions are upfront or trailing, and whether they are determined by volume, loan size or product. It sought information on when payments are made in the loan life -cycle, and which payment models predominate in which parts of the broking industry.53

Brokers are responsible for over half of new home loans.54 There are over 5,000 broker businesses.55 Typically, an aggregator, often owned by a bank, stands between the lender and broker.56 Significantly more loans come from aggregators than directly from brokers.57 Lenders also pay comparison websites for click-throughs to the lender,58 referrers,59 and their own staff, which can be up to 200% of their base salary.60 In general, brokers do not charge fees to borrowers, and gain all their income from commissions.61

The home loan market was worth $1,493.5 billion in December 2016.62 In 2015, lenders paid $1.42 billion in upfront commissions on $175 billion of home loans and

49 Ibid 69. 50 For a discussion of these channels see Ibid 29. 51 Ibid 29–32. 52 Ibid 41–47. 53 ASIC Report 516, above n 4; ASIC, ‘Review of Mortgage Broker Remuneration Structures’

(Scoping Discussion Paper, February 2016) (‘Mortgage Brokers’) 6, 7, 8. 54 ASIC Report 516, above n 4, 8. 55 ASIC, Mortgage Brokers, above n 53, 8. 56 ASIC Report 516, above n 4, 17. 57 $185 billion from aggregators, compared with $1.2 billion directly from brokers. ASIC Report

516, above n 4, 52. See also 60. 58 ASIC Report 516, above n 4, 57, 140. 59 Referrers include real estate agents, planners, accountants and lawyers. Commissions to referrers

are almost as high as to brokers though they do less. ASIC Report 516, above n 4; ASIC, Mortgage Brokers, above n 53, 21, 138.

60 ASIC Report 516, above n 4, 12, 129. 61 Ibid 75. 62 Ibid 6.


an additional $984 million in trail commissions on outstanding loan monies.63 In the September quarter of 2015, mortgage brokers originated $50 billion in home loans. The upfront commissions at 0.6% - 0.65% amounted to $300 million and the trail commissions were $50 million annually over the life of the loans.64 Trail commissions were estimated at about 0.15% annually.65 On a $500,000 home loan, lenders pay 0.62% in upfront commissions plus 0.18% in trail commissions. This is paid to an aggregator who takes their cut of about 15% of the upfront commission and over 20% of the trail and pays the broker businesses 0. 54% and 0.14%.66 Aggregators provide comparison software to brokers but there was no evidence of commissions to rank loans generated by the software.67 The rate of upfront commissions that lenders pay does not depend on cross-selling other products.68

There are also bonus commissions. Lenders pay aggregators increased commissions to reach particular loan settlement targets.69 There are also soft dollar commissions in the form of loyalty programs, broker clubs and travel and hospitality.70

There are usually clawback periods to prevent brokers churning by moving borrowers to new lenders in order to gain another upfront commission.71 One rationale for trail commissions, which are paid monthly by lenders, is to prevent churning.72 Commissions are also reduced if brokers arrange non-advertised discount rates.73 There are no penalties or clawbacks for soft (i.e. non-cash) benefits.74

Surprisingly, lenders cannot usually track remuneration to individual brokers as they cannot match individual loans with the intermediary.75 Only 20% of lenders and aggregators have a process to identify broker misconduct and recover commissions.76

C Car finance

Third parties such as car dealers and finance brokers who arrange car finance have had discretion to determine the interest rate within a range set by the lender.77 In a flex commission plan, the lender and the third party share the ‘flex commission’ that is the difference between the agreed minimum interest and the actual interest rate in the car finance contract. This can amount to 80% of the interest.78

63 Ibid 9. 64 Tony Boyd, ‘Mortgage broker salad days are numbered’, Australian Financial Review (online),

25 May 2016 < http://www.afr.com/brand/chanticleer/mortgage-broker-salad-days-are-numbered-20160525-gp3se5>.

65 Clancy Yeates, ‘Mortgage brokers to remain in the spotlight after ASIC review’, Sydney Morning Herald (online), 8 May 2016 <http://www.smh.com.au/business/banking-and-finance/mortgage-brokers-to-remain-in-spotlight-after-asic-review-20160506-goo666.html>.

66 ASIC Report 516, above n 4, 10, 76, 81, 87. For extensive detail see Appendix 2, 203. 67 Ibid 54. 68 Ibid 83, 111. 69 Ibid 11, 77, 89. 70 Ibid 11, 78, 113. 71 Ibid 94. 72 Ibid 85. 73 Ibid 10, 11, 94. 74 Ibid 196. 75 Ibid 22, 23, 35, 36. 76 Ibid 193. 77 ASIC, ‘Flex commission arrangements in the car finance industry’ (Consultation Paper, No 279,

3 March 2017) 5. 78 Ibid 6.


D Life insurance

Estimates of upfront commission amounts in life insurance have increased in successive reports.79 A high proportion of life insurance is distributed via an advice model that involves commissions.80 Advisors select how they will be paid by choosing the commission model.81 This is determined by a percentage of the premium paid by the insured. Payment is often split between the licensee and the adviser, say 15%/85%. Sometimes, the licensee takes a fee from the adviser and gives the adviser 100% commission.82 Commission payments are based on the value of the policy to the insurer. There is no correlation between the complexity of advice and the quantum of the commission.83

