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INSURANCE DISTRIBUTION IN CANADA: PROMOTING A CUSTOMER-FOCUSED SYSTEM

Maintaining a strong customer focus and having processes and procedures that protect customers has long been the fundamental underpinning of insurance legislation, marketplace regulation and the life and health insurance industry in Canada. More recently, the concept has emerged as a central tenet in the Insurance Core Principles of the International Association of Insurance Supervisors. Given the global focus on managing conduct of business (market conduct) risks and fostering a customer-focused culture, the Canadian Life and Health Insurance Association (CLHIA) decided that it would be timely to review practices surrounding the distribution of individual insurance from the perspective of the consumer. How do industry practices support positive customer outcomes? Could they be improved? The objective of the exercise is to ensure a robust, world-class environment for insurance customers in Canada. As the vast majority of insurance to retail customers is provided through advice channels, our focus is on practices that support those channels. Direct channels, e.g. insurance sold through call centres or on-line, are not addressed in this paper.

BACKGROUND International IAIS has adopted 26 Insurance Core Principles to provide coordinated guidance to insurance regulators around the world. With respect to the distribution of insurance, they recommend that insurance advisors be licensed, subject to proficiency standards and a code of conduct, and that both advisors and insurers incorporate the concept of "treating customers fairly" into their businesses. IAIS defines treating customers fairly as promoting positive customer outcomes such as:

Developing and marketing products in a way that pays due regard to the interests of customers

Providing customers with clear information, before, during and after the point-of-sale

Reducing the risk of sales which are not appropriate to the customers' needs

Ensuring that any advice given is of high quality

Dealing with customer complaints and disputes in a fair manner

Managing the reasonable expectations of customers Canadian environment Market conduct regulation is the responsibility of the provinces. The raison d'être of insurance market conduct regulation is customer protection. It is reflected in the mandate of provincial insurance regulators, and in legislative and regulatory provisions that, among other things:

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Prohibit unfair and deceptive practices

Require the licensing of insurance advisors

Require that advisors be screened and monitored for suitability, and that unsuitable activities be reported

Require insurers to belong to an independent third-party dispute resolution service

Require that customers be provided with material facts about the contract

Require that claims be paid promptly These regulatory approaches are reinforced by the work of the Canadian Council of Insurance Regulators (CCIR) and the Canadian Insurance Services Regulatory Organizations (CISRO), to which insurance superintendents and/or insurance councils belong. CCIR sets out a number of expectations about industry behaviour through the following:

Principles for Consumer Protection, which set out standards for disclosure, educated and ethical intermediaries, consumer education, consumer remedies and effective regulators

The National Complaint Reporting System, which requires insurers to report escalated complaints to regulators

Risk-based Market Conduct Regulation, which promotes the benefits of risk-based regulation and sets out regulatory principles for this approach

Managing Conflicts of Interest, which sets out principles that the customer's interest take precedence over the advisor's, that the advisor disclose conflicts or potential conflicts of interest, and that the product sold is suitable for the needs of the customer

Strengthening the Life MGA Distribution Channel, which makes recommendations to improve processes and clarity around insurer and MGA roles

The life insurance market in Canada is highly competitive, a fact that contributes to a customer-focused approach. Simply put, a customer-focused approach is critical to insurers if they are to continue attracting and retaining customers. Life and health insurers are members of the CLHIA, and adhere to a number of industry guidelines focused on good disclosure about products, screening and monitoring advisors, and managing conflicts of interest. A list of CLHIA Guidelines is attached as Annex A.

APPROACH OF THIS PAPER This paper is organized around what the industry believes are the key building blocks that contribute to a robust, customer-focused system. Under each, we explore the objective and the current practices that support that objective. And, where appropriate, we consider alternate practices that could be used to improve or enhance the system. A number of these recommendations would require appropriate transition periods and discussions between regulators and industry to fine-tune the details.

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A: CUSTOMERS CAN EXPECT KNOWLEDGEABLE AND ETHICAL ADVISORS International standards are that advisors be licensed, knowledgeable about the products they sell, subject to a code of ethical standards, and subject to ongoing review -- by the regulator, insurer, distributor and/or a Self-Regulatory Organization (SRO). Canada has a licensing regime in all provinces, overseen by a Superintendent of Insurance in some provinces, and by an Insurance Council in other provinces (the Western provinces, as well as Quebec). CCIR has principles that the advisor must place the interests of policyholders and prospective purchasers ahead of his or her own interest. Advisor associations, insurers and, in some cases, provinces, have codes of conduct for advisors. And insurers have a regulatory obligation to screen advisors for suitability, monitor advisors and report unsuitable advisors. In looking at this area, it is important to consider not just whether the right criteria have been established, but whether there is effective oversight of advisors, to ensure that they are meeting regulatory obligations and have appropriate policies and procedures in place. Licensing standards We commend the efforts of provincial regulators to harmonize pre-license proficiency standards through enhancements to the entry-level Life Licence Qualification Program which took effect January 2016. Additional post-licensing criteria are set by some, but not all jurisdictions. We believe that there are opportunities to further harmonize post-licensing requirements, as follows:

Recommendation 1: We recommend that all jurisdictions establish continuing education criteria for life licensees Recommendation 2: We recommend that all jurisdictions require errors and omissions insurance for life licensees

Regulatory oversight Regulators investigate advisors when complaints are filed and, in some jurisdictions, also conduct spot audits. Resourcing challenges and a wide array of competing regulatory demands can and do affect the capacity of regulators to take on a more proactive approach. It is our view that the Council model generally works very well and is more likely to contribute to a dedicated proactive approach. Councils operate with authority delegated from the Superintendent or from the government. Their mandate is to provide regulatory structure and oversight for those who distribute insurance. They have dedicated resources. They benefit from industry expertise, in that insurer, advisor and public representatives sit on each Council. (It is important to note that the role of Council representatives is never one of advocacy; rather, they are tasked with acting in the public interest, and lending their industry expertise to that task.) We believe that regulatory oversight could be further strengthened and harmonized by adopting a Council model across the country. In taking such an approach, it is important to avoid duplication and inefficiencies with existing regulatory structures. A coordinated provincial system, rather than a national SRO, recognizes that licensing is a provincial responsibility and ensures a closer link with advisors and customers. National coordination should continue to be provided through CISRO. (While a provincial

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model is contemplated, some provinces may choose to combine forces for efficiency purposes to establish a larger council, such as in Atlantic Canada.) Councils' authority should include the following:

Setting pre-and post-licensing proficiency standards

Licensing insurance advisors

Investigating advisors and taking disciplinary action, such as suspending or revoking licences and imposing fines

Auditing advisors on a risk-based basis

Addressing customer complaints involving advisors Recommendation 3: We recommend that all jurisdictions be represented with an Insurance Council structure of regulatory oversight, and that duplication and inefficiencies with existing structures be avoided.

Advisor Code of Conduct Some provinces have Codes of Conduct for advisors, while others do not. We believe there is value in having a consistent standard across the country and that CISRO, in its national coordination role, is well positioned to develop such a standard.

Recommendation 4: We recommend that CISRO establish a Code of Conduct for licensees that can be adopted by each jurisdiction.

Customer complaints involving advisors With respect to addressing customer complaints about advisors, provincial insurance regulation allows for sanctions to be taken against advisors, but does not provide the authority for regulators to recommend an advisor to pay restitution to the customer. This contrasts with the powers accorded to the OmbudService for Life and Health Insurers, to which life and health insurers belong. To remedy this imbalance, consideration could be given to expanded powers for Councils in this area, so that they could recommend restitution by advisors to customers. Any recommendation for restitution should be voluntary, as is the case with Ombudsman systems that apply to other types of advisors (e.g., Ombudsman for Banking Services and Investments). "Ethical walls" would need to be established between this and the regulatory functions of the Council.

Recommendation 5: We recommend that the power of Councils be expanded with respect to addressing customer complaints about advisors so that, in addition to taking sanctions against the advisor, Councils could recommend restitution by advisors to customers, as appropriate.

We note important new initiatives, like CCIR's new Framework for Cooperative Market Conduct Supervision in Canada and national databases for advisor screening, contracting and compliance, will further strengthen national coordination and increase the tools available to each Council.

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B: CUSTOMERS ARE PURCHASING PRODUCTS THAT ARE SUITABLE TO THEIR NEEDS, AND UNDERSTAND WHAT THEY HAVE PURCHASED

International standards are that advice needs to consider the customer's needs, priorities and circumstances, and explain/document the basis on which the recommendation is made. Understanding customers' needs In Canada, it is common practice for advisors to use a needs-based selling approach and recommend products that are suitable to the customer's needs, but this is only formalized into regulation in Quebec, which requires that an advisor analyze the needs of the customer and provide a copy of the information that has been gathered (often referred to as a needs analysis) whenever advice (a licensed advisor) is involved. It is our view that the Quebec approach should be adopted across the country. A needs analysis demonstrates that the advisor has an understanding of the customer's circumstances and needs before recommending a product to meet those needs. The duty to conduct a needs analysis and keep documentation of it would rest with the advisor, and a copy would be provided to the customer. Audits of advisors, whether they be undertaken by the regulator, insurer or distribution firm, would include looking for evidence of the needs analysis.

