Published Date: 07 March 2013

"FAIR and Beyond" - Speech by Mr Lee Chuan Teck, Assistant Managing Director, Monetary Authority of Singapore, at 11th Life Insurance Association Singapore Annual Luncheon

1   Thank you for inviting me to speak at this luncheon.  I would like to start by acknowledging two people in our midst: Hak Leh, the outgoing LIA President and Annette, the new LIA President.  Hak Leh has performed admirably as LIA President for the past 3 years.  I had the pleasure of working with him on the FAIR panel.  He was vociferous in defending his members’ interests.  Yet, at the same time, he was open to different views.  He always has the long-term interests of the industry and the consumer at heart.  I am deeply grateful for his contributions.

2   We are also heartened that Annette has agreed to assume the “hot seat”.   It will be a heavy role indeed.  Two big pieces of regulations will be implemented during her tenure: RBC and FAIR.  For both, there is a need for MAS to work closely with LIA – both in crafting the regulations and in implementation.  Globally, the life insurance business is also facing challenging times, emanating from a combination of tougher regulations, low and volatile asset returns and changing customer needs.  The industry is evolving and LIA plays an important role in shaping this evolution.  Annette certainly has her work cut out for her.  I ask that you give her your strongest support. 

3   I’ve entitled my remarks “FAIR and Beyond”.  I’ve been asked to spend some time talking about FAIR but I also intend to spend some time talking about things we need to do beyond FAIR.  This is, in effect, recognizing that the FAIR recommendations are necessary but not enough to meet our ultimate goal of improving the financial preparedness of Singaporeans.  More can be done.  Before touching on what those are, let me go back to the topic that has preoccupied us for the past year: FAIR. 

4   We presented the 28 recommendations from the FAIR panel on 16th January.  The response from all stakeholder groups – Product providers, distributors and consumers – has been positive.  Of those that disagreed with the recommendations, about half felt we could do more and half felt that we should do less.  To me, this suggests that the Panel probably struck the right balance – or as the Straits Times editorial aptly put it: “FAIR is fair”.  MAS has commenced consulting on the recommendations.  The consultation will run for about 3 months.  Thereafter, we will begin to respond in phases – starting with the more straight-forward recommendations.

5   What more can I say about FAIR?  In preparing for this speech, I went through all the responses from life insurance firms and agents to see which recommendations concerned them most.  There are three: spreading commissions; the web aggregator and the direct channel.  Let me take this opportunity to explain the Panel’s thinking behind these 3 recommendations.  I should emphasize that my comments are made on behalf of the FAIR Panel and not MAS.  The MAS consultation is ongoing and I would not want to pre-judge its conclusion.

6    First, spreading commissions.  The Panel recommended that commissions be distributed more evenly over the duration of the policy.  Specifically, the first year commission should be capped at 40% of total commission, with the remaining 60% is spread equally over the life of the policy or at least 6 years, whichever is shorter.  The intent is to better align the interest of agents and policyholders in the following situation.  Should the customer be poorly advised and ended up terminating the policy at the end of the first year, the agent would have foregone at least 60% of his commission.  If he terminated the policy at the end of the second year, the agent would have foregone 48% of his commission.  This gives the agent an incentive to ensure that the customer is properly advised before he committed to the policy.  The alignment is further strengthened when we couple this with a balanced scorecard remuneration framework, and subject future commission pay-outs, not just to premature terminations, but also to other fair-dealing indicators like the suitability of advice rendered and after-sales service.  In effect, we are hoping to shape behaviour by gradually changing the remuneration structure from one that rewards sales to one that rewards good financial advising and service.

7   While most agents would agree with the logic of the recommendation, they are understandably concerned about the potential impact on representatives’ income.  For existing representatives, there may be a one-time drop in income over two years, but this should be made up by higher incomes in future years since the commissions are merely deferred and not reduced.  To lessen the impact, we may consider spreading out the implementation phase over a longer period of time, instead of just 2 years as the Panel had suggested.