Insurers pay upfront, hybrid, and level commissions. The predominant form (82%) is upfront commissions. Some insurers pay 90% of their advisor distribution channel upfront commissions. Upfront commissions can be from 100% to 130% of a new premium plus 10% of renewal premiums. Hybrid commissions are about 70% of new premium and 20% on renewals. Level commissions involve 30% of the initial premium and 30% on renewals.84 The Trowbridge Final Report stated that the standard commission arrangements were: upfront commissions 120% of the first year premium and 10% of all subsequent premiums, hybrid commissions 80% of the first year premium and 20% of all subsequent premiums, and level commissions, 30% of each year’s premium.85 Insurers may claw back commissions if the policy lapses in the first year.86

The ubiquity of upfront commissions means advisers stick with insurers who pay these. They are an incentive for advisors to move the insured from one new policy to another in the search for high commissions. There is a correlation between high lapse rates of policies and upfront commissions.87 Lapse rates increase after the clawback period ends.88 Clawbacks have not worked to prevent conflicts of interest. The lapse rate on upfront commissions in stepped premium policies is about 7% in the first year and 14% in the second and subsequent years. This contrasts with 5% and 10% in the first and second years for hybrid commissions and 8% and 10% for level commissions.89 High upfront commissions helped insurers gain business but high lapse rates, linked to commissions, lose business.90 The cost of upfront commissions for life insurance, is significantly higher than the cost of a comprehensive financial plan.91

79 ASIC Report 413, above n 18; John Trowbridge, Life Insurance and Advice Working Group,

Interim Report on Review of Retail Life Insurance Advice (2014); John Trowbridge, Life Insurance Advice Working Group, Review of Retail Life Insurance Advice Final Report (2015).

80 ASIC Report 413, above n 18, 23–24. 81 Ibid 25. 82 Ibid 25. 83 Ibid 25 84 Ibid 24, 26. See Tables, ibid 27. 85 John Trowbridge, Review of Retail Life Insurance Advice Final Report (2015), above n 18, 22. 86 ASIC Report 413, above n 18, 26. 87 Ibid, 5, 34, 36. There is also a correlation between lapse rates and stepped premium types of

policies. 88 Ibid 34, 38. 89 Ibid 37. See Figure 16. 90 Ibid 39. 91 Ibid 52.


Taking money from superannuation, as recommended by some advisers, to pay for life insurance does not make sense.92

An opaque area is whether insurers pay commissions to reduce or deny claims. There are statements insurers pay rebates to super funds when claims are at a low level.93 The Commonwealth Bank submission to the Parliamentary inquiry on life insurance states: ‘CommInsure employees involved in the claims-handling process are also generally eligible to participate in annual incentive arrangements, which represent a relatively small proportion (on average around 12 per cent) of their overall remuneration’.94 The ASIC report on life insurance claims found remuneration-based conflicts of interest in denying claims with incentives for claims denial.95 Its subsequent report noted that performance indicators for some claims staff included ‘net loss ratios and income protection termination rates’.96 The publicly released Deloitte’s report into claims handling found no systemic issues, but did not consider remuneration practices.97

The sales practices associated with advised life insurance sales are evident from Australian Securities and Investments Commission, in the matter of NSG Services Pty Ltd v NSG Services Pty Ltd [2017] FCA 345. Prior to the FOFA reforms, representatives were paid on a commission-only basis. Subsequently, they received a base salary and a bonus if monthly sales exceeded monthly targets, though some remained on commission-only. Individuals were given a ‘pink sheet’ and required to repeat their training if they did not meet weekly sales targets. At weekly meetings, all received a dollar-denoted statement of everyone’s sales from the previous week, discussed how much insurance and superannuation each person had sold, and each person was required to tell a success story.98

IV COMMISSIONS AND CONSUMER DETRIMENT

The conflicts of interest generated by commission payments are between the provider, intermediary, and acquirer, for example in life insurance through the combination of high upfront commissions and high policy lapse rates99 and in mortgage broking with product recommendation and product provider conflicts.100 This persists into the organisation if management bonuses and commissions are linked to sales by intermediaries and employees. For the consumer, this results in unsuitable financial products, unnecessary products as a result of cross selling, costly products as

92 Ibid 58. 93 Maurice Blackburn Lawyers, Submission No 12 to Parliamentary Joint Committee on

Corporations and Financial Services, JPC Inquiry into the Life Insurance Industry, 18 November 2016, 8.

94 Commonwealth Bank, Submission No 24 to Parliamentary Joint Committee on Corporations and Financial Services, JPC Inquiry into the Life Insurance Industry, 18 November 2016, 16.

95 ASIC Report 498, above n 31, 91–92. 96 ASIC, ‘ASIC releases findings of CommInsure investigation’ (Media Release, 17-076MR, 23

March 2017). 97 Deloitte, ‘The Colonial Mutual Life Assurance Society Limited (CMLA)’ (Deloitte Claims

Review Program, 3 February 2017), 22 <https://www.commbank.com.au/content/dam/caas/newsroom/docs/CommInsure%20Deloitte%20Report%20Claims%20Review%20Program.pdf>.

98 Australian Securities and Investments Commission, in the matter of NSG Services Pty Ltd v NSG Services Pty Ltd [2017] FCA 345 (30 March 2017) [118]–[120].

99 ASIC Report 413, above n 18, 39. 100 Referred to as product strategy and lender choice: ASIC Report 516, above n 4, 10.


the commission inflates the cost, and inferior products if switched or churned to reap further commissions. There is associated fraud.

