A working group of insurance regulators admits that investor protection for buyers of segregated-fund policies is weaker than for mutual-fund investors, and is seeking advice on how best to close the regulatory gap.
Released on May 16 by the Canadian Council of Insurance Regulators (CCIR), the 26-page consultation paper paints an unflattering picture of how seg-fund regulation compares poorly to securities regulations governing mutual funds.
Furthermore, the gap will widen with the phasing in, starting on July 15, of reforms under the securities regulators' Client Relationship Model, phase 2. CRM2 will require enhanced fee disclosure and performance reporting. On these and other consumer-protection measures, including management reports on fund performance, advisor proficiency and standards of care, seg-fund regulations are less demanding than for mutual funds.
The paper cites the potential for regulatory arbitrage on the part of individuals who are dually licensed to sell both mutual funds and life-insurance products. "If one structure is perceived to be less onerous than the other there may be incentive for intermediaries to prefer to sell the products regulated under one regime over the other," the paper says.
Though the working group is unaware of any data concerning whether regulatory arbitrage may be occurring, it says regulations need to be amended to ensure that dual licensees have little incentive to prioritize their own interests over those of their clients.
The consultation paper, which does not necessarily represent the views of insurance regulators of any of the 10 provinces or three territories, says that insurance and securities regulators share common goals in regulating asset-accumulation products that fall under their respective jurisdictions.
"These goals include effective regulation that is responsive to consumer needs and industry trends, and, where appropriate, coordinating and harmonizing the treatment of similar products," the paper says. "Fair treatment of the customer is a primary concern for both sectors." The paper notes that because of the distinct characteristics of segregated funds, such as death benefits and maturity guarantees, there's also room for differences in regulatory requirements.
Among the areas where the working group favours greater regulatory harmonization is in the disclosure of fees paid to distributors. The CCIR will examine whether there should be enhanced disclosure of compensation paid to insurance agents by insurance companies.
To align with mutual-fund regulations, the paper says, all fees paid by the insurance account holder should be disclosed by the insurance company. Also to be considered is whether embedded compensation paid to agents, such as trailer commissions, should be restricted or banned altogether. This parallels the debate currently taking place among securities regulators over whether mutual-fund sponsors should continue to be permitted to pay distributors out of their management fees.
In other consumer-protection proposals, the consultation paper asks:
- Should seg-fund issuers be required to provide annual performance reports in dollar terms and for various time periods? The paper noted that under the CRM2 provisions being implemented this year by securities regulators, annual performance reports must factor in deposits and withdrawals, and specify the change in value of the account;
- Should there be mandatory seg-fund reports on investment performance, financial highlights and ratios, a breakdown of the management fees, and a summary of the fund’s investment portfolio? The content would be similar to the management reports on fund performance that are required for mutual funds. The paper estimates that because of their insurance benefits, management-expense ratios for seg funds are typically 50 to 150 basis points (0.5% to 1.5%) higher than for comparable mutual funds.
- Should there be mandatory risk ratings for seg funds, as there are for mutual funds? The paper notes that because of their insurance features, the risk exposure of a seg fund may be substantially different from that of a comparable mutual fund.
- Should there be a higher standard of care, product knowledge and sales oversight for seg-fund transactions than what currently exists? "Complaint and enforcement data indicate that some life insurers may not be monitoring the product knowledge and sales practices of those selling their products as well as is being done on the mutual-fund side," the paper says.
Life-insurance companies are currently not required to approve or provide training on their products, the paper adds, and in some cases the insurers "have not accepted responsibility for the sales conduct of licensed intermediaries selling their products."
The paper says more than 80% of the consumer complaints that seg-fund regulators receive are related to product suitability. "Consumers typically complained that they had not understood features such as the lock-in period for guarantees or how fees/charges were calculated."
Often, these complaints came from clients who had signed all of the required disclosure documents. The paper says this suggests that many clients do not read or understand the documents and would benefit from more "pro-active" disclosure from the agents who sold them the products.
The deadline to provide written submissions in response to the consultation paper is July 15. Submissions can be emailed to ccir-ccrra@fsco.gov.on.ca. Submissions can also be mailed via Canada Post to:
CCIR Secretariat
5160 Yonge Street, Box 85, 17th Floor
Toronto, ON M2N 6L9
