AHBA PRESENTATION TO THE PARLIAMENTARY COMMITTEE ON FINANCE PRESENTED (PCOF) ON 2nd OCTOBER 2001
Andrè Jacobs and Mark Arnold
On the 31st of July 2001, AHBA made a written proposal to PCOF in respect of the exclusion of the health care intermediary from the Financial Advisory and Intermediary Services Bill ("the Bill"). In essence, the proposal dealt with the fact that: -
∑ financial advice is complex and as a result market conduct regulation is required; and
∑ that the Bill contains, inter alia, many of the provisions currently contained in AHBAís existing Code of Conduct.
On the 2nd of October 2001, AHBA made an oral presentation to PCOF which addressed the following issues: -
1.The events that led to AHBA, which is a representative body of health care intermediaries, addressing PCOF;
2. Prevailing misconceptions in respect of the health care intermediary; and
3. Furnish practical examples, by way of a case study that illustrates that health care advice forms part of financial advice;
4. General principles dealing with market conduct and prudential regulations;
5. Concerns expressed by the Council for Medical Schemes ("the Council").
1.The events that led to AHBA addressing PCOF
∑ Consultative process When the Bill was initially drafted, an extensive consultation process was undertaken by the Financial Services Board ("the FSB"). Comment from all stakeholders, as well as the general public was invited. During the consultations, AHBA, the Registrar of Medical Schemes (at that time, Mr. D Kolver), the Life Offices Association ("the LOA"), the Financial Planning Institute of South Africa ("the FPI") and the South African Insurance Association ("the SAIA") voiced their support to repeal the provisions of Section 65(3) and (4) of the Medical Schemes Act, No. 131 of 1998. These sections provide for the accreditation of health care advisors.
AHBA conducted a one-day seminar during August 2000, attended by industry representatives such as the FSB and the Council. The seminar focussed on various aspects of the Bill and its future impact on health care intermediaries. Subsequent to the seminar, it came to the attention of AHBA that the Council requested that health care intermediaries be excluded from the Bill. This was a surprise to AHBA as there had been no previous indication to that effect by the Council, especially as every other industry participant had supported the inclusion of health care intermediaries under the Bill.
∑ The nature of a financial advisorís practice The majority of financial advisors provide advice relating to many financial products, such as (but not limited to), retirement funds, unit trusts, life assurance, short term insurance and health care. A clientís health care needs may be accommodated by more than one specific financial provider and their product(s). Whilst a financial advisor may specialise in one area of financial advice he will still be familiar with and apply general principles of financial advice. This is due to the fact that the underlying nature of financial advice remains the same regardless of the particular field or level of advice. Furthermore, the various disciplines within financial advice are integrated with one another and do not operate independently from one another.
∑ The function of financial advice The following extract from Financial Regulation in South Africa (Bamber et al) highlights that financial products differ from most other products or services which a person may purchase during the course of their lifetime. Some of the common characteristics of financial products are: -
∑ Financial products are purchased infrequently and the consumer has little experience regarding such products;
∑ The consumer lacks confidence when purchasing financial products;
∑ The consumer frequently requires advice both before purchasing financial products and thereafter;
∑ The consumerís needs can be satisfied by more than one type of financial product. For example, a consumerís health care needs may be met by joining a medical scheme or obtaining a health insurance policy which can be via a short or long term insurance product;
∑ The purchase of financial products often creates a fiduciary relationship between the intermediary and the client. We can interpret the fiduciary relationship to mean that the financial advisor assumes a responsibility towards the client and is responsible for providing the best advice under the circumstances.
AHBA believe that all of the criteria outlined above are equally applicable to products available within the health care environment.
The function of financial advice always remains constant. Financial planning organisations from 15 countries are members of the international Certified Financial Planning council, and follow the same financial planning process, namely: -
∑ Establishing a relationship with the client. ∑ Establishing the needs of the client. ∑ Analysing the needs of the client. ∑ Providing solutions to the clientís needs. ∑ Implement the recommended solutions. ∑ Ongoing revision of the recommendations.
The view that health care advice forms part of financial advice has been supported by various internationally recognised authorities such as the Health Insurance Association of America and Professor GL Marx of the University of Pretoria.