Some people do not even know they have been sold a product. In 2012, ASIC permanently banned Susan Heathwood from providing financial services. She had falsified 65 insurance policies by supplying false details of people who had not requested insurance, collected $380,897.22 in commissions and paid $49,275.22 in premiums to avoid detection.101 Abhinav Gupta, an authorised representative of ACE Insurance, issued 12 fictional policies. He was not paid a salary but was remunerated by ‘upfront and volume bonus commission paid upon policies sold, along with incentive prizes such as electronic devices and gift vouchers’.102

In add-on and consumer credit insurance individuals have bought one thing and ended up unknowingly buying insurance. Sometimes individuals are unaware they have bought a ‘useless’ product. In Australian Securities and Investments Commission v Cash Store Pty Ltd [2014] FCA 926 insurance was sold to the unemployed who were ineligible to claim.103 In 2015 Allianz agreed to refund $400,016 in insurance premiums following litigation against a payday lender who sold consumer credit insurance to individuals ineligible to claim under the policies.104 Retail banking customers have been sold commission linked insurance and credit products that were inappropriate, unsuitable, that they did not want and had not sought.105

Add-on insurance in conjunction with car sales is usually inappropriate.106 It is sold in a complex way and consumers do not understand the product. It benefits car dealers and insurers. Insurers compete by increasing commissions to ‘buy access to distribution channels’.107 In a three-year period, insurers paid car dealers $602.2 million in commissions and only $144 million to consumers as claims.108 The car dealers’ upfront commissions were up to 79% of the premium while the claims were 9% of the $1.6 billion gross premiums.109 This 9% as the percentage of premium paid in claims compares with 85% for car insurance, 55% for home insurance and 44% for travel insurance.110

There are problems with life insurance.111 In an eighteen-month period in 2012-2014, ACE Insurance representatives oversold insurance policies duplicating coverage already held by consumers. They also switched and churned policies so that consumers relinquished their old policies and took up new policies for either no purpose, as there was no change in coverage, or to their detriment as there was reduced coverage. They further sold policies that were unsuitable for the consumer as the consumer was ineligible for the policy or the consumer had sought specific coverage which was

101 ASIC, ‘ASIC permanently bans Sydney financial adviser’ (Media Release, 12-39AD, 12

November 2012). 102 ASIC, ‘Former insurance advisor permanently banned’ (Media Release 15-184MR, 14 July

2015). 103 Australian Securities and Investments Commission v Cash Store Pty Ltd [2014] FCA 926 (26

August 2014) [84]. 104 ASIC, ‘Allianz agrees to refund $400K in “useless” payday insurance premiums’ (Media

Release, 15-044MR, 3 March 2015). 105 Sedgwick, above n 1, 10. 106 ASIC Report 470, above n 30; ASIC Report 471, above n 30; ASIC Report 492, above n 30. 107 Aioi Nissay Dowa Insurance Company Australia Pty Ltd & Ors [2017] ACCC Determination

A91556 & A91557 (9 March 2017) 4. 108 ASIC Report 492, above n 30, 7, 12. 109 Ibid 9. 110 Ibid 15. 111 ASIC Report 498, above n 31, 92–93, 95.


specifically excluded in the policy as sold.112 The subsequent enforceable undertaking taken by ASIC refers to an ‘Enhanced Sales Model’ implemented around January 2013.113 Although the representatives as individuals had failed to act in the best interests of the client or give appropriate advice as required by law,114 the ‘Enhanced Sales Model’ had clearly played a role.

Commonwealth Financial Planning v Couper [2013] NSWCA 444 illustrates the switching problem in life insurance. This was decided on the old pre-FOFA test of ‘appropriate’ advice.115 The court commented on but did not provide a ringing judicial endorsement of the new test.116 The adviser switched the client from one life insurance policy to another. The new policy entitled the insurer to avoid a policy up to three years after entry into the insurance contract if existing medical conditions had not been disclosed. The client was diagnosed with pancreatic cancer. The new insurer avoided the policy. By the time judgment was given, the client was dead. The legislative provisions entitling an insurer to avoid a policy for non-fraudulent non-disclosure would not have come into play under the consumer’s old life insurance policy.117 The court concluded the adviser had put his duty to his employer ahead of his duty to the client.

What had prompted this when there was a clear legislative statement of the standard of advice? First, the adviser worked for Commonwealth Financial Planning, a subsidiary of the Commonwealth Bank, that we know has had a troubled history.118 Second, the new insurer was CommInsure, another Commonwealth Bank subsidiary with a troubled history. Third, the client was recommended to the adviser by another Commonwealth Bank employee, who would receive 30% of the first year’s premium of the new life insurance policy.119

Even under the new test, more than one third of life insurance advice fails to meet legal standards of appropriate advice in the best interests of the client.120 There is a correlation between remuneration and the quality of advice. Ninety-six percent of the bad advice was given by those who received upfront commissions.121

In the mortgage-broking market there are product strategy conflicts and lender choice conflicts. Lender choice conflicts lead to recommending a loan from a particular lender, despite this not being the best product.122 Brokers may use product recommendation software that selects lenders who pay bonus commissions.123

Loans arranged by brokers are larger and more expensive than those provided directly by lenders.124 Brokered loans have higher loan-to-value ratios, higher dollar amounts and are far more likely to be interest-only loans.125 Broker-arranged loans are

