Evaluation of the Financial Advisory and Intermediary

Services Bill

Presentation to

Portfolio Committee on Finance

Council for Medical Schemes

9 October 2001

Purpose of Presentation

• FAIS Bill has significant implications for the Medical Schemes Act – Through inclusion of definition of a health benefit as a

“financial product”– Proposals by FSB

• Inclusion in general framework requires that the implications of this framework are properly assessed

• Key concern: adequacy of checks and balances• Key concern: process followed

Key Issues

• Arms-length relationship between regulator and regulated

• Ability for all parties to participate evenly in the development of legislation

• Credibility of regulatory framework depends fundamentally on:– Independence of regulators– Appropriateness of the powers allocated to regulators– Even-handedness in the legislation (linked to process)– Even-handedness in the subordinate legislation (linked

to process)

Topics Covered

• Conflicts with the Medical Schemes Act• Anti-competitive behaviour• Delegations• Ombud• Exemptions• Subordinate legislation• Other issues• “Cost benefit analysis”

Conflicts with the Medical Schemes Act

•Issues–FAIS creating regulatory confusion–Definition of “health benefit”–Unintended regulation of medical scheme administrators–Reform process underway in terms of Medical Schemes Act–FSB recommendations

Medical Schemes: broker market

• 80% of medical scheme beneficiaries in open schemes

• 7,000 brokers accredited by Council• 1 broker for every 640 open scheme beneficiaries• 1 broker for every 214 principal members• Pressure to increase commissions to

accommodate new entrants• Act requires a maximum of 3% + VAT for

admission with no provision for ongoing commissions (many administrators forced to pay more)

Medical Schemes Brokers: Concerns

• Primarily an issue of broker remuneration and incentives

• Member movements strongly linked to broker remuneration – scheme swapping, “co-administration”

• Group movements are most important (unlike ST and LT Insurance)

• Brokers in a position to pressure administrators and schemes into paying higher commissions

• Brokers own shares in administrators

Large-scale Member Churning

• In the first nine months of 2000, some 830 000 existing beneficiaries changed schemes

• Member movement: – drives up non-healthcare related costs– destabilises industry, especially through

erosion of stable restricted membership pools

The Response

• Discussions with AHBA/SAHIA, and other stakeholders, regarding mechanisms to grow medical scheme membership and reward value added to environment, while reducing perverse incentives in the environment for churning, including such options as:– Promotion of greater transparency through Code of

Conduct– Linking payment of commission to use of brokers– Promotion of negotiated professional fees for

ongoing services to clients

Medical Schemes: Concerns with FAIS Bill

• Inadvertently includes medical scheme administrators – as they provide advice on medical scheme benefits

• Administrator and broker will be faced with confusing situation

• Dual regulatory environment• Incorporation under the ombud has clear

problems (within the current formulation)

Medical Schemes: Concerns

• FAIS already provides for extensive exemptions• Additional legislation and regulations in MSA will

eliminate FAIS legislation – so why regulate in the first place?

• FAIS inclusions and FSB recommendations will undermine holistic approach to regulation in terms of MSA

• Not cost-efficient as FAIS will undermine effectiveness of structures set up in terms of the MSA

Medical Schemes: Concerns

• Functional approach in FAIS implies that medical scheme brokers doing other business will fall under FAIS in any case – why then create a dual arrangement?

• The independence of the ombud is in question and the use thereof cannot be regarded as beneficial

• The legislative framework for inclusion under the ombud needs review

Medical Schemes: Recommendations

• All references to the regulation of medical scheme brokers and intermediaries must be removed from the FAIS Bill

• Proposed amendments by the FSB must be disregarded

• Use of the ombud should be considered through amendments to the MSA, and not through provisions in FAIS

Protection from Anti-competitive Behaviour

•Issues:–Horizontal collusion–Vertical collusion–Usefulness of increased transparency and conduct regulation–Measures that need to be considered

Public Agent

Product 1

Product 2

Product 3

Incentive for product supplier to provide kickbacks to agents (brokers, advisors, intermediaries)

Upsets principal-agent relationship and results in market distortions

Commissions

Financial Products

Public

No discountXNo bypass or discount permitted via arrangments with Financial Product Suppliers

Commissions set collusively by intermediaries

Anti-competitive behaviour

• Commission and remuneration of brokers• Conflicts of interest• Collusive and anti-competitive practices• The right not to use a broker or intermediary• Claw-backs need to be considered

Delegations

•Issues:–Wide powers to delegate–Independence of the Regulator

Minister of Finance

Head of TreasuryAny other Treasury

Official

Registrar

Financial Services Board

Chairperson Any person appointed by the Board

Executive of the Board

Any person recognized by or

under this Act

Any power

Any power

Any power& duties

Any power & duties

Any power

Any power including delegated powers

Any power including delegated powers

Any power including delegated powers

Delegations: Shortcomings

• Scope of delegations:– No limits placed on what can be delegated– No limits placed on what can be delegated to “any

person recognised or regulated by the Act”– Registrar has powers of exemption, which according to

the Act can be delegated

• Conclusion:– High risk of regulatory capture

Delegations: General Recommendations

• The scope of delegations need to be specified within the Act– Powers that can be delegated– Powers that cannot be delegated