2. Prevailing misconceptions in respect of the health care intermediary
The sustainability of the health care intermediary market
According to the Councilís records, there are currently 5 050 intermediaries (excluding apprentices) that are accredited. Using the 1999 statistics of registered principal members on open schemes (1 579 798), we can assume that there is on average, an intermediary for every 312 principal members. This would, at first glance, appear that an intermediary would not earn sufficient income based on the number of members to whom services are being rendered and therefore be persuaded to "scheme-swap or member churn". However, the intermediary market is in fact sustainable without these practices and the following serves as motivation:
∑ An intermediary's income is not limited to (and only dependent upon) that of health care products. There are alternative revenue streams from other financial services products, consulting fees, etc.
∑ The number of intermediaries accredited with the Council does not necessarily imply that these intermediaries are actively involved within the health care market, or that their main stream of income is from health care advice. If for example, the intermediary focuses mainly on other financial services products, but in order to furnish comprehensive advice to the client, is required to be accredited with the Council to introduce, inter alia, member(s) to a scheme, then the statistics cannot be seen as a true reflection of the number of intermediaries involved mainly within the health care industry.
∑ Provision should be made that some intermediaries, whilst accredited, do not market any medical scheme(s) or their products and will not reapply for accreditation. The number of principal members being serviced per intermediary would therefore be increased.
Churning There is a presumption that churning is an economic incentive. As stated above, financial advisors do not receive the majority of their income from health care advice.
Although there may be limited cases of financial advisors churning their clients, the Bill will assist in reducing (and hopefully eliminating) this type of behaviour by transparent disclosure requirements. If remuneration is kept at the same level regardless of whether advice is given to a consumer at inception or on an ongoing basis, this will obviate the incentive for financial advisors to churn their clients unnecessarily.
Remuneration It has been reported that intermediary remuneration is a big contributor to escalating medical scheme premiums. In addition, it has also been suggested that the recipient of the financial, specifically, health care advice, be responsible for payment to the individual financial advisor. These allegations are used by the Council to support the separate governance of the health care intermediary to enable them to directly intervene and control the remuneration of the health care intermediary. However, governance of the health care intermediary under the Bill will not prevent the Council from ensuring protection of the health care rand.
The financial product provider must ensure that a client (who may be a member of a medical scheme) understands the mechanics of the financial product and how it may impact on their health care risks. In fulfilling this obligation, financial advisors / intermediaries are utilised and must therefore be accordingly remunerated. The removal of the financial advisor will not result in lower overhead costs for the financial provider due to the fact that internal structures would have to be established to inform or familiarise the consumer with a particular financial product. Hence the consumer or recipient would ultimately still bear the costs associated with the financial provider directly furnishing advice without the assistance of a financial advisor.
We must also take account of the fact that the purpose of the Bill is to educate and protect the consumer. A majority of consumers requiring a financial product would in many instances be unable to afford an additional financial advisorís professional fee. As a result, they may dispense with obtaining the financial advisor advice and purchase the financial product without appreciating the possible financial consequences. The result would be that the intent and purpose of the Bill would be thwarted.
A suggestion to the Councilís remuneration concerns would be to ensure that the appropriate industry regulatory bodies co-operate to ensure the prevention of "remuneration arbitrage". Although it is beyond the scope of this memorandum, this point was highlighted at the presentation to encourage proper market conduct.
3. A case study that illustrates that health care advice forms part of financial advice
Mr. J, a very healthy 30 years old, just married with a newly born baby asks Mr. P an accredited health care broker and certified financial planner to draw up a comprehensive financial plan. Mr. Jís previous financial needs in order of importance were:
∑ Short term insurance
∑ Short term savings
∑ Investment plan
∑ Medical scheme
∑ Life cover
After a comprehensive needs analysis and current provisions it was discovered that his priorities should change as follows:
∑ Increase disability cover dramatically;
∑ Improve retirement provision to maximise tax benefits;
∑ Increase life cover marginally;
∑ Reduce short term insurance;
∑ Reduce short-term savings due to the tax deduction being exceeded;
∑ Retaining investment portfolio constant but invest portfolio more aggressively; and
∑ Reduce medical scheme to a less comprehensive medical scheme or option.
These proposed amendments to Mr. Jís portfolio were clearly explained with full disclosure of the impact it will have on his familyís risks.