112 ASIC, Enforceable Undertaking: ACE Insurance Limited, Document No 029533136 (24

February 2016). 113 Ibid 6. 114 Corporations Act 2001 (Cth) ss 961B, 961G, 947D. 115 Corporations Act 2001 (Cth) s 945A (repealed 1 July 2012). 116 Commonwealth Financial Planning v Couper [2013] NSWCA 444 (16 December 2013) [105]. 117 Insurance Contracts Act 1983 (Cth) s 29 (3). That policy had been held for longer than three

years. 118 See Senate Economics References Committee, Parliament of the Commonwealth of Australia,

Performance of the Australian Securities and Investments Commission, (2014). 119 Commonwealth Financial Planning v Couper [2013] NSWCA 444 (16 December 2013) [5]. 120 ASIC Report 413, above n 18, 40; Corporations 2001 (Cth) ss 961B, 961G. 121 ASIC Report 413, above n 18, 7, 42. 122 ASIC Report 516, above n 4, 10. 123 Ibid 79. 124 Ibid 10. 125 Ibid 14, 154, 158, 161.


more likely to go into arrears.126 Higher loan-to-value ratio loans attract lender’s mortgage insurance, an additional expense.127 Consumers dealing through mortgage brokers borrow more, pay more interest, and pay for more insurance. They are different from those dealing directly with lenders.128 They are younger, with slightly lower incomes.129

Consumers also paid more depending on how their car finance was arranged as there were differences between the base rate and flexed rates, on offer up until recently from car dealers. The difference was the commission. On the same amount borrowed, a consumer could pay over $6,000 in interest charges, and commissions could be well over $2,000 dollars higher than at the base rate.130

V REGULATING COMMISSION PAYMENTS

Different regulatory interventions have continued to evolve dealing with commissions. They include disclosure, partial banning, timing of commission payments, and caps on the allowable amount. Ongoing reviews are expected to recommend further solutions.

A The Disclosure Model

Disclosure offers greater protection to the intermediary than to consumers

overburdened with information they are unlikely to fully read or comprehend. The theory is that disclosure of commission payments may alert a potential buyer to conflicts of interest and act as a brake on a decision to acquire the product. It is a feature of the FSR reforms and of credit legislation. Disclosure has proved inadequate within a relatively short period.

The FSR reforms introduced new statutory disclosure obligations for licensees. One of these restricted the way persons could describe themselves in dealing with clients. If they received commissions but did not fully rebate them to clients, or received volume based remuneration, gifts or benefits from an issuer that may influence their actions, they could not describe themselves as independent, impartial or unbiased.131 Both licensees and authorised representatives had to disclose information in the Financial Services Guide about commissions or benefits to be received by the providing entity or others as listed.132 Other information about relationships that reasonably may influence a provider in providing services had to be disclosed.133 If the service was provision of financial advice, the Statement of Advice also required information about commissions, interests and relationships capable of influencing the

126 Ibid 16, 154, 164. 127 Ibid 159. 128 Ibid 155. 129 Ibid 13, 156. 130 ASIC Consultation Paper 279, above n 77, 6. 131 Corporations Act 2001 (Cth) s 923A; National Consumer Credit Protection Act 2009 (Cth) s

160B. 132 Corporations Act 2001 (Cth) ss 942B(2)(e); 942C(2)(f); Corporations Regulations 2001 (Cth)

reg 7.7.04. This does not require specific detail. Reg 7.7.04A enables the client to request further information. Reg 7.7.07 sets out disclosure by the authorised representative and reg 7.7.07A the client request for further information.

133 Corporations Act 2001 (Cth) ss 942B(2)(f); 942C(2)(g).


providing entity in providing the advice.134 If the product could generate a return, information about commissions that could impact on the return have to be disclosed in the Product Disclosure Statement.135 These disclosure obligations exist alongside the further obligation to manage conflicts of interest and provide services fairly.136

Prior to the FSR reforms, most life agents were remunerated by commission without any obligation to disclose the amount.137 The client had no way to assess any potential conflict of interest due to commission payments. ASIC had raised commission structures and disclosure with life companies138 and earlier investigated preferential commission payments for recommending its own products at the National Australia Bank.139 Commission payments and conflicts of interest were not ASIC’s highest priority at this time.

An insurance broker differs from an authorised representative as they are the agent of the insured. Prior to the FSR reforms they did not have to disclose the amount of a commission received from an insurer unless the client requested this, and were prohibited from receiving commissions contingent on the total premium or total amount insured.140 In 2005, after the FSR reforms and in response to findings in the USA, ASIC found an increase in the amounts of contingent payments to brokers coupled with inadequate disclosure of commissions.141 Subsequently, some brokers ended arrangements for contingent remuneration.142

The market volatility of 2008-2009 revealed the extent of the commission payments problem. The ensuing Joint Parliamentary Committee inquiry into financial products and services recommended that government and industry together find a way to stop payments from product manufacturers to financial advisers.143 This report discussed remuneration-based conflicts at length.144

The FOFA reforms were a response to this inquiry and marked a move away from a statutory model that, through disclosure, imperfectly echoed fiduciary duties towards the client. They addressed conflicted remuneration and obligations towards the client in the market for financial advice by introducing a ‘best interests’ duty’ and regulating ‘conflicted remuneration’ – but only in certain circumstances.145 It was clear that

134 Corporations Act 2001 (Cth) ss 947B(2)(d), (e); 947C(e), (f). 135 Corporations Act 2001 (Cth) s 1013D(1)(e). Some commission payments may also fall under s

1013D(2)(b). 136 Corporations Act 2001 (Cth) ss 912A(1)(aa), 912A(1)(a). 137 ASIC, ‘Final Report of the National Life Insurance Disability Campaign’ (Report, No 10,

February 2001) 32. At that time the Life Insurance Code required the means of remuneration to be disclosed but not an amount. A simple ‘commission’ was sufficient. In the 1990s multi agents had moved to risk products precisely because they did not need to disclose commissions. Financial System Inquiry, Government of the Commonwealth of Australia, Financial System Inquiry Final Report, (1997) (‘Wallis’) 263–264.

