Consumer Credit Enquiry Report: Life Offices’ Association & SA Insurance Association briefing

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Finance Standing Committee

08 May 2008
Chairperson: Mr N M Nene (ANC)
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Meeting Summary

The Life Offices’ Association gave a summary of the situation relating to Consumer Credit Insurance and the triggers to the enquiry, highlighting the persistent rumours of non-compliance. The Zimele standards were said to represent the long-term insurance industry’s Financial Sector Charter commitment to provide accessible products to low-income consumers, and these were explained. A proposal to incentivise Zimele had been made to benefit consumers and force out illegal operators. In relation to consumer education, the Association suggested that there must be a move away from generic financial literacy to specific product education.

The Report by the Panel of Enquiry into Consumer Credit Insurance was presented by Judge PM Nienaber. He referred to the methodology used by the Panel as casting the net as wide as possible, through questionnaires and gathering evidence from members, outsiders and meetings with the Financial Services Board, National Credit Regulator and the National Treasury. In the end the Panel could only comment on information given, leading to the possibility that the report was incomplete. It was noted that the core issue had been that consumer credit was an offshoot of credit, not of insurance. It could not be separated from the credit arrangement.

The recommendations made by the Panel report had addressed various issues. The Panel considered whether the premium should be regulated in the lower income end of the market and felt  this should apply. The Panel was unanimous that the servicing fee need not be regulated. This would go some way to eliminate problems. The introduction fee was seen as a philosophical problem that should be determined by the regulators concerned. There remained concerns that the lower end of the market was open to exploitation, and it was eventually resolved that there should be no commission capping at this end of the market. The NCR emerged as the  recommended regulator  because of the intrinsic link to credit and the fact that they had the capacity.  A dedicated committee should be formed  to deal with market conduct. Credit insurance was sent to have a sustainable value proposition, provided that the weaknesses in the system were addressed. Consumer awareness and education was to be an important aid to helping consumers avoid the pitfalls of credit insurance.

The South African Insurance Association said it would take industry bodies a fair amount of time to digest the 275 page report. The consumer education initiatives of this Association were outlined but it was noted that the scope of the need for financial literacy  was beyond its reach.

The main issues arising from the discussion included a request for a more specific explanation of the sections of the legislation that were unclear, clarity on cell captives, how the price of credit was determined, the question whether additional insurance was necessary if risk was already factored into the interest rate, the separation of roles as seller and credit insurance intermediary and the role of brokers. Once again the point was made that there had been poor participation by consumer organisations.

Meeting report

Consumer Credit Insurance in SA: Report of Panel of Enquiry
Life Offices’ Association (LOA) Briefing
Mr Gerhard Joubert, CEO: Life Offices’ Association, gave a brief overview of the role of the LOA which was to be the industry representative and self-regulatory body for the long- term insurance industry. He reviewed the total individual recurring new business for 2007 and said that it was useful to see what the size of the market was. He discussed the factors that led to this enquiry. Among these were the persistent rumours about non compliance around commission. He noted that there were no facts offered or formal complaints made.  This made it very difficult to do anything to remedy the situation. He added that all specific allegations had been responded to. The Zimele standards were a focus. He explained that Zimele represented the long-term insurance industry’s Financial Sector Charter (FSC) commitment to provide accessible products to low-income consumers. He said it took the industry a while to define standards. He noted that the methodology was based on fair Charges, easy Access and decent Terms (CAT) and said that this was not just a pricing issue.

In regard to Credit Life standards Mr Joubert referred to price caps and the monthly premium rate being of particular importance, noting that LOA were trying to establish fair (not necessarily low) rates for consumers. He said that the industry had not made sufficient use of the Zimele products and the LOA had proposed to incentivise the use of the Zimele. He said that this was supposed to push illegal operators out of the industry, but consumers still had trouble gaining access to these services. It was to be encouraged for the greater good of the community.

Mr Joubert then moved on to discuss the way forward. The LOA was currently analysing the consumer report and would submit initial recommendations to the LOA board by 29 May 2008. A workshop with FinMark Trust was also in the pipeline. The provisional recommendations were that there be regular communication by the insurance company to the client to increase awareness of cover, use of pre-existing conditions and extending the claim notification period to assist beneficiaries.

