Impact of proposed ban of DSC Sales on Segregated Funds
- David Gray and Byren Innes
- March 10, 2022
- Uncategorized
Intermediaries and insurers will be impacted by this proposed regulatory change
Regulatory Backdrop
The long-anticipated harmonization of regulations on Mutual Funds and Segregated Funds has begun. The Canadian Council of Insurance Regulators (CCIR) and the Canadian Insurance Services Regulatory Organizations (CISRO) have announced a plan to ban Deferred Sales Charge (DSC) sales of Segregated Funds effective June 1, 2023.
The regulators have stated that upfront commissions in segregated funds may present similar concerns to the sale of other financial products in terms of the potential for conflicts of interest as well as alignment in cost and services provided. In situations where the consumer is relying on an Advisor to sell them a suitable product, and the Advisor is being paid by the product manufacturer for the sale, these concerns apply.
The CCIR and CISRO are committed to improving outcomes for segregated fund customers and are contemplating what other changes may be needed in upfront commissions for segregated funds. As segregated funds and mutual funds are investment products with similar characteristics, insurance regulators are concerned about keeping the regulatory regimes for these products as harmonized as appropriate. The aim is to avoid any regulatory arbitrage in the sale of these products and to provide similar investor protection for both products.
In addition, CCIR and CISRO have Front-end Load purchase options under review in order to improve consumer outcomes.
Why? At the forefront of these changes are Consumer Protection and Fair Treatment of Customers. A parallel regulatory review is also targeting sales incentives to minimize any conflicts of interest. Protecting the consumer is paramount.
Segregated funds have been an established instrument to support a risk profile that needs or wants guarantees within a client’s investment portfolio. Insurance companies have been relied upon to provide the protection within their investment products, which comes with additional costs. Segregated Funds appeal to investors seeking yield while providing downside protection of capital.
Impact:
Our analysis shows that if an Advisor’s Segregated Fund sales were 100% DSC, switching to No-Load funds would require over 50 months to reach a breakeven point on revenue. While clearly this could impact the financial viability of an individual Advisor’s practice, the aggregate of all Advisors in a Distributor could have amplified impacts. The full impact is dependent on the mix of business – life insurance, living benefits, employee benefits and investment sales.
All parties will need to be thoroughly informed and educated on how these changes will impact and change their business model and processes going forward. Compliance and regulations will continue to get more involved in Advisor’s day to day practices. The following are a number of considerations as stakeholders review their options.
Challenges:
- Advisors: Transitioning business model to level or fee-based compensation. How is this managed from a business process as well as cash-flow considerations?
- Distributors: Transitioning business model to level or fee-based compensation. How is this managed from a business process as well as cash-flow considerations? What is the overall mix of business in the Distributor? What programs could a Distributor offer to assist Advisors in their transition?
- Carriers: Product development changes are typically a long process. Resource and technology constraints may affect the ability to quickly offer a newer suite of products that are compliant. If these products and their compensation options do not already exist, the process gets longer. What will be the impact of these changes on both new sales and net redemptions? What programs can a Carrier put in place to assist their Distributors and Advisors in making this transition successfully?
- Platform: Unlike IIROC and (a few) MFDA firms, a Nominee-name /Fee-based platform does not exist in the MGA world. There is no ‘Seg Fund Dealer”. Is this capability needed to accomplish the transition? If yes, who are the vendors? What is the cost of implementing a solution? Will Distributors invest in this? What capital requirements would be needed? What might be the holding/reporting requirements – e.g., client statements, CRM2, etc.?
- Succession planning for Advisors: The aging Advisor populations are poised to sell their businesses as they transition into retirement. What impact will the new cash-flow emergence have determining the value of segregated funds as part of the total sale price of a book of business? What impact will this have on Distributors? .
More to come. Other regulatory harmonization efforts
Securities regulators, such as CSA and SROs continue their efforts to protect consumers and to drive improved consumer outcomes. These will also need to be harmonized with the sales of Segregated Funds from insurance companies. Currently, the securities regimes are in the process of fully implementing the changes required to be compliant with Client Focused Reforms (CFR), under the amendments to National Instrument 31-103. Enhanced KYC requirements will logically apply to Segregated Funds as well.
Advisors and Distributors would need to apply the diligence requirements of Know Your Product (KYP) to support an enhanced suitability determination and increase the rigour around the products made available to their clients. Like IIROC and MFDA firms, insurance firms can expect that similar requirements will be applied to Life Insurance Distributors and Advisors. Carriers can expect to be actively engaged in providing the information and support needed to comply with KYP.
Time is short and the impact will be significant
While June 2023 seems a long way off, the next few months will be taken up by consultation. Following June 2022, the final regulations and guidelines will emerge. Impacted stakeholders will have less than a year to make the transitions required and some of the financial impacts may be significant. The direction is set. Those impacted can start now in analyzing the complete view of implications on the transformation required. What are the people, process, product and technology changes that need to be addressed? What are the new business and operating models required to succeed?
For an assessment of the impact to your firm, contact us at info@jclm.bm or give us a call to set up a consultation.
Reference: https://www.ccir-ccrra.org/Documents/View/3687