138 ASIC Report 10, above n 137, 50. 139 ASIC, ‘ASIC concludes commission disclosure review of National Australia Bank’ (Media

Release, 01/331, 19 September 2001). 140 Insurance Agents Brokers Act 1984 (Cth) s 35. There was an exception for brokers acting under

a binder (being an agent for the insurer) and this had to be disclosed. ASIC, ‘Insurance broker remuneration arrangements’ (Report, No 42, June 2005) 14, 15; ASIC, ‘ASIC places premium on insurance conflict management’ (Media Release, 05-184, 30 June 2005).

141 ASIC Report 42, above n 140, 5, 16. 142 Ibid 17. 143 Ripoll, above n 10, 150–151 (Recommendation 4). 144 Ibid 75. 145 On conflicted remuneration see ASIC, ‘Conflicted Remuneration’ (Regulatory Guide, No 246, 4

March 2013).


disclosure of commissions was an ineffective protection. Nevertheless, carve-outs from these reforms meant in many instances commissions could continue to be paid.

Credit is regulated separately from other financial products.146 Unlike other products, but not dissimilarly to advice, both credit providers and intermediaries (credit assistants) have an obligation to recommend or provide only ‘not unsuitable products’. Lenders and intermediaries must be licensed147 and there is a disclosure regime which includes commissions. Licensees must have a Credit Guide and give it, directly or through their representative, to a consumer with whom they are likely to enter a transaction.148 Commissions must be stated, but not with any degree of precision, as this may be simply a method of calculation.149 The lender’s Credit Guide does not state commissions at all.150 Credit assistance providers and credit representatives must give information about commissions they are likely to receive from the licensee (including volume bonuses in the case of credit assistants and credit representatives) and if they are likely to pay a commission to a third party for the introduction of business.151 Comparison websites do not usually disclose remuneration arrangements to consumers.152

When a licensee suggests a consumer enter into or remain in a particular credit contract, the consumer must receive a credit proposal document which gives likely commissions in greater detail.153 This includes each type of commission payable, by whom, to whom, and a reasonable estimate of the amount.154 The estimate must be shown in dollars, as a proportion of the amount borrowed, or as an estimate of the value of a benefit. There must be information about payments to third parties. There are carve-outs for mortgage managers.155

At the time of, or prior to entry into a credit contract, the consumer must receive a pre-contractual statement about the contract.156 This includes a statement about commission amounts – if ascertainable.157

Taken together, this mishmash of information is unlikely to give a consumer a clear picture of who is paying what to whom in connection with a particular loan. The ASIC report on mortgage brokers has tried to make some sense of this. Loans arranged by the lender without the intervention of a broker will include information about commissions. This will not include commissions to the lender’s staff, and is unlikely to include amounts paid to comparison sites or referrers. With loans organised by a broker or aggregator, the consumer will first receive general information about the types of commissions paid to the broker such as upfront and trail commissions, then later more detailed information. This is unlikely to include

146 National Consumer Credit Protection Act 2009 (Cth). This incorporates the National Credit

Code based on earlier uniform legislation. 147 National Consumer Credit Protection Act 2009 (Cth) ss 6, 7, 35. 148 National Consumer Credit Protection Act 2009 (Cth) ss 113 (2)(g), 136 (2)(g), 158(2)(g). 149 There is an exception for credit card commissions. See National Consumer Credit Protection

Regulations 2010 (Cth) reg 27. 150 National Consumer Credit Protection Act 2009 (Cth) s 126. 151 National Consumer Credit Protection Regulations (Cth) 2010, regs 26A(3), 27B, 27A(4). 152 ASIC Report 516, above n 4, 142. 153 National Consumer Credit Protection Act 2009 (Cth) s 121. 154 National Consumer Credit Protection Regulations 2010 (Cth) reg 28G. 155 National Consumer Credit Protection Regulations 2010 (Cth) reg 28H. 156 National Consumer Credit Protection Act 2009 (Cth) sch 1 National Credit Code, ss 16, 17. 157 National Consumer Credit Protection Act 2009 (Cth) sch 1 National Credit Code, s 17(4).


information about commissions to the aggregator, if the aggregator is characterised as something other than providing credit assistance.158

B The Banning Model

Commissions are banned on MySuper Products,159 and ASIC has moved to ban

flex commissions. By inserting a new provision in the National Consumer Credit Protection Act 2009 (Cth), ASIC proposes to ban benefits in relation to credit contracts that are determined by reference to the annual percentage rate or fees and charges payable under the contract, and where the interest rate or the fees and charges have been ‘determined, proposed or influenced’ by the service provider.160 This would apply more broadly than car finance.

