Insurance industry regulators are urging life insurers to halt sales of segregated funds that charge investors penalties for withdrawing their money early.
The Canadian Council of Insurance Regulators (CCIR) and the Canadian Insurance Services Regulatory Organization (CISRO) released a statement on Thursday asking insurers to refrain from selling any new segregated fund contracts that have early withdrawal penalties, known as deferred sales charges. The regulators also said they expect the industry to halt such sales by June 1, 2023.
“There is a high risk of poor outcomes associated with DSCs in segregated fund sales and this form of sales charge is not consistent with treating customers fairly,” the CCIR and CISRO said in a joint statement.
The move to a potential ban of DSC segregated funds follows a nearly decade-long review of similar DSC commissions in the mutual fund industry.
In 2020, the Canadian Securities Administrators, an umbrella group for all provincial and territorial securities regulators, announced the sale of mutual funds with DSCs will banned as of June 1, 2022.
Often hidden from investors, DSCs force clients to pay an early withdrawal fee that can be as much as 6 per cent of the value of their investment to cash out of their funds. The fee tends to fall by a percentage point each year, moving down to zero after holding funds for five to seven years.
Segregated funds are similar to mutual funds but have a built-in insurance contract. Policyholders are given a guarantee on a portion of their principal investment, and their money is put into a portfolio of underlying mutual funds.
Canadians had more than $143-billion invested in segregated funds as of January, 2022, of which 42 per cent is in funds with DSCs, according to research firm Investor Economics, a unit of ISS Market Intelligence.
Segregated funds and mutual funds often have similar investment characteristics, including their fee structures. As a result of the similarities, CCIR and CISRO said they are interested in keeping the regulatory regimes for these products as “harmonized as practical and appropriate, to avoid any regulatory arbitrage in the sale of these products and to provide similar investor protection for both products.”
Later this year, the two insurance regulators will set up a joint consultation on upfront commissions in sales of segregated funds to look at other changes to compensation that may be needed, including “understanding the impacts of a complete ban of upfront commissions” or “other measures that could be taken to improve consumer outcomes,” as well as the potential impact on insurers and intermediaries.
During an industry event earlier this month, Mark White, chief executive of the Financial Services Regulatory Authority of Ontario, said mutual funds and segregated funds should be harmonized unless there’s a “product or market reason to diverge.”
“Otherwise we’re going to open ourselves to regulatory arbitrage and to unfair consumer outcomes,” he added.
The insurance industry has been under fire for not following investment dealers in banning DSC funds. Investor advocate Ken Kivenko of Kenmar Associates says the insurance industry’s failure to ban DSCs at the same time as the charges will end for mutual funds presents a “dangerous regulatory arbitrage scenario.”
There is a high likelihood that dual-licensed salespersons who can sell mutual funds and insurance products will convert mutual-fund clients into DSC segregated funds, Mr. Kivenko said. “The outsized commissions associated with DSC sales represents a material, irreconcilable conflict of interest – a conflict that empirical research has shown to be harmful to clients, especially the elderly,” he said.
Mr. Kivenko says the likelihood of converting clients into segregated funds is amplified by the fact that the higher conduct standards recently introduced in the securities sector with new client-focused reforms do not apply in the insurance business.
Harmonizing rules, he said, would “prevent further erosion of the hard-earned savings of Ontarians and another Ontario regulatory malfunction scandal.”
After the consultation with stakeholders, CCIR and CISRO said they “intend to move forward swiftly” with a policy position and guidance on upfront commissions in sales of segregated funds.
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