Mind the gap

“I think that the disclosure rules we see with CRM2 [inevitably] will be applied to insurance as well,” says Cameron Foley, financial advisor with Hartry Foley Financial in Oakville, Ont., which operates under the umbrella of Markham, Ont.-based Worldsource Financial Management Inc. “[Disclosure] comes down to transparency and accountability, and that’s what these changes are all about. It makes perfect sense for this to apply to every aspect of the industry, from mutual funds to seg funds and exchange-traded funds.”

Although securities regulators have encouraged firms to apply the new disclosure regimes for securities to many or all products that insurance advisors sell, including seg fund contracts and annuities, the CRM2 regime is not mandatory for insurance products.

The prospect of extending CRM2 rules beyond seg funds to life insurance policies is a less popular notion in the insurance industry.

“Even if [a policy] has an investment [component], it’s primarily life insurance,” says Pierre Sasseville, national compliance officer with Kitchener, Ont.-based Financial Horizons Inc., which operates both a managing general agency (MGA) and a mutual fund dealer. “You’re buying life insurance, and you have the option of maybe putting money into it. So, I don’t see why an advisor would have to disclose his commission on life insurance.”

A rule change in this area would have significant implications for advisors who sell life insurance only. Whereas investment advisors typically maintain an ongoing relationship with clients, providing portfolio reviews and continued service in exchange for the ongoing compensation those advisors receive, life insurance often is sold as a one-time transaction, with little – if any – followup.

“That’s where it’s different in the insurance industry,” says Foley. “A lot of times, people sell a policy, then you might not hear from the broker ever again.”

So, if clients begin receiving reports highlighting the commissions their insurance agents receive, both initially and on an ongoing basis, those investors may question the value they’re getting in return.

From a compliance perspective however, Sasseville says, harmonized CRM2 disclosure rules for seg funds and mutual funds certainly would simplify things: “I would prefer to work with one set of rules than two sets of rules because the chance of making errors is far less if you only have one set of rules to apply.”

Dual-licensed advisors would benefit from a single set of rules rather than trying to juggle different rules for different products, says Foley. “Having consistency across the [financial services] sector as a whole would be a benefit to clients – obviously, first and foremost – but to advisors as well,” he says. “You can streamline your process across the board.”

The Canadian Council of Insurance Regulators (CCIR) indicated recently that new rules mandating this type of cost and performance disclosure for life insurance products may be on the horizon. In a recently published issues paper on seg funds, the CCIR suggests that, given the similarities between seg funds and mutual funds, having enhanced disclosure for one product – but not the other – may cause confusion among investors. Aligning seg fund disclosure requirements with CRM2, the paper states, could be a solution.

“The paper suggests very specifically that there is a gap that [the regulators] have perceived,” says Susan Silma, lawyer and co-founder of Guelph, Ont.-based consulting firm CRM2 Navigator and formerly a director with the Ontario Securities Commission, “and that they have a desire to plug the gap in disclosure requirements.”

Although the CCIR paper focuses on seg funds, Harold Geller, associate lawyer with law firm McBride Bond Christian LLP in Ottawa, believes regulators should consider extending CRM2 disclosure requirements to other insurance products as well. Permanent life insurance policies with investment components, such as universal life, he says, should be subject to the same regulatory requirements as other investment products.

“The reason why most people are sold universal life products is because they represent an investment opportunity,” says Geller. “You can create enormous amounts of investment room inside this product, and then you can put your money into segregated funds within that side account.”

Lack of comparable disclosure requirements – among other inconsistencies in the regulatory framework – for those investments vs other investment products, Geller says, is highly problematic. “There’s a gaping hole,” he says. “Nobody talks about that.”

Regardless of which products ultimately face expanded disclosure, Silma says, insurance agents and firms need to prepare themselves for the fact that changes are coming.

“There are a number of indications that insurance products probably will face some sort of increased disclosure expectations over the next few years,” she says. “Some insurance agents might be thinking that they don’t need to be paying attention to CRM2 because it doesn’t touch their world yet, but I encourage them to try hard to get in front of this.”