LOA Consumer Education had funded Financial Sector Charter consumer education to the value of R10 million in 2007. Trade associations played an important role here as they provided a credible source of information. A focus on vulnerable consumers was highlighted. He concluded by saying that the LOA needed more focused programmes in conjunction with the South African Insurance Association (SAIA). There needed to be a move away from generic financial literacy as consumers needed more specific knowledge.

Report by Panel of Enquiry into Consumer Credit Insurance
Judge Peet Nienaber , who had chaired the Panel of Enquiry, stated that the enquiry had been triggered, in part, by the report by Bruce Cameron in Personal Finance 07/07/2007 – “Regent bent commission law to boost policy sales” and similar other reports. After a brief introduction he discussed the methodology of the enquiry. This included inviting members of the public to participate, questionnaires, evidence from members and outsiders and meetings with the Financial Services Board (FSB), National Credit Regulator (NCR) and National Treasury (NT). He said they were trying to cast as wide a net as possible  and that the response from consumer organisations was poor and disappointing. The constraints faced by the Panel were a general lack of the powers of investigation, and lack of power to compel evidence from non-members. He said that if the information submitted was incomplete, to that extent so would the report be incomplete.

As a general point, Judge Nienaber noted that consumer insurance was an offshoot of consumer credit, and it could not be separated from the credit arrangement. Consumers did not always get a fair deal. There were “fault lines” to be corrected and activity would be required in order to change this.

Commissions were raised and international models were examined. Australia, the UK and the USA all had different arrangements, ranging from market oriented to fixed commissions. Intermediary remuneration brought about several issues, specifically that of the difference between introduction fees and servicing fees. The introduction fee was said to be pre-contractual and a fairly standard way of canvassing new business. The servicing fee was of a post-contractual nature and was mainly due to outsourcing of administrative work. The different capping formulae in the Short Term Insurance Act  and the Long Term Insurance Act for these fees had the potential to lead to arbitrage. The root of the problem here was the capping of the servicing fee. The credit provider was not a proper intermediary, therefore the administrative work was simply sub-contract work. Its capped nature caused a distortion and led to potential conflicts of interest and manipulation.

The way forward was outlined according to the issues debated. The first was that of premiums. The core question was: Should premiums be regulated at all? This was put to insurers. Their reply was that it be would be anti-competitive. Moreover the Panel considered whether the premium should be regulated in the lower end of the market. The Panel felt this should apply. The Panel was unanimous that the servicing fee need not be regulated. This would go some way to eliminate problems. Two major views were expressed regarding the introduction fee. One suggested that market forces determine the level of the fee, while the other contended that it should be regulated. The judge said this was a philosophical problem and should be determined by the regulators concerned. The main concerns centred around the exploitation of the lower end of the market, and to this end it was eventually resolved that there should be no commission capping at this end of the market, in line with what was applicable to funeral business.

Judge Nienaber remarked that South Africa should take note of the studies conducted by Australia, the UK and the USA to improve market conduct.   He said the problem lay mainly with monitoring and the investigation of non-compliance. With an emphasis on transparency and proper disclosure, a key recommendation was that a dedicated committee be formed to deal with market conduct.

The next recommendation by the Panel concerned which regulator should assume control of credit insurance regulation. Prudential control should stay with the FSB. For market conduct and compliance, it was recommended that principal control should rest with the NCR. The reasons offered were mainly that credit insurance was an offshoot of credit, not insurance, and that the NCR had the infrastructure do to so.

Regarding the Value Proposition, the Judge stated that people on the street saw credit insurance as a scam and this was due to a number of poor perceptions. The presentation highlighted that despite the problems (including lack of consumer awareness, wide exclusion clauses and short notice periods), credit insurance had a sustainable value proposition, provided that the weaknesses were properly addressed.

The most important comments made on consumer education were that consumers' exposure to financial products needed to increase and they needed to be educated on specific dangers, to help them better deal with the products and their pitfalls.

Generally the Panel sought to deal with issues on which opinions may legitimately differ and to acknowledge that some of the recommendations may not be popular. As a result of this enquiry, much valuable information had been collected, which deserved to be preserved. The Panel hoped that, irrespective of whether the recommendations were accepted, its report would serve as a contribution to a better understanding of consumer credit insurance in South Africa.