The FOFA reforms banned conflicted remuneration for financial advice – at least to some extent. Prior to this commissions were rife.161 Commissions that are ‘conflicted remuneration’ are banned under the Corporations Act 2001 (Cth).162 Conflicted remuneration is a monetary or non-monetary benefit given to a financial services licensee or its representative who provides financial product advice to a retail client that could reasonably be expected to influence the choice of financial product recommended to the client or the advice given to the client.163 Volume based benefits (calculated by reference to value or number of financial products) are presumed to be conflicted remuneration unless proved otherwise.164 This is quite different from, say, credit, where we saw volume based commissions regulated by disclosure.

Certain products remain outside the net. These include general insurance165 and life insurance outside superannuation.166 Despite these exclusions, Parliament recommended that risk insurance products be monitored.167 There is a carve-out for employees or agents of ADIs (or banks) recommending general insurance, consumer credit insurance or basic banking products.168 Benefits relating to advice about interests in time-share schemes are not conflicted remuneration.169 Non-monetary benefits that would otherwise be conflicted remuneration, escape the ban if they are worth $300 or less.170 Genuine education and training courses and information technology and software are not conflicted remuneration.171 If no financial advice has been given in the

158 ASIC Report 516, above n 4, 178, 179, 180, 181. 159 Superannuation Industry (Supervision) Act 1993 (Cth) s 29SAC(1)(9a). 160 ASIC Consultation Paper 279, above n 77, 9. 161 Only 16% of adviser revenue came from fees. Ripoll, above n 10, 17. 162 AFSL licensees and authorised representatives may neither give nor receive conflicted

remuneration: Corporations Act 2001 (Cth) ss 963E, s 963G, 963J, 963K. Other representatives may not accept conflicted remuneration: s 963H. See ASIC, ‘Conflicted Remuneration’ (Regulatory Guide, No 246, 4 March 2013).

163 Corporations Act 2001 (Cth) s 963A. On financial product advice see s 766B. 164 Corporations Act 2001 (Cth) s 963L. Platform operators cannot accept volume-based shelf-space

fees: s 964A. 165 Corporations Act 2001 (Cth) ss 963C (1)(a), 963B (1)(a); Corporations Regulations 2001 (Cth)

reg 7.7A.12G. 166 Corporations Act 2001 (Cth) s 963B (1)(b); Corporations Regulations 2001 (Cth) reg 7.7A.12A. 167 Parliamentary Joint Committee on Corporations and Financial Services, Parliament of the

Commonwealth of Australia, Corporations Amendment (Future of Financial Advice) Bill 2011 and Corporations Amendment (Further Future of Financial Advice Measures) Bill 2011 (2012), xiv (Recommendation 8).

168 Corporations Act 2001 (Cth) s 963D; Corporations Regulations 2001 (Cth) reg 7.7A.12H. 169 Corporations Regulations 2001 (Cth) reg 7.7A.12C. 170 Corporations Act 2001 (Cth) s 963C (b)(i); Corporations Regulations 2001 (Cth) reg 7.7A.13. 171 Corporations Act 2001 (Cth) s 963C (1)(c); Corporations Regulations 2001 (Cth) reg 7.7A.14.


previous twelve months, commissions can be paid on the issue or sale of a financial product.172

The FOFA reforms changed remuneration models in the advice industry. The value of fees increased while the value of commissions decreased. Product issuers paid less in product commissions to licensees. Nevertheless, some licensees still received most of their remuneration from commissions, particularly insurance commissions.173 Further review in the ‘Fees for no Service’ Report led ASIC to conclude: ‘[W]e are concerned that the industry (including licensees and advisers) may still have a culture of reliance on ongoing trail revenue (through commissions and fees) for a portion of their income, without necessarily providing advice to customers in return’.174 In any case, not all providers and their representatives have complied.175

The anomalies between the Corporations Act and the ASIC Act plus the separate regulation of consumer credit means that advice about a ‘credit facility’ is not financial product advice and therefore not subject to the definition of conflicted remuneration and is not banned.176 This can only result in regulatory arbitrage.

C The Cap Model

The focus on regulating commissions has switched from financial advice to

insurance. The insurance industry has been singularly successful in evading regulatory obligations – often on the basis of an appeal to the reciprocal duties of utmost good faith. This is the case with insurance exceptions for FOFA and for the prohibition on unfair contract terms. The ban on conflicted remuneration in the financial advice context arose because of conclusions that disclosure had been inadequate to manage conflicts of interest. The Ripoll report stated that there was evidence to suggest the only way to improve financial advice was to remove conflicts of interest by banning commissions.177 FOFA proceeded to do this but with an ‘influence test’ and the carve-outs discussed above.

We are now presented with another model specifically for life insurance which does not ban commissions but which caps them.178 Is the implication that capped commissions will avoid a conflict of interest? This does not appear to have been the case for consumer credit insurance where there is a cap of 20% of the premium on consumer credit insurance and where contravention is a strict liability offence.179

172 Corporations Act 2001 (Cth) s 963B(c). 173 ASIC, ‘Review of the financial advice industry’s implementation of the FOFA reforms’ (Report,

No 407, 17 September 2014) 28–29. 174 ASIC, ‘Financial advice: Fees for no service’ (Report, No 499, 27 October 2016) 40. 175 Australian Securities and Investments Commission, in the matter of NSG Services Pty Ltd v NSG

Services Pty Ltd [2017] FCA 345 (30 March 2017). 176 For the purposes of the Corporations Act (but not the ASIC Act), a ‘credit facility’ is not a

financial product: Corporations Act 2001 (Cth) s 765A. 177 Ripoll, above n 10, 116. 178 General insurance monetary benefits are not conflicted remuneration: Corporations Act 2001

(Cth) s 963B(1)(a). 179 National Consumer Credit Protection Act 2009 (Cth) sch 1 National Credit Code, s 145. See

comment in ASIC, submission to Australian Competition and Consumer Commission, Submission relating to authorisation application to the Australian Competition and Consumer Commission – A91556 & A91557, November 2016. Note that monetary benefits in connection with consumer credit insurance are not conflicted remuneration: Corporations Amendment (Life Insurance Remuneration Arrangements) Act 2017 (Cth) s 963B(1)(ba).