Some firms already have. They and their advisors who operate on both the investment and insurance sides of the financial services sector are taking steps toward voluntarily disclosing CRM2 information for all products they offer, to the extent possible.

“They believe that [disclosure] is going to be good information for clients, and that clients will appreciate it and benefit from it,” says Silma.

While more detailed account performance information is feasible for most firms to provide, cost information is more of a challenge. In order for MGAs to provide cost reporting at the level of detail required by CRM2, that would require a breakdown of cost information from the carriers.

Even in the absence of those numbers, however, Silma says, proactive advisors could crunch some numbers and come up with their own estimate of costs for clients.

Foley agrees that insurance agents are better off proactively addressing the topic of cost disclosure with clients – before clients ask about it. “Advisors should inform their clients even before the disclosure comes to insurance,” Foley says, “because there might be awkward situations if clients see their costs on the mutual fund side, then come back to their advisor and say, ‘Where are the costs on this side?'”

Even though it might be an uncomfortable conversation initially, Foley says, it’s an opportunity for advisors to highlight the value in the services they offer. Advisors also should keep in mind that clients are looking for this kind of information – and voluntarily providing it is likely to be a gesture that clients appreciate.

“Investors are, for the most part, not looking for very detailed calculations,” Silma says. “They just want some sense of whether [a product or service] has a reasonable cost, and have some context for it, and they want this information in a much simpler form than what is immediately available for insurance products.”

EXTENDING POS

Although much discussion has focused on the un- even regulatory landscape between insurance and securities products as a result of CRM2, another “gap” issue is emerging: the application of the Fund Facts and other point-of-sale (POS) rules to mutual funds, but not to exchange-traded funds (ETFs) and certain aspects of segregated funds, despite their many similarities.

The Fund Facts rules for mutual funds, together with the POS requirements that came into force in May 2016, mandate that clients purchasing a mutual fund must receive a two-page, double-sided, plain-language document outlining key features of the fund before the sale. Although the rules currently apply only to mutual funds, regulators are in the process of imposing similar requirements on ETFs, with the goal of ensuring consistent regulatory treatment of investment products.

ETF manufacturers already produce a similar disclosure document, but are awaiting guidance from regulators that will standardize the content to be included in the proposed ETF Facts, according to Pat Dunwoody, executive director of the Toronto-based Canadian ETF Association: “The industry is preparing for that initiative.”

The element of the initiative that remains unknown, Dunwoody says, is whether delivery of ETF Facts will be subject to the new POS rules for mutual funds. As ETFs have intraday pricing, she says, pre-sale delivery could be challenging. “In a lot of respects, pre-sale [delivery] doesn’t make any sense for us, given that you would actually have to look at a clock to determine whether the client received the form prior to the sale,” she says.

In the world of segregated funds, meanwhile, insurance carriers already produce plain language Fund Facts-style forms that are similar to the ones required in the mutual fund industry. According to Guideline G2 from the Canadian Life and Health Insurance Association (CLHIA), the Fund Facts form for insurance products must be provided as part of an “information folder” delivered to clients before they sign an application for a seg fund, along with a “Key Facts” document that briefly describes the insurance features of the fund.

G2 is incorporated into the Insurance Act regulations in Ontario, and in Quebec, the Autorité des marchés financiers (AMF) has a similar rule. In other provinces, Fund Facts rules are not formally embedded into insurance regulations. However, according to the Canadian Council of Insurance Regulators (CCIR), compliance with G2 is required by all common-law jurisdictions.

The elements of G2 pertaining to Fund Facts have been in place since 2011. Since insurance agents have always been required to provide disclosure prior to the sale of an insurance contract, the prospect of pre-sale delivery of Fund Facts was not as contentious for seg funds as it was for mutual funds. One point of difference, however, involves subsequent fund purchases. If a Fund Facts form has been revised since a client’s purchase of a mutual fund, in most cases, the client must be provided with the revised form before further purchases. That rule does not apply to seg funds, but the CCIR published a paper in May 2016 seeking input on whether to institute the same requirement.

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