Association of Independent Life Insurance Brokers (Singapore) Congress 2002 27 February 2002
Keynote Address by Mrs Hauw Soo Hoon, Executive Director (Insurance), Monetary Authority of Singapore
Flight to Quality: A Reality Check
Good morning, ladies and gentlemen. It is a pleasure to join you here today.
Among the audience here today are some who have been in the life broking business for many years. There are also those who are presently in the tied agency system but with aspirations to become financial advisors with the coming into force of the Financial Advisors Act (FAA).
For this purpose, it would be useful to share some developments we have observed over the past 18 months since 1 July 2000 when MAS started to regulate and supervise life insurance brokers under the Insurance Intermediaries Act.
Many of these observations do not suggest that it would be one rosy promising future for Financial Advisors. While there is certainly much potential in this development, there are also many challenges to overcome. It is therefore quite appropriate to include the following subtitle? Flight to Quality? A Reality Check?.
As the focal point - the Financial Advisors Act - is generating a lot of interest for everyone. It would be useful if I could first start by explaining what the Financial Advisors Act is about so that we all have a clear and common understanding of this new framework.
The Financial Advisors Act
The Financial Advisors Act was passed by Parliament in October 2001 and targeted to become operational in the second quarter of 2002 with the release of the Financial Advisors Regulations. It would provide an integrated regulatory and supervisory framework governing the provision of financial advisory activities for a broad range of investment products.
Under this framework, there will be 2 main classes of Financial Advisors - organizations that are either licensed FAs or Exempt FAs. As the name implies, Licensed FAs would be organizations that are holders of the Financial Advisors License, acquired after a licensing process with the MAS. Exempt FAs, on the other hand, do not need to go through this licensing process. This is because they are financial institutions that are already regulated by the MAS under other principal Acts. For example, this would include banks, insurance companies and stock-broking firms. While Exempt FAs are exempted from the licensing requirements, they would like Licensed FAs - have to comply with the full range of all other requirements with respect to their business conduct. These requirements include market conduct, sales and advisory process, and training and competence.
To amplify this we can consider the case of life insurance companies more closely and their two roles under the new regulatory framework. First, primarily as manufacturer of life insurance products, regulated under the Insurance Act. Second, as the principal of its agency force, a life insurance company would be an Exempt FA, regulated under the Financial Advisors Act, while its agency would be considered its FA representatives.
Beyond this structure, there are several important key principles and concepts which I would like to highlight in the operation of the FA framework.
I shall first touch on the concept of Customers' interests.
Financial Advisors must, first and foremost, give due regard to the interests of its customers. The provision of financial advice must be conducted in a fair, professional and ethical manner. One practical application of this principle means that financial advisors are required to have a reasonable basis for their recommendations. This is to ensure that due consideration has been given to the person's investment objectives, financial situation and particular needs.
The first element under this concept is the Know your Client requirement in respect of his financial objectives, risk tolerance, employment status, financial situation, current investment portfolio and number of dependents. Subsequently, in conducting a Needs Analysis process, a FA rep should analyze the information provided by the client and identify appropriate investment products for the client. Proper documentation and record keeping of client information and recommendations should underpin this process to meet the objective of providing good advice to customers.
Next is the concept of consistency.
FAA is an integrated regulatory and supervisory framework. Its scope cuts across a number of financial services industries involved in the provision of financial advice relating to investment products. The requirement for consistency in regulatory approach is an important desired outcome of the new framework. The concept of consistency presents itself in at least 2 ways. First, consistency must apply to processes for the same product. This means for the same investment product such as life insurance, advisors from different distribution channels would be subject to the same rules and standards. Secondly, consistency would apply to similar products. That is to say, the sale of functionally similar products such as single premium investment-linked policies and unit trusts would be subject to similar rules and standards, to the extent possible.
The next concept, accountability, is captured under the 1 rep 1 principal rule. Each FA representative can represent only one principal and this applies to both licensed and Exempt FA firms. The principal is responsible for developing, supervising and monitoring the conduct of their representatives at all times, including aspects of market conduct and competence. This is to ensure that there is absolute clarity to investors as to the status of the financial advisor representative. In this way, consumers would understand who would be accountable for his professional behaviour as a FA representative and his accountability.
Under the Insurance Intermediaries Act (IIA), life brokers are required to be independent. An example of the practical application of independence is the prohibition of volume-driven commissions under the IIA. A similar concept of independence exists under the Independent Financial Advisor framework in the UK. However, their less than happy experience with polarization has caused the regulator to consider its abolition.
I wish to highlight that under the Act provisions of FAA, there is no mention of or requirement for independence. Licensed and Exempt FA firms will not face restrictions on volume-based remuneration and exclusive arrangements with product providers. It is more important that financial advisors be guided by the concept of reasonable basis for advice and provide good objective advice to their clients.
However, as a result of feedback received on the Consultation Paper, the MAS is reviewing the issue with respect to carving out an independent status within FAs. Even if the concept of independence is included, there is a need to provide clear definition of what that means, to the extent possible.