In 2014 ASIC issued a report on retail life insurance explaining how consumers are given advice about life insurance products and to assess if, as required by law, the advice is in the consumer’s best interests.180 ASIC examined remuneration practices, product design, policy lapse rates, coverage and claims, and premiums in the life insurance industry. It found upfront commissions were the major form of remuneration.181 Earlier, the industry itself had identified problems with ‘churning’ life insurance products and attempted to address this through a proposed voluntary industry standard to claw back commissions if a policy lapsed.182 If the lapse was in the first year of the policy, the clawback was 100%; if in the second year, 75%, and 50% in the third year. This attempt at self-regulation failed due to competition issues and lack of consensus within the industry.183

The ASIC Report set out issues for further consideration and led to the Trowbridge Report commissioned by the Association of Financial Advisers and the Financial Services Council.184 The task was to address misaligned incentives and remuneration arrangements causing poor consumer outcomes. This was not characterised as eradicating or managing conflicts of interest but as ‘minimising’ conflicts of interest.185 The most important element was ‘restructuring the remuneration advisers receive from insurers’.186

Trowbridge recommended: a ‘Reform Model’ for adviser remuneration, being a combination of level commissions alongside an initial Advice Payment,187 a ban on non-commission remuneration and benefits that might influence product choice or advice,188 and a self-regulatory, customer focused Life Insurance Code of Practice.189

In October 2015, the government responded to the Murray inquiry and indicated support for reforms based in part on the Trowbridge Report. The Murray Report had recommended a level commission structure but the industry proposed stepped reductions in upfront commissions.190 The Government also announced a review for 2018.191

At the end of 2015, the Assistant Treasurer (The Hon Kelly O’Dwyer) announced legislation to reform life insurance remuneration. This used the formulation of ‘aligning the interests’ of firms and consumers that emerged from the Murray

180 ASIC Report 413, above n 18, 9. 181 Ibid 26–27. 182 Financial Services Council, ‘Churning in life insurance’ (Media Release, 4 August 2011);

Financial Services Council, ‘New life insurance framework will reduce premiums’ (Media Release, 3 August 2012). See Department of Parliamentary Services (Cth) Bills Digest, No 36 of 2016–17, 9 November 2016, 6–7.

183 Kate Kachor, ‘FSC backs down on policy framework’, Financial Observer (online), 15 February 2013; in Department of Parliamentary Services (Cth) Bills Digest, No 36 of 2016–17, 9 November 2016, 7.

184 John Trowbridge, Review of Retail Life Insurance Advice Final Report (2015), above n 18. 185 Ibid 5. 186 Ibid 5. 187 Ibid 24 (Recommendation 1). 188 Ibid 40 (Recommendation 3). 189 Ibid 60 (Recommendation 6). There is now a Life Insurance Code of Practice which addresses

suitability and advice to prevent churning or switching. See Financial Services Council, Life Insurance Code of Practice (2016) cls 4.1(9b); 4.8 <https://www.fsc.org.au/policy/life-insurance/code-of-practice/life-code-of-practice>.

190 See ASIC, ‘Retail life insurance advice reforms’ (Consultation Paper No 245, Australian Securities and Investments Commission, 15 December 2015) 10.

191 The Treasury, Australian Government, Improving Australia’s financial system: Government response to the Financial System Inquiry (2015) 20.


Report.192 The package, formulated with input from industry, included: a Life Insurance Code of Practice devised by the Financial Services Council, power for ASIC to set caps on commissions, strengthened disclosure of remuneration in life insurance Statements of Advice, and legislation banning volume-based payments.

The Corporations Amendment (Life Insurance Remunerations Arrangements) Act 2017 (Cth) (to come into effect at the beginning of 2018), does not fully ban conflicted remuneration in life risk insurance products.193 It sets out circumstances in which commissions may still be paid.194 Commissions on life insurance product advice remain not conflicted remuneration, therefore allowable, but only in certain circumstances.195 The legislation introduces the notion of a benefit ratio.196 ASIC may determine benefit ratios, that is, the quantum of the commission to the premium.197 Level commissions may still be paid. Upfront commissions may be paid to a certain level. If the benefit ratio is the same in successive years as the issue year it will not be conflicted remuneration.198 This caps the first year commission and creates level commissions. The first year (or upfront commission) can be higher than subsequent years if there is a clawback provision.199

Benefits in relation to information about, and dealing in a life insurance product with a retail client, provided neither the information nor dealing is in the context of providing financial advice are conflicted remuneration and therefore banned.200 However, there are circumstances in which they are not conflicted remuneration and therefore allowable. This includes monetary benefits that could not be reasonably expected to influence whether or how information is given, 201 level commissions, and higher upfront commissions plus clawback which are allowable for advice.202

The Regulations do not set out the allowable benefit ratios or clawbacks. The 2015 ASIC paper provides some insight, but should be viewed with caution.203 The initial government reform proposal was to step down upfront commissions from 80% of the first year policy to 60% of the first year policy over a three-year transition period.204 If insurers adopt a hybrid model, ASIC proposed a maximum of 60% in the policy’s first year, and a 20% maximum in subsequent years.205 For the clawback,

192 The Hon Kelly O’Dwyer Minister for Revenue and Financial Services, ‘Government announces significant improvements to life insurance industry’ (Media Release, 6 November 2015).

