Insurance agents who sell segregated funds soon could face sales oversight rules and disclosure requirements similar to those pertaining to mutual funds. Regulators are considering ways to harmonize the rules in the two product categories.

Although greater harmonization of the rules is welcome in the insurance industry for the most part, some advisors, such as Bradley Sumner, an advisor with Investment Planning Counsel Inc. in Kingston, Ont., warn that the prescriptive nature of the requirements in the mutual fund space is not the right approach for the life insurance industry.

“The bureaucratic regulations [for mutual funds] are so smothering that they handicap quality advisors from being able to do financial planning for their clients satisfactorily,” says Sumner. “If the two [sets of regulations] become one, that’s just going to be a heavier burden on the advisors.”

In May, the Canadian Council of Insurance Regulators (CCIR) released a discussion paper on the regulatory framework for seg funds, inviting feedback on ways to ensure the regulations both protect consumers and provide a competitive and efficient marketplace for the product.

The CCIR paper largely focuses on the gaps in regulation between seg funds and mutual funds in areas such as sales oversight, standard of care and disclosure, particularly given the new rules coming into force under the second phase of the client relationship model (CRM2), which apply to mutual funds but not to seg funds. One CCIR goal is eliminating the potential for regulatory arbitrage.

The paper states: “If one structure is perceived to be less onerous than the other, there may be an incentive for intermediaries to prefer to sell the products regulated under one regime over the other.”

Nevertheless, the CCIR paper also states that the regulator hasn’t seen statistical evidence of advisors shifting from mutual funds to seg funds.

However, Sumner says, he has observed this trend: “In recent years, because of the overpowering [nature] of the [Mutual Fund Dealers Association Canada] and all of the bureaucratic regulations, there are more advisors saying, ‘I’ve had enough of all of these regulations. They’re taking up too much of my time and effort, so I’m going to move clients over to the segregated fund side’.”

There is conditional support for greater correlation in the regulations facing seg funds and mutual funds, considering the similarities in the products. Although the two product categories are structured differently, and seg funds have unique guarantees and estate planning features, the core investment components of the two products are similar.

“There has to be recognition that they’re not identical products,” says Susan Allemang, head of regulatory and policy affairs with the Independent Financial Brokers of Canada in Mississauga, Ont. “But, at the same time, the focus should be on working toward similar outcomes for investors.”

Although insurance regulators and securities regulators share many expectations about the approach to be taken, the insurance industry’s methods tend to be more principles-based.

“There is this notion that the securities side is regulated and the insurance side isn’t,” says George Aguiar, president and CEO of Mississauga, Ont.-based GP Wealth Management Corp., which operates both a mutual fund dealer division and a managing general agency. “That’s not the case. The regulations are different.”

The CCIR paper implies that a more stringent approach to regulation may be necessary. Specifically, the paper suggests that the general level of oversight of insurance agents may be insufficient. The paper points to a review of complaints about seg fund transactions, which show that more than 80% of those complaints are related to agents’ sales practices, especially regarding suitability of the product.

“[Requiring] a higher standard of care, product knowledge and sales oversight for segregated fund transactions [might be appropriate] in all provinces,” the CCIR paper states. “Complaint and enforcement data indicate that some life insurers may not be monitoring the product knowledge and sales practices of those [agents] selling their products as well as is being done on the mutual fund side.”

Adopting a more prescriptive regulatory regime is likely to be a challenge for some insurance agents, says Aguiar: “It has to be a process that simplifies workflow for advisors.”

The disclosure requirements for seg funds and mutual funds are similar. At the point of sale, mutual fund investors are required to receive a two-page, double-sided Fund Facts document that outlines key information about the product. Clients purchasing seg funds receive a Key Facts document that highlights the insurance features of the product.

However, CRM2 disrupts the playing field regarding disclosure. Mutual fund investors will begin receiving separate annual reports with clearer cost and performance reporting, a requirement that doesn’t apply to seg fund holdings, which are purchased outside of the securities dealer. There is concern that when investors begin receiving those new reports early in 2017, they’ll wonder why they’re not getting the same information for seg funds.

“We would have some concerns at this point that without that information [for seg funds], that will cause more questions to be asked,” says Aguiar. To avoid confusion, he adds, the insurance industry should provide the same level of disclosure as the investment side. “Ultimately, you want to make sure that the investor experience is consistent.”

GP Wealth has taken steps to align its sales and disclosure practices on both sides of the business. The firm will provide its seg fund clients with the same performance reports that mutual fund clients will receive under CRM2. GP Wealth also is working to provide the same type of cost reporting for both types of clients.

However, Aguiar says, his firm needs information from the insurance carriers in order to make that happen.

The Canadian Life and Health Insurance Association Inc. (CLHIA), however, does not believe CRM2 is the best approach for seg funds. While the CLHIA’s recent paper on insurance distribution supports more detailed cost transparency for consumers, the disclosure provided under CRM2 “is not as comprehensive or transparent as it could be.”

In addition, given certain differences between seg funds and mutual funds, the CLHIA paper argues, applying CRM2 to seg funds would not be appropriate.

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