Insurance advisors must adapt to post-DSC seg fund world

“You’ve got 12 months to recondition your business; otherwise, it’s going to be a challenge for you,” said John Cucchiella, president of SMEx Advisory Corp. in Toronto. Advisors who take a holistic approach to their business will be best positioned to thrive, he added: “I think the ones that perhaps don’t have the best practice management behaviours, they’re already or soon to be out the door.”

Earlier this year, the Canadian Council of Insurance Regulators (CCIR) and the Canadian Insurance Services Regulatory Organizations (CISRO) urged insurers to “refrain from new DSC sales in segregated fund contracts in line with the June 1, 2022, ban in securities, and expect a transition to a cessation of such sales by June 1, 2023.”

Changes to compensation models driven by regulatory changes aren’t new for the wealth industry, “but it’s the first time it’s hit the insurance world,” said Byren Innes, managing director and executive consultant with Jennings Consulting Ltd. in Toronto.

In fact, the insurance industry — including managing general agencies (MGAs) and manufacturers — is scrambling to get in front of not only the ban on DSC sales but also possible restrictions to or elimination of upfront commissions.

The CCIR and CISRO stated they will consult on upfront commissions in sales of segregated funds and consider a complete ban in the interest of harmonizing mutual-fund and seg-fund regulations “to avoid any regulatory arbitrage.”

Investment advisors looking to avoid the DSC ban for mutual funds have been able to shift to selling seg funds, but now “there’s no other registration category to go to,” said Dan Hallett, vice-president and principal with Oakville, Ont.-based HighView Financial Group.

DSC sales of seg funds have been “gradually” declining, Innes said, as some advisors and the industry have been anticipating the regulatory changes. “My guess, though, is that the bulk of seg fund [sales] are on DSC,” he said.

Investment Executive asked eight seg fund manufacturers about their plans to end DSC sales ahead of June 1, 2023. Firms also were asked whether clients could cancel existing DSC seg fund contracts with partial or full relief from early redemption penalties before the ban date.

Of the six firms that provided responses, four stated they intended to end DSC seg fund sales ahead of the ban but gave no dates.

John Killeen, vice-president and head of investment distribution with Sun Life Global Investments (Canada) Inc., stated in an email that there had been a “steady decline” in use of the DSC option and the firm is developing a plan to discontinue DSC sales prior to June 2023.

Sun Life advisors no longer sell DSC seg funds, Killeen added, and third-party advisors have “continued to decrease their support of DSC funds over time.”

Firms said they would work with clients under the terms of their existing DSC contracts, which may already allow for early redemptions or the porting of schedules among mandates without penalty. No firms indicated they would allow for early redemptions specifically in relation to the anticipated ban, although several said they already consider early redemption requests on a case-by-case basis.

Aly Damji, president of HUB Capital Inc.in Woodbridge, Ont., said the trend away from DSCs in seg funds has been accelerating due to the rise in popularity of commission chargebacks. Under the chargeback structure, the advisor, not the client, repays upfront commissions if the client redeems the fund early.

Damji said he supports a ban on DSCs, but added that clients “need independent advice regardless of how much they have in assets. By getting rid of some of these upfront commissions, clients will have fewer options.”

If regulators move ahead with their proposed bans, advisors will have to grow their books or go out of business as “their revenue is going to go down significantly,” said Kirk Purai, president and CEO of Carte Risk Management Inc., an MGA.

“Advisors need to get their book to [the] $10-million mark, as opposed to $5 million,” Purai said, which is the average seg fund book size for Carte advisors. “For the ones who are under $5 million, they may need to partner with another advisor and be able to subsidize their cost somehow.”

However, advisors hanging on to DSCs and/or upfront commissions may be delaying the inevitable, Innes suggested.

The era of DSC seg fund sales “is done — I’m positive,” Innes said. And if regulators decide not to ban upfront commissions, “they’ll have [a] really tight sandbox around it: ‘You can charge X on this kind of fund and Y on this kind of fund.’ I don’t think that’s a solution [as a long-term business model]. The solution is fee-based accounts, quite frankly, which is where the mutual fund world went.”

Innes said advisors considering a transition to a fee-based model should figure out how much revenue they will lose as a result.

“Analyzing the book [of business] is the first step — figuring out what the pain is going to be and then what are my strategies,” Innes said.

The next step is to communicate with clients about how the insurance business is changing, said David Gray, senior consultant with Jennings Consulting. In late April, the Canadian Securities Administrators and the CCIR published proposals that would enhance total cost reporting for investment funds and segregated funds.

“The No. 1 thing you need to do is be transparent,” Gray said. “Nobody likes to get a surprise.” If the MGAs and manufacturers with which an advisor does business “aren’t moving as fast as you think they need to” in terms of helping with disclosure and business transition, “get involved and get things moving.”

The elimination of DSCs and a possible elimination of upfront commissions could make supporting new advisors in the business even more challenging for an industry struggling to attract the next generation.

“You’re going to have to move away, for the first few years, from a commission-based model to more of a salary position,” Gray said. “You’re seeing that at a lot of the IIROC shops, where they’re combining a lot of small accounts, having one or two salaried advisors taking care of the assets under management, and then graduating [those advisors] to larger book sizes.”

Cindy David, president and estate planning advisor with Cindy David Financial Group Ltd. in Vancouver, believes the insurance industry will develop more programs to provide older advisors with a succession plan. And more advisors are transitioning their business to their children, she said.

An industry transition away from DSC will be “a good thing, even from a practice perspective,” David said. “If you have already eliminated DSCs, your residuals are higher and you have more time to sit back and think about how best to serve your client.”

Insurance advisors need to rise to the challenge of evolving regulations and find ways to adapt their businesses to best serve their clients, David added: “Do I want you as my financial advisor if you don’t have the wherewithal to figure out how to survive [changes in] your industry? Not really.”