193 The Regulations may prescribe when benefits in relation to life insurance are conflicted remuneration and therefore banned: Corporations Amendment (Life Insurance Remuneration Arrangements) Act 2017 (Cth) s 963AA.

194 The Act is in similar terms to the Bills of February 2016 and October 2016. 195 Corporations Amendment (Life Insurance Remuneration Arrangements) Act 2017 (Cth) s

963B(1)(b). 196 Corporations Amendment (Life Insurance Remuneration Arrangements) Act 2017 (Cth) s

963B(3A). 197 Corporations Amendment (Life Insurance Remuneration Arrangements) Act 2017 (Cth) s

963BA(2). 198 Corporations Amendment (Life Insurance Remuneration Arrangements) Act 2017 (Cth) s

963B(1)(b)(iii)(A). 199 Corporations Amendment (Life Insurance Remuneration Arrangements) Act 2017 (Cth) ss 963B

(1)(b)(iii)(B), 963BA. 200 Corporations Amendment (Life Insurance Remuneration Arrangements) Regulations 2017 (Cth)

regs 7.7A.11B(1); 7.7A.11B(2). 201 Ibid reg 7.7A.11C (1)(a). 202 Ibid regs 7.7A.11C(1)(b)(i),(ii). 203 ASIC Consultation Paper 245, above n 190. 204 Ibid 11, 14. 205 Ibid 14.


ASIC proposed 100% of the first year commissions and 60% of the commissions in the second year.206

A collective attempt to cap has failed. The Australian Competition and Consumer Commission (ACCC) denied authorisation to an insurers’ proposal to cap add-on insurance commissions paid to car dealers at 20%.207 ASIC had given qualified support for a voluntary cap. Modelling suggested a 20% cap would improve claims ratios but still not provide good value.208 ASIC suggested the cap should apply to all intermediaries, not just car dealers, and that the 20% legislative cap on consumer credit insurance had not solved problems in that arena.209 The ACCC did not grant the authorisation because high commissions are an incentive for high cost policies that have little value or benefit and are sold in a high-pressure environment with conflicts of interest. A cap, it said, would not remove incentives, reduce the overall price, improve quality, or provide information.210 The question remains then why a cap on add-on insurance would be acceptable, but an effectively much higher cap on life insurance would not be acceptable?

D The deemphasising approach

Despite evidence of commission induced detriment in sales of home loan products, ASIC has focused on ‘moving away from’ and ‘changing’ commissions rather than banning or capping them. It advocates moving away from soft dollar based and bonuses based on volume commissions.211 It suggests lenders should change the standard upfront and trail commission model and reduce reliance on the size of the loan to calculate their amount.212 The design of remuneration structures, says ASIC, should lead to ‘good consumer outcomes’.213

The Retail Remuneration Review Issues Paper doubts systemic risks in current remuneration practices justify banning commissions. Nevertheless, it says banks should reduce their emphasis on product-based payments and banks say this is happening. This may be so for employee pay, but there is little evidence for third party broking channels as banks believe this will risk their market share.214

VI CONCLUSION

Commissions linked to sales value or volume will result in potential conflicts of

interest and consumer detriment. Arguments that commissions are good for consumers because without them they would not be sold life insurance or would not have assistance to choose a mortgage, reflect the culture, belief systems and habits of product providers. Urging the market to move away from commissions, or capping

206 Ibid 17, 18. 207 Aioi Nissay Dowa Insurance Company Australia Pty Ltd & Ors [2017] ACCC Determination

A91556 & A91557 (9 March 2017). 208 ASIC, submission to Australian Competition and Consumer Commission, Submission relating to

authorisation application to the Australian Competition and Consumer Commission – A91556 & A91557, November 2016, 4.

209 Ibid 6, 7. 210 Aioi Nissay Dowa Insurance Company Australia Pty Ltd & Ors [2017] ACCC Determination

A91556 & A91557 (9 March 2017) ii. 211 ASIC Report 516, above n 4, 24, 25. 212 Ibid 24. 213 Ibid 26. 214 Sedgwick, above n 1, 39.


commissions, may highlight the problem and for a short time reduce potential damage to consumers. Banning forms of conflicted remuneration for some products or services (advice) but then allowing others, is not logical. How is the damage from conflicted financial advice greater than the damage from unsuitable and useless insurance or paying more for a similar home loan product? One part of this story is how industry is reviewing its own practices. Would it not be better to have clear suitability statements, clearer statements of the nature of the product and move to commission-less product neutrality by banning all commissions on all financial and credit products and services? Instead of competing on the amount of a commission, firms could compete on the quality of the product and help to consumers. There is no compromise between incentivised sales for access to products and persons and, to use a nineteenth century term, the evil in commission-induced conflicts of interest.

commission culture: a critical analysis of commission...

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