• The basis upon which any power can be delegated needs to be specified within the Act

• No power in respect of this Act should be delegated to any stakeholder representatives

• Guidelines concerning the exercise of any powers need to be transparent in the Act (to ensure impartiality at all times)

Delegations: Specific Recommendations

• No delegations should be allocated to a “representative body”

• The delegation of a Minister’s powers should be very carefully assessed– Regulations– Key appointments

• The blanket provision dealing with the delegation of delegated powers needs to be reviewed

The Ombud

•Issues:–Judicial independence–Rules (the establishment thereof)

Ombud: Requirements for Judicial Independence (from case law)

• Objective: ensure a reasonable perception of impartiality

• Conditions of independence:– Security of tenure (decision-maker removable only for just

cause);

– Secure against interference by the executive or appointing authority

– Basic degree of financial security from arbitrary interference by the executive in a manner that could affect judicial independence

– Institutional independence with respect to matters that relate directly to the exercise of the tribunal’s judicial function

Ombud: FAIS Framework

BoardAdvisory

CommitteeRegistrar

Ombud

Powers:•Appoint ombud•Remove ombud•Make rules•Establish levies•Financial oversight

Board makes decisions after consultation on:•Appoint ombud•Remove ombud•Rules

Could be the chairperson of the Board, and therefore exercise the same powers

Ombud: Pension Fund Adjudicator

Minister of FinanceAuditor General

Pension Fund Adjudicator

Powers:•Appoint ombud•Cannot define a complaint•Make regulations

Financial accountability

Ombud: Short-comings with Respect to Independence

• Executive interference: – Board determines the complaint and the manner in

which complaints are to be dealt with– Financial independence: accountable to Board, and

levies established by the Board and therefore not free from arbitrary interference

– Establishment of rules: wide scope rests with the Board to establish rules in any manner it sees fit.

• Conclusion:– Independence of the ombud is significantly in question!

Ombud: Recommendations

• Financial oversight: the Ombud should be audited by the Auditor General and be independent from the Board, the Registrar and the Minister of Finance

• Appointment of Ombud: should be by the Minister of Finance, “after consultation” with all regulatory authorities (not just the FSB) affected by the decision

• Advisory Committee: No relationship to the Advisory Committee of any form should established

• The provisions relating to rules should be replaced by requirements for regulations (basis: more transparent and require Ministerial approval)

• Guidelines and principles for the establishment of regulations relating to the ombud need to be set forth in the Act itself

Powers to Exempt

• Power to exempt should rest with the Board and not the registrar

• Exemptions should apply to persons, and not to provisions of the Act – such amounts to an amendment of plenary legislation

• The basis for permitting exemptions should be more clearly stated in the Act– In public interest– Not provide preferential market treatment– Etc.

Advisory Committee

•Issues:–Independence–Make-up–“Veto rights” and powers

Advisory Committee: Recommendations

• More guidance given to Minister in appointing members

• Should not contain representatives• Should have no powers• Should not have veto rights over codes of

conduct or any subordinate legislation

Subordinate Legislation: Recommendations

• More complete framework of enabling legislation needs to be provided

• Proposed rules should instead be provided for in regulation

• Codes of conduct should be promulgated in regulation (after consultation with relevant stakeholders)

Codes of Conduct

•Issues:– Potential bias in the establishment of the Codes of Conduct

Codes of Conduct: Concerns

• Concerns:– Drafting is responsibility of the Registrar– Must be drafted “in consultation” with the Advisory

Committee, Representative bodies of the Financial services industry and “client and consumer bodies determined by the Advisory Committee

– Code of conduct can be vetoed by the Advisory Committee and stakeholder interests

• Conclusion:– Code of Conduct will be biased in favour of industry

interests

Codes of Conduct: Recommendations

• Should be in regulation• Made “after consultation” with Advisory

Committee and relevant stakeholders• Power to make codes of conduct should not be

delegatable

Other Issues

• Power of the registrar to declare an application or resolution contrary to the Act – wide ranging, open-ended and will probably be struck down (Clause 38)

• Fit and proper• Conflicts of interest: Clause 16(1)d is inadequate• Enforceable consumer rights framework

entrenched in the main Act and not in subordinate legislation

• Need appropriate governing principles in the main body of the Act

“Cost-benefit analysis”

• Results of study based on unmotivated assumptions– 2% saving from inappropriate sale of LT insurance– 1% saving from increase in return on premiums

invested due to “increased competition”– 1% reduction in ST insurance premiums

• Benefit = R1,155 billion???• Alternative scenario sees consumers out of

pocket by R3,664 billion (conservative estimate)– 4% increase in ST and LT commissions