Recommendation 6: We recommend that all jurisdictions require that the advisor conduct a needs analysis prior to making a recommendation to the customer and provide a copy of this information to the customer before or at the time of policy delivery.

Explaining the product and its suitability to the customer In terms of product disclosure made to customers before they make a buying decision, insurers already produce excellent point-of-sale material that meet or exceed industry and regulatory minimum disclosure requirements. For Individual Variable Insurance Contracts, customers receive a Key Facts document that describes the contract and a Fund Facts document that describes the investments within the contract. For life and health insurance products, customers receive material written in clear language that describes the product and any limitations or exclusions. While the needs analysis is a valuable tool in assessing a customer's situation and needs, and in guiding the advisor to make a recommendation that is suitable to those needs, this does not, in and of itself, ensure that the customer understands why the recommended product is suitable to them. It is our view that additional documentation would be helpful. A short (e.g. 1 page) document from the advisor outlining what product was recommended and why, would be useful to customers in confirming their understanding of what they have purchased, its intended objective and how it meets their needs.

Recommendation 7: We recommend that all jurisdictions require that advisors provide to the customer, before or at the time of policy delivery, a brief written explanation outlining the product recommendation and why it is appropriate for the customer.

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C: REMUNERATION MODELS FOSTER FAIR OUTCOMES FOR CUSTOMERS; CONFLICTS OF INTEREST ARE MINIMIZED AND DISCLOSED

International standards are that remuneration structures should be designed to encourage responsible business conduct, and that insurers and advisors need to manage potential conflicts of interest, either through avoiding the conflict or through disclosure. Recognizing that life insurance is a valuable asset for most customers but is a product that is sold rather than bought, the remuneration system generally used is commission-based, e.g., the advisor is paid by the manufacturer when a product is placed with them. Any remuneration system needs to fairly reward advisors for their work and avoid incenting them to make recommendations not in the best interests of the customer. In Canada, the potential for conflicts of interest (or the perception of such) is managed in a twofold way -- first, by fostering needs-based selling and making recommendations that are suitable to the customer, and second, by advisor disclosure about the insurers that they represent and how they are paid. This is reinforced through CCIR's principles for managing conflicts of interest, and supported by industry practices and guidelines. There are some international jurisdictions that have taken more extreme approaches, like banning commissions on certain products. These have generally been in response to specific mis-selling scandals that highlighted weaknesses in regulatory or industry structures or cultures in those jurisdictions. At least one other jurisdiction (Australia) is capping upfront commissions to address a "churning" problem, where one policy is replaced by another with questionable customer benefit, but a new commission is generated for the advisor. In this section, we consider three areas that could give rise to conflicts of interest (or a perception of such) if not properly managed: (i) replacements of life insurance policies; (ii) travel incentives related to the placement of policies with life insurance companies; and (iii) disclosure of distribution costs for wealth products. (i) Replacements

As noted, Australia is restructuring its compensation system to address a churning problem. Does a similar problem exist here? Do current practices support customers' interests or are changes needed? The reality is that Canada does not have a systemic churning problem. The lapse rate (percentage of policies that are dropped, often in order to be replaced by another policy) in Australia is 15%. By contrast, Canada's lapse rate is 4%, and it's not clear how much -- if any -- of this is related to churning. Unlike churning, good replacements are driven by the customer's interest because their circumstances have changed or a different kind of policy offers better benefits, e.g. where new policies offer unique features not previously available or when insurance rates have dropped. Good practices already in place in Canada through regulation and industry guidelines help to ensure that when a policy is replaced, it is in the customer's interests to do so. Regulators require that the advisor provide the customer with a Life Insurance Replacement Declaration, which outlines eleven questions to be considered. The advisor is also required to provide a written detailed explanation of the advantages and disadvantages of replacing the policy. Insurers impose a "charge-back" period where advisors are required to repay their commissions if a policy is replaced within a specific time period. As well, insurers have processes in place to monitor both internal and external replacements and "red-flag" situations which suggest inappropriate replacements.

