It is a sad fact of life in the Australian financial services industry that today’s cutting-edge product with all the bells and whistles will be next year’s legacy product.
It is also a sad fact of life for the industry that legacy products are costing insurance companies, financial services houses and superannuation funds in the order of $350 million a year.
The extent of the problem was made clear at this year’s Investmentand Financial ServicesAssociation (IFSA) conference on the Gold Coast when the chief executive of Tower Australia, Jim Minto, called for an industry-wide approach, arguing that the “selective buying off of the most vocal clients” was not equitable.
Minto and his fellow Tower executive, Grahame Evans, made clear that doing nothing was not an option in circumstances where the costs per policy would only continue to grow.
Discussing the issue with Money Management in the week after the IFSA conference, Evans said that while the Government had indicated its support for a rationalisation process, the issue for financial services companies was the manner in which that process would be implemented.
“It is a question of where this fits on the Government’s policy priority list and the nature of the anti-detriment process,” he said.
However, Evans said the issue needed to be handled with some urgency in circumstances where the longer a solution was delayed the worse the problem was likely to become.
But in reality the legacy products problem has been with the Australian financial services industry for more than half a decade, posing questions not only for individual companies but the regulators as well.
The Australian Prudential RegulationAuthority (APRA) in 2004 acknowledged that the growing number of legacy products would give rise to increasing operational risks.
APRA said that with the move away from traditional life insurance products to investment-linked and contemporary products, many life insurers had significant portfolios of traditional policies made up of differing products series — some with only a handful of policies still in force, a range of terms and conditions, and varying bonus requirements.
“A number of insurers have also inherited products through mergers and acquisitions,” it said.
“Many of these legacy products run on old IT systems and the corporate memory required to run these products is being lost as staff move on.”
APRA said it was concerned about the increased operational risk posed by these portfolios of traditional products, a risk that was likely to increase over time.
The regulator said that a number of life insurers had had to compensate policy-holders because of errors discovered in older style products, with both the compensation and the associated systems changes to deal with the errors having proved expensive and time-consuming.
“APRA expects that systems and processes for legacy products are adequately maintained and that insurers devote appropriate resources to the management of legacy products,” it said.
The problem for the major insurers and financial services houses is that their legacy products not only give rise to administrative problems but also taxation issues that can only ultimately be addressed by the Federal Government.
In mid-2005 when IFSA wrote a submission to the Federal Government on the question of legacy products, it not only pointed out what might be achieved by way of a range of legislative amendments to the Financial Services Reform Act, the Superannuation Industry Supervision Act and the Corporations Act but also what might be achieved in terms of taxation law.
IFSA pointed out that under current tax law a liability was generally triggered when a person moved out of a financial product, even if they were moving into a very similar product.
“This creates a significant barrier to product rationalisation and is a key reason why customers are unwilling to terminate their interest in a legacy product,” the submission said.
It was a point driven home to Treasury officials during the IFSA conference, but one that elicited few specific responses.
However, the Government is understood to be sympathetic to the problems confronted by the financial services industry and to the argument that it would be helpful if transitioning a customer from a legacy product to a similar more modern product offering was a tax neutral exercise.
“The proposal is that when a person is moved from one product to another because the product provider has used this proposed process, then there will be comprehensive tax neutrality so that the person pays the same amount of tax and at the same time as they would have if they had retained the old product,” the submission said.
It said that in the absence of such tax relief, product providers would rarely be able to meet the threshold test to use the process.
According to IFSA chief executive Richard Gilbert, his organisation has been trying to broker a solution to the legacy products and rationalisation issues for most of the past decade, but acknowledged that it has only been in the past two years that the issue has been gaining traction.
The importance of the issue to IFSA and its constituents was made clear in its 2005 submission, where it said that the annual economic benefits resulting from the removal of existing legal barriers would be between $120 million and $350 million.
It said this represented the equivalent of approximately $70 per customer in legacy products and that, additionally, efficiency gains from product rationalisation should result in a reduction in product risk and consequent regulatory savings.
IFSA said that such savings would translate into significant benefits for both customers and industry by way of positive implications including enhanced competitiveness, improved disclosure, improved safety, reduced operational risk, access to innovative investment opportunities and cost reductions.
It said the principal risks with product rationalisation were customer dissatisfaction with a possible loss of benefits arising under an existing financial product and taxation consequences flowing from termination of interests in the product.
It said these issues could be addressed by imposing a no-detriment requirement on the financial product provider and introducing taxation rollover relief to maintain tax neutrality.
According to Tower’s Evans, the benefits of product rationalisation extend well beyond the manufacturers to reach into the adviser/client relationship.
He told the IFSA conference that from an institutional perspective, legacy products gave rise to extremely complex and inefficient systems and unhappy clients, while from an adviser/ client perspective they meant that there was little chance of developing strong relationships.
