To Members of the Legislative Council:
I’m writing to inform you about one of the largest financial scandals in the history of Hong Kong. It involves hundreds of thousands of victims, the vast majority of which are clueless about what happened to them. I suspect most of you have never heard of an investment-linked insurance scheme (ILAS), even though some of you probably own one. This product is typically promoted as the equivalent of a pure fund investment, when it is actually a fund investment wrapped within an insurance contract, which has several layers of additional high fees. The entire first year of premiums are often paid to the agent or broker as a sales commission.
Because it is extremely profitable, this product is aggressively promoted to Hong Kong citizens, despite the fact that it was designed for expats. The “insurance wrapper” (also called a “tax wrapper”) allows expats to evade capital gains and estate taxes in their home countries. The tax savings is supposed to offset the high fees, but in most cases, the fees completely eat up the tax savings and more. This has been widely reported on in other countries. See this Reuters article for an example. Such reports are basically saying that most ILAS products are ripoffs.
If an ILAS product is a bad deal for expats, then it’s a much worse deal for locals. Because Hong Kong citizens don’t pay capital gains and estate taxes, a tax wrapper is useless to them. It offers no tax savings. Its fees are unnecessary. Even if a particular ILAS product were ok for an expat, it would still be hard to make the case that it is right for a local. What this means is that every sale of an ILAS product to a Hong Kong citizen is arguably a mis-sale. Advisers have no good reason for recommending ILAS to them instead of a pure fund investment.
I’ve read a report in the South China Morning Post in which an industry professional is quoted as saying that 75% of all investment products sold to consumers in Hong Kong are ILAS products. If that is even roughly accurate, the number of ILAS mis-sales might reach into the millions. That same SCMP article also quotes another industry professional estimating that 93% of ILAS products are surrendered before maturity, which triggers a steep penalty. In other words, these products are essentially poison pills, or time bombs that blow up in the face of almost everyone who buys one, no matter whether the purchaser is an expat or local.
I believe Hong Kong would be better off if ILAS didn’t exist. Its primary value is to help expats cheat their governments out of tax revenue. But if that’s an essential service, I’m told that there are cheaper ways for expats to evade taxes, such as through offshore brokerage accounts. This means consumers in Hong Kong, including expats, have nothing to lose if ILAS were to be banned. Consequently, I think the Legislative Council should seriously consider banning it.
Of course, insurance and brokerage companies would oppose a ban on ILAS, as it would result in the extinction of a $17 billion HKD per year business and leave thousands of ILAS agents unemployed. However, that is no excuse for allowing the continuation of what is essentially theft. A small short-term shock to the economy is inevitable and necessary. Cleansing the system would make the economy healthier in the long-run. Investors would accumulate more savings by paying less fees, and unemployed ILAS agents would eventually find new jobs in more useful sectors of the economy.
Banning ILAS is not a comprehensive solution though because the root of the problem lies deeper. There are other products which are being mis-sold. Whole life insurance is perhaps becoming a scandal of almost equal proportions. The source of all this evil is the commission-based sales model, which creates a conflict of interests for brokers and agents. They can earn more money by fleecing their clients, so inevitably, many choose to fleece their clients. They prefer to sell products which earn them the highest commission rather than products which are best suited for their clients’ needs (e.g., ILAS rather than pure funds, whole life rather than term life insurance). This problem is not unique to Hong Kong. In the UK, millions of consumers have been mis-sold investment and insurance products due to the misaligned incentives created by commissions. The costs have run into the tens of billions of pounds. Over the past few decades, scandal after scandal has ensued: the pension scandal, the endowment scandal, the PPI scandal, the CPP scandal, among others. Regulators and legislators in the UK got so sick of dealing with these scandals that they eventually decided to ban commissions altogether. Australia has done this too. The only way Hong Kong can effectively deal with its plague of mis-selling is by following the examples set by the UK and Australia, by banning commissions and other forms of corrupting sales incentives. I urge LegCo to begin working on this immediately. The longer nothing is done, the bigger the mess that will have to be cleaned up later.
The mess is already mind-boggling, and justice will not be served until all victims are compensated. In the above-mentioned scandals in the UK, millions of victims got their money back. Wrongdoing companies were forced to restore mis-sold consumers to the position they would be in if they had been given proper advice from the beginning. I believe Hong Kong’s ILAS victims should be restored to the financial position they would be in if they had originally been sold a pure fund investment, rather than ILAS. The calculations would be complicated, but it could perhaps be simplified by allowing victims to surrender their ILAS policies with no penalty, and then forcing mis-selling companies to refund all the fees that they collected. I urge LegCo to offer its support to regulators and the courts in making sure that justice is served.
In a recent high profile lawsuit, an influential businessman, Jeremy Hobbins, accused his broker of mis-selling him a series of ILAS products. He correctly pointed out that his broker’s advice was tainted by greed, that the advice was given solely so that the broker could profit at his expense. He claimed that the undisclosed high commission paid by the insurance company, Skandia, to the broker, Clearwater, amounted to bribery. The judge sided with the broker and the insurance company. He argued that because the industry is a cartel and the high commissions are standard, the dealings between the broker and the insurance company were acceptable. If Clearwater and Skandia were guilty, then the entire industry was guilty. In other words, if the judge had ruled in favor of Mr. Hobbins, then a tsunami of similar lawsuits would have ensued, which would have likely bankrupted many players in the industry. He did not want responsibility for unleashing all of that. He would have been a hated a man, and I would not be surprised if his ruling were influenced by concern about blowback to his career or his personal safety. He summarized as follows, “The practice of insurers paying commission to insurance brokers may or may not be unsound. It ought possibly to be strictly regulated or even prohibited altogether. I express no view on the matter. That is a question of policy best left to the legislature, not the Court, to tackle.”
I hope the Legislative Council will tackle this issue and ensure that the hundreds of thousands of other ILAS victims are treated more fairly than Mr. Hobbins was. I believe there needs to be another lawsuit, a collective lawsuit, on behalf of all these people. I’ve written letters to the Hong Kong Monetary Authority and the Securities and Futures Commission to seek their opinion on possible regulatory breaches by companies selling ILAS, breaches which might serve as grounds for a successful lawsuit on the scale I have suggested. I have forwarded those letters to all of you, and I welcome any of you to step forward and offer your own thoughts on the matter.
Before I conclude this letter, I want to offer one last legislative proposal: mandatory financial literacy. The financial industry is a jungle in which predators are lurking around every corner waiting to pounce on ignorant consumers. Part of what makes mis-selling scandals possible is a widespread lack of knowledge about different financial products and how to compare and evaluate them. This information deficit could be dealt with by the introduction of an investor’s license, analogous to a driver’s license. People wouldn’t be allowed to invest in anything other than the cheapest and safest financial products, like certain exchange-traded index funds, without having first proved they could do it knowledgeably, wisely, and safely. So, for example, if someone wanted to invest in a product as complex and expensive as ILAS, they would first have to pass an exam to obtain an investor’s license. Afterwards, they’d be free to invest, but I doubt anyone would invest in something like ILAS if they actually understood how it compared to alternative options.
I will be forwarding this letter to regulators and dozens of news organizations. Feel free to respond to all recipients. I am also posting this letter at TheRapeOfHongKong.com. I hope some of you will decide to join me in raising public awareness about the ILAS scandal and build public support for what needs to be done. It shouldn’t be difficult. A little understanding will go a long way.
Thanks for everyone’s time. I look forward to seeing justice.