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The current system supports customer-focused practices, with appropriate checks and balances. We do not believe that changes are needed. (ii) Conference/travel incentives related to the placement of policies with insurance companies It is not uncommon for insurers to provide additional incentives for the placement of policies by allowing advisors to qualify for conferences and to pay for their expenses to attend. While these conferences have a significant educational component to them, they are often held out-of-Canada in desirable locations. It should be noted that the fact of conference incentives does not, in any way, obviate the advisor's obligation to ensure that all recommendations put the interests of the customer first. We have seen no evidence, nor are we aware of customer concerns or complaints, that these incentives give rise to a conflict of interest which negatively influences an advisor's recommendations. In fact, surveys conducted by Newlink have found that advisors put greater weight on all other factors (e.g. products, insurer service, insurer reputation, underwriting, etc.) when choosing which product to recommend. And, while such conferences may be considered a "perk", travel costs are a taxable benefit to the advisor consistent with Canada Revenue Agency (CRA) rules. However, we recognize that, in those situations where an advisor has a choice between various insurers, conference incentives could contribute to a perception of a conflict of interest. It is not the intent of insurers to create or contribute to such perceptions. We note that, in the mutual fund industry, regulators have banned travel incentives at the manufacturer level where the possibility exists that the incentive could influence a representative's recommendation, but continue to allow them at the distribution level, e.g. mutual fund dealers, where representatives can place business with a variety of manufacturers through the dealer, so no particular bias exists. If a similar approach was applied to insurance, a regime that could potentially deal with any perceived conflicts would be the following: a) Insurers that manufacture products and distribute them through independent channels be

allowed to offer only trips with reasonable professional content where advisors must pay their own travel and accommodation costs. This would counter the perception that advisors are placing a product with a particular insurer in order to qualify for a trip.

b) Insurers that manufacture products and distribute them through an exclusive sales force be allowed to offer trips with reasonable professional content, and have the option to pay advisors' expenses. In this scenario, there is no incentive to recommend one insurer's product over another.

c) Distribution firms that operate through independent channels and have a range of insurers'

products on their shelves be allowed to offer trips with reasonable professional content, and have the option to pay advisors' expenses, provided that such trips are not tied to placing business with any particular insurer, and there is no incentive to recommend one insurer's product over another.

Recommendation 8: We recommend that regulators consider parameters on new incentive travel programs, along the lines noted above.

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(iii) Disclosure of distribution costs for wealth products Individual Variable Insurance Contracts (IVICs, also called segregated funds) are offered by life and health insurance companies and distributed by life-licensed advisors. They are often compared to mutual funds and the question arises as to whether regulatory consumer protection for both is sufficiently similar. IVICs and mutual funds are fundamentally different in some respects, in that IVICs are insurance products which offer protection against loss of capital and, in some cases, guarantees related to payout levels, all of which are backed by capital reserves and governance requirements set by prudential regulators. There are no similar guarantees or consumer protection for mutual funds. However, similarities between the two products exist, from the consumer's perspective, in that they both involve investments which can have variable returns (albeit with downside protection, in the case of IVICs). Some years ago, insurance and mutual fund regulators developed common point-of-sale disclosure regimes which require that consumers receive disclosure about the investment option in a brief document called Fund Facts, as well as, in the case of IVICs, brief disclosure about the IVIC contract and its features in a Key Facts document. The Fund Facts document requires disclosure of the Management Expense Ratio (MER) of the fund, in percentage terms. This regime was fully implemented for IVICs in January 2011, and will be fully implemented for mutual funds in 2016. Meantime, mutual fund regulators have adopted a "Client Relationship Model 2" approach that will, as of mid-2016, require that distribution firms (mutual fund dealers) provide distribution costs, in dollar terms, in annual statements. There has been some suggestion that IVICs should follow the CRM2 approach and provide distribution costs in their annual statements. While we understand the desire to have some commonality in approach, we do not believe it is appropriate for IVICs to mimic CRM2. For one thing, there are differences between the two products, e.g., the manufacturer rather than the distributor produces annual statements for IVICs, some of the specific costs for mutual fund dealers don't apply for IVICs, etc. But more fundamentally, we believe that the CRM2 approach, while well-intentioned, is not as comprehensive or transparent as it could be. It carves out distribution costs (the monies paid to the mutual fund dealer) from the full MER. We believe that the full MER is more relevant to the consumer as this is the amount deducted from a consumer's investments for administration, distribution and service. As an industry, we support more detailed cost transparency for consumers, in a manner that is meaningful and relevant to consumers. This would mean disclosure of the MER and any additional costs or fees. The MER should be broken down into its component parts which, for IVICs, would be administration, distribution and insurance. Further, we believe that this standard of full cost transparency should apply to similar products, such as mutual funds. Current disclosure requirements for IVICs are set out in the industry Guideline G2, Individual Variable Insurance Contracts relating to Segregated Funds and adopted as regulation in Ontario and Quebec. We anticipate the necessary changes could be made within this framework. Details, including implementation approaches, would need to be worked out between regulators and the industry.