8   The impact on new agents may be less transient.  A study by LIA suggests that first year income for new agents will drop by an average of 14%, assuming that sales volume remains unchanged.  This may limit the industry’s ability to recruit quality agents at a time when we are also raising the bar for new entrants.  How do we address this? Other parts of the financial advisory industry have implemented different measures.  One is to move entirely to a salary-cum-bonus system as the banks have done.  A smaller step is to pay a salary during the first few years as some stock-broking firms have done.  Yet another way is to allow new representatives to keep a larger portion of their commissions as some independent FA firms have done.  Life insurance companies may wish to consider similar moves.

9   Second, the web aggregator.  The web aggregator was intended as a way to leverage on technology to make it easier for consumers to compare products.  This has worked well for many products: from electrical appliances to plane tickets and hotels and closer to home, motor insurance.  Some believe that life insurance products are too complicated for web aggregators because the pricing will often need to be customized to the individual buyer.  I beg to differ.  Clearly, for more complex products, the prices represented on the aggregator will need to be more indicative.  But this is still useful in that it gives the customer a reference point.  And if asked, the insurer must be able to explain why the final price he is paying is different from what was shown on the aggregator.  The Ministry of Health introduced a similar idea for hospital bills.  MOH’s website contains actual hospital bill sizes for about 80 treatments.  The prices are purely indicative because individual situations will vary.  But it still provides helpful guidance to patients in deciding which hospital to go to.  The Panel felt that if we can do this for medical treatments, we can certainly do the same for life insurance products.   Life insurance cannot be more complex than a heart by-pass!

10   A more valid concern with web aggregators is that they tend to narrow the point of comparison to prices alone.  At the extreme, this is unhealthy as it may cause insurers to dilute underwriting standards and price products unprofitably.  While this is a valid concern, the remedy cannot be to obscure comparison.  Rather it is to provide more dimensions for comparison on the aggregator.  These may include service standards, credit ratings and so on.  MAS will be working with LIA to develop these indicators.

11   Finally, the direct channel for basic insurance products.  Of all the 28 recommendations, the direct channel was the least well-understood.  This is not surprising since it is a novel idea and there is no comparable system elsewhere.  A well-known consultancy firm, for example, told us that there might be an adverse selection problem in the direct channel because there is no under-writing.  This is not true.  There will be the same under-writing process in the direct channel.  The only difference between the commission channel and the direct channel is that the latter does not carry advice and so only incurs a nominal administrative charge rather than a full commission.  Because it does not require advice, we will need to restrict it to a narrower list of products and limit the amount that can be bought through it.  Beyond that, there is no difference between the two. 

12   A strong benefit of the direct channel is that it can act as a price discovery mechanism for advice.  To put it simply, if a product is available for ‘X’ in the direct channel, but people are willing to pay ‘X+Y’ for the same product in the commission channel, then ‘Y’ is a market-determined fair price for advice.  In the Panel’s view, using market forces to set commission levels is superior to us artificially setting a cap on commissions. 

13   What are the concerns?  From the insurance companies, the main concern is consumer expectations.  Will consumers’ who buy a basic insurance product through the direct channel expect to receive the same level of service and advice as the existing channels?  This is a valid concern but not an insurmountable one. MAS and LIA need to work together to clarify what buyers from the channel should and should not expect.  From the agents, the main concern is whether the channel will threaten their livelihood.  At this stage, it is not clear how good the take-up of the direct channel will be; even though we have received many letters from consumers enquiring about the channel and asking for a wider product scope.  At one extreme, if the much-quoted assertion that insurance is sold and not bought holds, the channel will only cater to a select few and agents’ activities will remain largely unaffected.  At the other extreme, the channel takes off in a big way and basic insurance products are bought largely from the direct channel.  In such a situation, agents will need to evolve their role.  Currently, agents spend 60-80% of their time prospecting for new clients.  With the direct channel, there will be less need for prospecting since customers are now approaching the insurance companies rather the other way round.  There will, however, be more opportunities for agents to advice on products beyond the basic ones.  In a sense, the agents will become more like financial advisers and less like financial salesmen.