A few months later he was hospitalised due to an accident and suffered complications. His expenses were R50 000 more than his medical scheme limit.
He is upset and wants to seek recourse for bad advice, to who will the complaint be lodged? (The FSB or the Council?)
Should Mr. J complain to the Council, it might be decided that the advice was inappropriate (only investigating singular product advice). Should Mr. J complain to the FSB, it might be decided that the advice was totally appropriate (investigating a comprehensive financial needs analysis).
The only regulator able to analyse a comprehensive needs analysis, and consequently the financial advice, would be the FSB. The public and all industry related associations accepted this principle.
4. General principles dealing with market conduct and prudential regulations It is the stated intention of the Bill to govern financial advice and thus ensure the protection of the public when purchasing financial products. This purpose will be best achieved by a "catch all" governing legislation that deals with all various disciplines in the financial services industry. More importantly consumers will know where to seek clarification and if necessary, recourse. This will further promote legal certainty. The exclusion of the health care intermediaries from the Bill will result in a duplication of regulatory bodies and legislation that will undermine the intention of the legislator as evidenced in the Bill. This principle of a "catch all" legislation was proposed by the Nel commission.
Limitation of general arbitrage It is AHBAís submission that the inclusion of health care intermediaries in the Bill will significantly reduce the potential for arbitrage in the areas of: -
This is best illustrated by way of a practical example. It is not uncommon for a financial advisor to furnish advice to an employer on aspects relating to the pre-funding of their medical scheme liabilities for employees upon their retirement. The extent of the liability will have to be examined which in most instances an employer will have insufficient resources to immediately meet this liability. In order to reduce this liability the financial advisor may give poor advice by suggesting alternative medical scheme benefits that cost the company less but which detrimentally affect the employee has they have much less health coverage. The financial advisor further advises the employer to implement a provident fund and discloses all aspects relating to the provident fund as required under the Bill. A fee is charged for his consulting advice, (fully disclosed) and commission for implementing the provident fund. However, in the case of this financial advisor not receiving remuneration from the medical scheme he is not governed under the Medical Schemes Act. Any subsequent recourse to the financial advisor for incorrect advice pertaining to the medical scheme benefits is not available to the complainant because no remedy can be sought under either the Bill or Medical Schemes Act. Proper Dispute Resolution Measures
The Bill provides for a thorough dispute resolution structure, including an ombudsman. This provides protection, not only to the public, but also adequate protection to other role players. It can be expected that an ombudsman would not only be unbiased to the regulator, public or financial advisors but would also add unbiased legal fairness to disputes. The Medical Schemes Act does not provide for similar dispute resolutions. The Council seeks to govern the provisions of financial advice, and the provision of services by Administrators whilst upholding the rights of medical scheme members. This obviously does not offer protection to all role players as a direct conflict of interest could arise within the Council in mediating disputes.
Public Protection Effective public protection will only occur in an environment were the consumer is aware of their rights and the procedures in order to obtain recourse when those rights are infringed. Section 41(1)(c) of Chapter 3 of the Constitution (Co-operative Government) provides that government and organs of state shall provide effective, transparent accountable and coherent government within the Republic. It is AHBAís submission that the Bill will assist in achieving these goals.
Consistent Professional Standards The inclusion of health care intermediaries under the Bill will contribute to consistent professional standards in so far as all intermediaries operating in the Financial Services industry will have to conduct themselves in accordance with the same rules and regulations. This will promote market certainty and accordingly enhance public protection.
Co-operative Government Section 41(1)(c) of the Constitution provides guidelines for the co-ordination of legislation and action between various spheres of government or organs of state to ensure that they do not encroach on the functional integrity of others spheres of government. Precedents in this regard already exist by way of the Pension Funds Act and the Unit Trust Control Act. Currently prudential issuessurrounding thegovernance and administration of pension funds are dealt with in the Pension Funds Act. Market conduct pertaining to financial advice in this arena will be governed under the Bill. Similarly the Unit Trust Control Act governs prudential issues pertaining to that sphere of the Financial Services industry, whilst the Bill will govern the market conduct issues. The exclusion of health care intermediaries from the Bill will result in the governance of both prudential and market conduct issues under one Act, i.e. Medical Schemes Act. We believe that there is no justification for this exception.