South African Insurance Association (SAIA) Briefing
Mr Barry Scott, Chief Executive, SAIA, concluded the presentation with a few closing comments. He said that it would take industry bodies a fair amount of time to digest the 275 page report. He said he was not sure how many of the Panel's recommendations would be picked up, but said that they would have some bearing on the consideration of Section 48 of the Short Term Insurance Act. He added that the micro-insurance discussion paper would be available by the beginning of 2009 and said it would have impact on the way the industry dealt with consumers. In regard to consumer education, he made mention of the three areas targeted. These were community representatives doing face to face literacy, financial education in schools and mass media (advertising in taxi ranks and trains). The campaign aimed to reach millions of people, but he felt that the scope of education needed was huge and was far beyond the reach of bodies like SAIA. He reiterated the importance of education as most of the problems faced arose as a result of an uninformed consumer base.

Discussion
The Chairperson opened the question session by referring to the Long Term Insurance Act (LTIA) and Short Term Insurance Act (STIA) regulations and the Panel’s view that they were unclear. He asked if the Panel could identify specific areas that were unclear. He wanted the Panel to expand on the regulation of the service fee. He stated that he did not understand cell captives, and asked for clarity on this topic.

Judge Nienaber responded by referring the Committee to the report, specifically Chapter 6, and stated that the legislation was complex. This rather technical chapter provided detail of what was unclear.

He said that according to Section 48(2) of the STIA, there was no commission cap for underwriting managers and this created problem. He expanded on this statement by adding that “cell captives” were a South African invention and said that they could lead to “ring fencing of insurance”. This in turn had the potential to lead to the circumvention of commissions, and created potential for conflict of interests. He said the FSB must look carefully at the possibility of issuing cell captive licences  to minimise these problems.

Dr D George (DA) asked if the Panel had looked at how the price of credit was determined, as it was linked to the individual’s risk. He said that the interest rate reflected the risk of an individual applicant. He wanted to know why there was a need for credit insurance in light of this and asked if this question featured in the deliberations.

Judge Nienaber said that on the issue of price determination, the question of whether the premium was excessive was dealt with in Chapter 13, “Value Proposition”. He said that these prices were actuarially determined and consisted of various components such as risk, expenses, fixed costs and profit. The basic issue was whether the premium should be regulated. The Panel had made the recommendation that it should not. The control of this fell within the ambit of the National Credit Regulator. It was incumbent upon them to ensure that prices and costs were not exorbitant.

Mr K Moloto (ANC) asked why Credit Life Insurance should be regulated by the NCR, and if the NCR had the expertise to ensure credit providers were compliant. He also asked how it would be possible to ensure people had options.

Mr Joubert said that they had contacted eight consumer representative organisations as well as placing advertisements calling for submissions from the public. The response was very poor and he could not explain why the public did not respond. This made it difficult to obtain suggestions on what problems there were and what options consumers needed.

Judge Nienaber responded that there was a lack of consumer education and referred the Committee to Chapter 12. The free choice rule was applicable here, where consumers had the right to ask about their options. As a general practice, consumers, though they were aware of this, just did not want to go to the trouble. This led to them simply accepting the first suggestion from the trader.

Mr B Mnguni (ANC) asked what the role of the credit provider was in this issue.

The Chairperson highlighted the fact that, as previously stated, there was no intermediary in this scenario.

Judge Nienaber said that the Consumer Credit Insurance (CCI) was primarily for the benefit of the credit provider, to cover them in cases of default.

Mr Moloto noted the fact that this was a unique situation. He asked how it could be possible to separate the insurance from the commodity seller while the retailer was the one selling the insurance.

Mr Scott said that the differentiation in roles between the credit provider and an intermediary, like an insurance broker must be noted. He said brokers’ maximum commission was capped at 20% and they could make a good living selling traditional insurance. However, they would on average only make R10 to R20 on a consumer insurance deal. This could not generate enough income. It was not feasible to have formal brokers selling consumer insurance, therefore this must reside with the retailer. This was seen very markedly in the furniture selling market.

The Chairperson said that he did understand why commissions needed to be taken when this insurance was sold by the retailer.

Dr George said that if  a service provider was offering a product at a set interest, that provider should surely be pricing the risk into the interest rate. Further insurance seemed exorbitant.

Judge Nienaber replied that not everyone would be taking out credit insurance. This was a way of covering these situations. He acknowledged that a valid point had been made and suggested the question might be better answered by the actuaries.

The meeting was adjourned.

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