Opportunities provided by FAA
With the basic FA framework and concepts laid out, we can now examine what the introduction of the FAA means to market players and how market dynamics could change consequently. I would focus on some developments on the insurance industry that might occur.
The FAA should be good news for the financial markets because of the expanded range of choices available as a result. Consumers have more choice because product manufacturers and distributors themselves have more choices. Product manufacturers would benefit by virtue of the scope for increased channels of distribution.
Licensed FA would have more products to sell; in particular, they could source unit trusts from the fund managers. This translates into an expanded product range for life brokers. However, life insurers as exempt FA can also sell unit trusts under the FAA, though this is more form than substance. Single premium investment linked products are very similar to unit trusts. The fund management industry is already managing billions in funds especially from CPF channeled through the life insurance distribution.
A more interesting development is that under the new framework, life insurers can also source products from one another. To illustrate, insurer A could already be manufacturing a specialized product which insurer B does not want to produce because it might be too capital intensive. So insurer B approaches A to become its distributor. Insurer A may agree because it could then achieve an earlier return of capital on this specialized product. Such alliances might mean that the advantaged position that life brokers have presently in being able to source for products from various life insurance companies may soon erode.
Further to this, life companies may then decide to delineate and differentiate their manufacturer and distributor roles more clearly. They might decide to set up their own separate FA firms. They could also consider allowing selected tied agents to become FA Reps in their FA firm. When that happens, licensed FA would find a new breed of competitor that would be possibly be better capitalized, resourced and more competitive.
While these are some predictions for the future, let me come back to address the reality of present challenges. The reality, unfortunately, does not paint a rosy picture. But it is important for us to see things as they are, and not only as how we wish them to be. This would put all potential FA aspirants in a better position to make the right decisions.
Most of the life broking principals evolved from the agency systems. As such they may, at the start, have adopted fairly similar agency models - one that they were familiar with. They built multi-tier systems, provided agency rewards, conducted recruitment and training based on profile of tied agents. In short, they have competed head-on with insurance companies but with much lesser resources. Moving from a situation where they were agency managers to being business owners, many principals almost immediately found themselves struggling to strike a balance between time spent on business management versus sales management - all this while having to watch the bottom line from month to month.
Moving to managing a brokerage also means having to be responsible for compliance issues. For example, consider the CEDLI recommendations, implemented in 2001. The aim of these recommendations is to raise efficiency, transparency and quality in the distribution of life insurance products. Life broking principals, like the insurance companies, had to comply with the needs-based sales process, the training and competence and enhanced disclosure requirements.
Let me illustrate with one example. The Training & Competence plan is a very important document. A broking principal should have a well-conceived, documented plan that includes implementation details. It is a master plan that lays down details for the selection and development of broking staff.
However, T&C plans from many life broking firms were not well conceived. Many have training plans but the competence component of the formula was missing. It is essential to continuously assess the adequacy of the knowledge and skills of the broking staff. For this purpose, a good tracking system needs to be in place to monitor whether the desired level of competence has been attained, and to point out when upgrading of skills is needed when the situation warrants change. In one instance, the 40-page T&C plan of one company had 25 pages of website prints of training programs of well-known US insurance companies. The relevance of these pages remains a puzzle to the MAS.
While there may be opportunities, the picture of the emerging reality is that all market participants must seriously consider whether they have the capacity to put in place the requisite business model for success.
Life brokers are well positioned to meet the impending challenges. Many in the pioneer ranks of life broking practitioners have learnt very quickly what worked well in the market and made rapid adjustments to their business models. Those who are waiting to come in could well learn from these practitioners what are the critical success factors. There is no need to repeat expensive mistakes. It is critical that every one thinks through to select a business model that is likely to succeed.
The first step in meeting the challenges of the new marketplace is for all aspirant FAs to have a clear understanding and implications of the FA framework. After a close examination of the regulatory framework, one should assess the rules and examine them in relation to your business operations to consider first whether there is the capacity to meet its requirements. It is not enough to meet only the letter of the law on this regard but to aspire to go beyond its basic requirements. This is because exceeding basic regulatory requirement would mean a higher chance of engendering sound business operations.
Next, you should ask what new strategies you should design to become successful in the new era. Identify a niche area in which you can work out your value added proposition and beef up the competencies for yourself and your representatives.
Revisit your business plan. Do not consider it as a document completed merely for regulatory submission. It can be a very useful tool and its detailed preparation can be a disciplined process for yourself in the justification of a business case for staying in or applying for a new FA licence.
For those who desire to become Financial Advisors representatives, the same process of thinking and evaluation is necessary. It is important to understand the different business practices of the agency and licensed FA systems, and what that means in operational applications and in the professional development plan of the representatives. Then choose the model that aligns with your personal objectives. Be clear as to what value add you can provide to the customers.
The MAS has a preference for the distribution model that proves to be cost-efficient, competent, professionally managed and which adds value in the financial advisory process. The life broking model carries its own unique strengths as well as disadvantages, but with carefully considered plans and thorough execution, there is no reason why it cannot be a successful model.
The 'Flight to Quality' is a necessary path that even the entrepreneurial spirit must take to win at the end.