Head of FAIR Canada lauds latest declaration from insurance regulators, but has concerns over 'clear conflict of interest'
It’s been a week since the Canadian Council of Insurance Regulators and [CISRO] unveiled guidance requiring insurers to manage conflicts of interest relating to advisor chargebacks through strict control measures. And while the head of one of Canada’s leading investor advocacy groups is commending the move, he’s also concerned that it doesn’t go far enough.
“I'm glad CCIR and CISRO are taking this issue seriously,” Jean-Paul Bureaud, executive director and CEO at FAIR Canada, told Wealth Professional. “But I think advisor chargebacks create such a clear conflict between clients and advisors … Outside of a ban, it’s not clear how you could manage the conflict.”
Advisor chargebacks have been proposed as an alternative to deferred sales charges, which have already been banned for mutual funds and are expected to be prohibited for new segregated fund sales across Canada by June 1. As of now, only Ontario is the only province to officially announce it is banning DSCs on new seg funds.
But Bureaud argues that compared to DSCs, advisor chargeback commission structures are much worse for Canadian consumers.
Chargeback schemes create direct conflicts of interest
Under the DSC model, an investor or consumer puts money in a fund with the help of an advisor, who gives them advice related to the benefits and performance of the product. If they decide to redeem their interest from the fund before a specific amount of time specified under the DSC schedule, they’ll have to pay an early redemption fee. That structure, critics say, is ripe for abuse by advisors who disregard their clients’ needs for liquidity when recommending DSC funds.
The industry has attempted to address that conflict through advisor chargebacks, which charge the cost of early redemptions to the recommending advisor. Not only do they ease the financial pain for clients, the reasoning goes, but they also create an incentive for advisors to not push segregated funds on clients who may need access to their funds before the official redemption schedule elapses.
But as Bureaud explains, chargeback schemes put clients’ and advisors’ interests in direct opposition during an early redemption scenario.
“As the advisor, I don't want my client to redeem because I'm going to be out of pocket,” he says. “Just as much as investors don't like to pay commission fees up front, advisors don't like to have to pay back commissions later on. So, their interests are in a direct conflict when the client wants to sell. In these situations, it would not be unreasonable to expect an advisor to try to convince the client to keep their money in the seg fund, and, if they need to liquidate some holdings, persuade them to consider selling another investment.”
While Bureaud acknowledges some conflicts can be addressed through disclosure, he is not convinced it would be a suitable approach for advisor chargebacks.
Insurance regulators putting compensation in focus
To be sure, CCIR and CISRO’s joint statement calling for robust controls among firms using the scheme sends a strong signal to the industry, as does their vocal concern over the use of advisor chargebacks and other conflicted compensation schemes. In an emailed statement, a spokesperson for the regulator said there are an estimated 3 million segregated fund policyholders across Canada today.
“Upfront commission may motivate advisors (particularly less experienced advisors who have lower incomes) to sell [segregated funds] to customers for whom the product is not suitable,” CCIR spokesperson Tony Toy told WP. “As such, CCIR and CISRO believe this risk calls for, at a minimum, robust control measures to ensure customers are treated fairly when this option is used.”
CCIR and CISRO said they will continue to monitor customer outcomes related to upfront compensation in individual segregated fund contracts, including DSCs and chargebacks; those target customer outcomes were outlined in a discussion paper published last fall. The regulators are also working on guidance relating to compensation schemes for segregated funds; once implemented, CCIR and CISRO members may monitor the extent to which industry complies with the expectations.
“CCIR and CISRO members may monitor for additional outcomes within their jurisdictions,” the spokesperson said in the email to WP. “Some members may also collect additional information about segregated funds.”
“I’m glad the regulators … want strong controls, and they’re also going to monitor the situation. It’s so important to collect that data,” Bureaud says. “The industry may do as they suggest, and only sell seg funds with these fee structures to clients who hold them for the long term. Given the risks to consumers, however, it is critical that regulators assess the data they gather to determine whether this is indeed the case, or whether they need to take more robust measures to protect consumers in these scenarios.”