5. Concerns expressed by the Council
We have proposed factors and workable solutions that address the Councilís concerns without the need to create the anomaly of a certain sector of financial advisors being excluded from the provisions of the Bill.
Consumer Protection The Bill requires, inter alia, disclosure of a number of issues by a financial advisor to their client and has also made provision for a code of conduct. In addition, the FSB has recourse to quasi-judicial bodies to enforce the provisions of the Bill, regulations thereunder and codes of conduct. If the conduct of a financial advisor is regulated under more than one Act and it contravenes only one of them resulting in their licence being withdrawn, this may not prevent that advisor from continuing to render advice under the alternative governing Act. Whereas in the case of a catch all legislation, this scenario would never occur.
Remuneration Council may still regulate the remuneration by capping the maximum amount payable and which is the current practice. This could include a consistent approach relating to services that the health care intermediary renders from inception. These will in many instances be to the clientís advantage and a precedent already exists in this regard. The LOA currently caps commissions payable in respect of risk benefits (GLA/PHI) provided via group funds such as a retirement fund. It is common practice in a retirement fund industry for retirement fund consultants to waive the commission on risk benefits, or negotiate a lower level of commission, in lieu of the administration fees they already receive from the retirement fund for administering the receipt of contributions and payment of retirement benefits to and from the fund.
Churning The Council is being quoted extensively in the media on the issue of health care intermediaries churning existing members between schemes. They have quoted figures of movement of 877 436 beneficiaries for the period from January 2000 September 2000 whilst during the same period only 57 000 new members entered the private health care industry, in support of their contentions. These statistics are flawed and do not take into account a number of factors, which when considered in the totality, provide a very different and more realistic picture of the situation.
Utlising a ratio basis of principal member: dependants of 1:1.7 the quoted figure of 877 436 beneficiaries translates into 324 976 principal members. Furthermore the Council has not taken into account the impact of normal labour turnover, which stands at approximately 15% of the formally employed population. Applying a similar turnover ratio to the private health care medical scheme population, it is apparent that the potential exists for 388 889 principal members to have transferred schemes due to a change in employment.
Whilst AHBA is patently aware of the fact that this calculation is in itself flawed as not all principal members who change employment will change schemes, it is nevertheless clear that labour turnover has a significant impact on the figures quoted by the Council. Similarly the Council has not taken into account the extensive merger and acquisition activity in the private sector. As one company is absorbed or merged with another, human resource practices are rationalised and standardised resulting in groups of employees moving from one scheme to another.
Furthermore the Council has not taken into account the administrative difficulties experienced by two large commercial schemes, being Caremed and Fedhealth during the period under review. Significant membership movement away from these schemes occurred as a result of both the administrative and/or financial difficulties experienced by the schemes during the said period. AHBA therefore disputes the conclusions reached by Council in interpreting the data. It is a simple commercial reality for Health Care intermediaries that the rebroking of a client employee base from one medical scheme to another is a costly and time intensive exercise which in the vase majority of cases is not a profitable exercise.
Asymmetry of Information We have already outlined why health care products and the advice given in respect thereof is no different from any other financial product. It is inherent in the nature of providing financial advice that there will be asymmetry of information between the consumer and financial advisor for the very factors outlined by Bamber et al. To successfully address this issue, it is necessary to educate the consumer on all relevant information pertaining to the product and the impact thereof on the consumerís personal and financial circumstances. Thus a primary component of providing of financial advice is to address the asymmetry of information existing between the consumer and the financial advisor.
Loss of income to the Council Should the market conduct of the health care intermediary be governed under the Bill, the income that the Council received for the accreditation of the intermediary will be offset against the fact that no expenses will be borne by the Council as a result of it not regulating this function any longer.
6. CONCLUSION Our written and oral submissions have clearly demonstrated salient factors which justify the inclusion of health care intermediaries under the Bill. We have also demonstrated the dangers inherent in excluding health care intermediaries from the Bill and the arbitrage opportunities that may be created. As highlighted throughout our submissions, we have also indicated the support of a wide variety of industry players as they too are affected by the future governance of the health care intermediary.
We thank the Parliamentary Committee on Finance for the opportunity afforded to AHBA to present its views.