14   The FAIR Panel report is a bold attempt to change the face of the financial advisory industry and to lift it onto a higher plane.  We have considered but not recommended ideas like mandatory fee-based advising because we assessed that Singaporeans are not quite ready for these.  At the same time, we have borrowed ideas from other industries like the web-aggregator and also suggested novel ideas like the direct channel that has not been tried elsewhere.  If we succeed, the financial preparedness of Singaporeans should improve.  We will measure this financial preparedness along 3 dimensions: Having enough financial resources for exigencies, having sufficient retirement savings and having adequate insurance protection.  The Financial Education Steering Committee has commissioned a survey to measure the current state of financial preparedness and to track this over time.

15   As I alluded to earlier, FAIR alone cannot achieve this goal.  FAIR principally addresses the distribution part of the value-chain.  The distributor lies between two other actors: the product manufacturer and the consumer.  These 2 other parts need to be addressed too.  Let me touch on consumer education first.  Ten years ago, we launched a nation-wide financial literacy programme called MoneySENSE.  The idea was to deliver basic financial messages to the general population: household budgeting, buying a house within your means, basic investing, retirement planning, insurance and so on.  To extend our reach, we used various channels: mass media (we have a TV programme called Mind your Money on CNA, TV5 and most recently on TV8), newspapers, website and facebook, and also relied heavily on our partners like the CPF, NLB, CDCs and of course the financial industry.  LIA is a key partner for us. 

16   As we move into the next 10 years, the challenge for us is to help people translate this knowledge into practice.  A study by the Federal Reserve Bank of Cleveland found that financial education has the largest impact on behaviour only if it is delivered just before they are about to make a financial decision.  This means that we have to develop a strategy of sending tailored messages to people at key points in their lives: when they graduate from school, when they start working, when they get married, when they buy a house, when they have children and so on.  Because financial representatives are often present at the point of major financial decisions, associations like the LIA have a critical role to play.

17    Finally, I want to spend some time talking about product manufacturing since I’m in a room full of product manufacturers.  In the last 10 years, the types and volume of financial products offered to retail investors have surged.  Banking products, insurance products and even capital market products have all become more creative.  The current low yield environment will continue to spur more product innovation.  

18   Over the next few months, MAS will be working with the industry to review the state of product offerings to retail customers.  We will be asking three questions.  First, are there significant product gaps in the market?  There may be a genuine need for a product but market structures or conditions may inhibit the provision of such a product.  In the insurance segment, a few products are commonly cited: Micro-insurance especially for lower income earners, annuities for retirees and long-term care insurance.  In all 3 instances, CPF has provided viable solutions in the form of the Dependant Protection Scheme, CPF Life and Eldershield.  Nevertheless, for those whose needs extend beyond what the CPF schemes can provide, there may still be a need for a private sector solution.  I am heartened that a few insurance companies have taken on themselves the task of filling these gaps.  More can be done.    

19   The second question is the converse of the first:   Are there products out there that are inherently unsuitable for retail distribution?   The HEC school of management did a study on the European retail structured products market.  Interestingly, they found that banks that cater mainly to unsophisticated customers tend also to have the most complex structured products.  In other words, the most complex products are sold to the most unsophisticated customers.  Their conclusion is that banks use complexity to exploit an informational rent from their customers.  That is a euphemistic way of saying that they are deliberately making their products more complex so that they can charge their customers more.  We need to guard against such behaviours.

20   The third question is about the cost of product manufacturing.  Are products efficiently created?  This question is especially important in a time of low asset returns.  For costs that are fixed, like fund management fees, ensuring adequate disclosure and open competition is the most effective way to keep costs in check.  For costs that can vary over time, like expenses allocated to Participating Funds, there must be clearer rules so that these costs are appropriately managed.  In this regard, MAS is currently undertaking a review in this area and will be issuing further rules.

21   In summary, improving the financial preparedness of Singaporeans requires a multi-prong strategy covering products, distribution and consumer education.  The FAIR recommendations will significantly enhance the quality of advice and the distribution of products.  MoneySENSE, together with our partners will work towards increasing the effectiveness of financial education.  My challenge to you as product providers is to put customers at the heart of your product development and build simple, effective and economical products.  We look forward to working closely with all of you on all 3 fronts.  Thank you.