Recommendation 9: We recommend that insurance and mutual fund regulators and their industries work together to implement more detailed cost disclosure (MER and any additional costs and fees) in the annual statements provided to IVIC policyholders and mutual fund customers. For IVICs, the MER would be broken out to its three components -- administration, distribution and insurance costs.

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D: CUSTOMERS CAN EXPECT ONGOING INFORMATION ABOUT THEIR POLICIES AND ONGOING SERVICE

International standards are that insurers should service policies through to the point at which all obligations under the policy have been satisfied. In Canada, insurers have a number of processes in place to provide ongoing service, including issuing annual statements for those policies with cash values and handling claims in a fair and effective manner. Life and health insurance policies are often long-term policies, sometimes in place for decades before a claim occurs. It is important that customers have access to service during the life of the policy. Administrative matters, such as address or beneficiary changes, are often dealt with directly by the insurer. Advisors play an important role in providing ongoing service, as well, by doing reviews of customers' circumstances from time to time to see if their insurance needs have changed. Sometimes, ongoing service will be provided by the selling advisor, but in other cases, the advisor has left the business or retired. And sometimes, customers will request a new advisor if they're not satisfied with their existing advisor. Where companies have exclusive sales forces, these issues are more readily addressed, i.e. the insurer can assign a new advisor to the customer. Where companies deal with independent sales forces, there can be more challenges. While there may be different approaches to ensuring that the best interests of the customer continue to be met, we believe that the key principles underlying ongoing service are: (1) that the customer is entitled to ongoing service and advice, and (2) that the customer has the right to appoint a preferred advisor

Recommendation 10: We recommend that regulators work with the industry to deal with the issue of ongoing service for insurers with non-exclusive distribution channels, building from the principles set out above, with the objective of developing an industry guideline that will reflect these commitments.

CONCLUSION This report's recommendations are designed to build on existing strengths in regulatory and industry customer-facing practices to support international standards in a way that reflects the culture and regulatory structure of life insurance distribution in Canada.

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Annex A: CLHIA Guidelines Guideline G1, Product Disclosure, deals with disclosure materials that insurers develop about their individual insurance products. Guideline G2, Individual Variable Insurance Contracts relating to Segregated Funds, sets out requirements in a number of important areas, including pre-sales disclosure, policy delivery, contracts, and fundamental changes. Guideline G3, Group Life and Group Health Insurance, sets out practices for group insurance, covering such areas as member certificates, conversion privileges, and change of insurer. Guideline G4, Coordination of Benefits, sets out a consistent set of rules to follow when an individual is covered under more than one group insurance plan. Guideline G5, Travel Insurance, sets out pre-sales disclosure and delivery practices. Guideline G6, Illustrations, sets out practices for pre-sales and post-sales insurance illustrations, reinforcing that non-guaranteed features are clearly identified and the impact of the variability of these features is well illustrated. Guideline G7, Creditor's Group Insurance, sets out operating and disclosure practices for Creditor’s Group Insurance. Guideline G8, Screening Agents for Suitability and Reporting Unsuitable Agents, sets out a framework to assist companies in establishing and maintaining a system for screening and monitoring agents. Guideline G9, Direct Marketing, sets out disclosure practices in the direct marketing channel. Guideline G10, 10-day Insurance Contract Rescission Right, sets out an industry standard of a "free-look" period for customers after receipt of a new life or accident and sickness policy. Guideline G11, Policyowner Statements and Notices, sets out disclosure practices for in-force policies. Guideline G12, Capital Accumulation Plans, sets out regulators' expectations for the operation of CAPs (this Guideline was developed by the Joint Forum and adopted by CLHIA). Guideline G13, Compensation Structures, Managing Conflicts of Interest, deals with insurers’ practices to monitor and manage conflicts of interest that could arise due to sales-related compensation. Guideline G14, Confirming Advisor Disclosure, deals with insurer practices to confirm that advisors are making appropriate disclosure about themselves and potential conflicts of interest. Guideline G15, Guaranteed Withdrawal Benefit (GWB) Illustrations, describes the information that should be included in illustrations of IVICs offering guaranteed withdrawal benefits. Guideline G16, Quebec Drug Insurance - Eligible Persons in Public and Private plans, sets out principles related to eligibility for coverage of certain persons under private plans.

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Guideline G17, Out-of-Country/Out-of-Province/Territory Coordination of Benefits, sets out the processes applying to coordinating payments from plans under which an individual is covered for out-of-country/out-of-province/territory medical expenses. Guideline G18, Insurer-MGA Relationships, clarifies the roles, responsibilities and accountabilities within insurer-MGA relationships.