To the Office of the Commissioner of Insurance and the Office of the Ombudsman:
I appreciate OCI’s last response, but I am disappointed by it. I am cc’ing this email to the Office of the Ombudsman in notification that I will soon be issuing a formal request for an investigation of ILAS regulators, with special emphasis on the Insurance Authority. Until then, I will refer the Ombudsman to TheRapeOfHongKong.com, where I have posted several articles and letters (including this one) that explain the unfolding ILAS scandal and its impact on countless thousands of Hong Kong investors.
I will now go through OCI’s last letter, line by line, pointing out its flaws.
“We are unable to comment on the suitability of an ILAS policy for a particular client in a specific case on the basis of only one page of an FNA without considering the totality of the circumstances and facts.”
That is not true. Compared with other investment products, the fees on many ILAS policies are so high and the conditions so unfavorable to investors (decades-long contract, surrender penalty, credit risk, etc.) that advisers shouldn’t be recommending them to anyone. Nobody on this planet knows with certainty that their income will be secure for the next 25 years, or even 5 years. It comes as no surprise that 93% of ILAS policyholders are estimated to exit their policies early and suffer extortionate penalties. Undoubtedly, many of these policyholders inevitably encountered unpredictable changing life circumstances and could no longer afford to keep making contributions, and maybe needed emergency access to funds. It is both stupid and unethical for advisers to recommend these long-term contracts when pure fund investments are cheaper and don’t have a risky lock-in period. It’s not necessary to know anything about the client to judge that these products are usually a disaster and suitable for no one. Take Standard Life’s Harvest 101 as an example. On a 25 year contract, most of the money paid during the first two years is metaphorically flushed down the toilet, eaten by long-term administration fees if not by a surrender penalty. At the end of 25 years, nearly half the potential investment returns will be lost to the compounding effects of policy-level fees. Meanwhile, policyholders face the risk of potentially losing all their money if the insurance company goes bankrupt. Such an occurrence is not unthinkable. I’ll illustrate with an example.
I know one person who owned an ILAS policy called AIG Capital Saver all the way through the financial crisis of 2008. AIG would have collapsed if the US government hadn’t bailed it out. If AIG had been allowed to go bankrupt, an AIG Capital Saver policy could have become worthless, and everyone who owned it might have lost all their savings, just like owners of Lehman minibonds. The next time a large insurance company faces bankruptcy, ILAS policyholders might not be so lucky. Consequently, it’s senseless for Hong Kong investors to be encouraged to invest in ILAS when they can invest in funds directly (and much more cheaply) without taking on this catastrophic risk.
In summary, ILAS is expensive, risky, and inflexible. Greed is the only explanation for why it is promoted and sold so aggressively to Hong Kong consumers. If the commissions weren’t so high, no adviser would recommend it. If consumers were informed, none of them would buy it. If OCI were a decent regulator, most of these products would be banned.
“We should be most grateful if you could pass us all the information related to the alleged case so that we can take follow-up actions.”
That case has already been reported. The purpose of my last correspondence was to highlight a broader issue.
Even if OCI could not evaluate the suitability of an ILAS product for a particular person without loads of personal details, it is still possible to evaluate the suitability of ILAS for a society as a whole, and it’s a fact that ILAS isn’t suitable for the vast majority of Hong Kong citizens, since ILAS is a product designed to avoid foreign taxes that Hong Kong citizens don’t pay. Despite this fact, it’s estimated that 75% of investment products sold to Hong Kong consumers are ILAS products. A more appropriate number would be closer to 0%. This egregious imbalance reveals that ILAS is being scandalously over-sold and mis-sold to the Hong Kong public. OCI has disgracefully failed to acknowledge this situation or take appropriate action. Countless thousands of consumers have suffered as a consequence.
“ILAS products are in essence insurance-cum-investment products and hence a popular option for those with both investment and estate/tax planning needs.”
This is the second time that OCI has told me that ILAS is “popular”. I don’t believe it. There is a distinction between “popular with consumers” and “flogged by commission-hungry salespeople”. Even if ILAS were truly popular among informed consumers with specific needs, we should then ask: What percent of Hong Kong investors have both investment and estate/tax planning needs that are best satisfied by ILAS products? The number must be close to 0%, yet ILAS is pitched to everyone indiscriminately.
None of my friends, colleagues, and acquaintances who were sold ILAS products had ever heard the term “investment-linked assurance scheme” until I mentioned it to them. None of them fully understood what they had bought or that there existed much cheaper, safer, and flexible investment options. All my personal experience contradicts the claim that ILAS is “popular”. I suspect this myth is a self-serving lie propagated by the insurance industry, and OCI has been foolish for lapping it up.
“However, we understand that some clients may acquire ILAS for pure investment reasons, because, for instance, they cannot invest direct in mutual funds due to the substantially higher entrance threshold. Through an ILAS product, these clients may invest a much smaller amount in a number of funds at the same time. There are also clients who choose ILAS because of the free fund-switching service.”
The underlined parts are false.
Fund-switching within ILAS is not really free. There is usually a hidden bid-offer spread fee charged each time that funds are switched. Even without this hidden fee, the other combined fees of an ILAS policy are so obscenely high that it’s laughable to call any aspect of an ILAS policy “free”.
It’s also a lie to say that investors can’t invest directly in mutual funds due to substantially higher entrance thresholds. Not all mutual funds have high entrance thresholds, and OCI is ignoring options such as MPF special voluntary contributions (SVC), Fundsupermart, iFAST Central, and ETFs. I will describe those options below. Even if such options didn’t exist, advisers still shouldn’t be recommending ILAS to anyone who is concerned about high entrance thresholds. People who aren’t disciplined enough to save even $10,000 HKD for a fund investment certainly aren’t disciplined enough to save $1,000 HKD per month for 25 years. These people are virtually guaranteed to stop their contributions, which means ILAS is a terrible, unsuitable recommendation for them. (As I mentioned before, it’s estimated that 93% of all ILAS policyholders, not just low-income investors, take a surrender penalty before their policy matures.)
I’ll now describe some alternatives to ILAS, whose existence proves that no Hong Kong citizen needs or should be advised to buy ILAS for pure investment reasons.
Every working person in Hong Kong is familiar with MPF because they are required to pay into it. What most people don’t know is that they can make special voluntary contributions to MPF, and their money will not be locked up until retirement. They can cash in their funds anytime without penalty and switch funds for free. Minimum contributions for some plans (such as BEA’s) are as low as $100 HKD. The lowest minimum contribution for any ILAS policy that I know about is $1,000 HKD (10 times higher). Yet greedy advisers systematically do not recommend SVC because they earn a much higher commission by selling a far more expensive and risky ILAS policy.
Advisers might try to defend themselves by saying that ILAS is a superior recommendation because it can provide more fund options than MPF, as if this small benefit somehow outweighs all the other things that are wrong with ILAS. My first response is that the benefits of ILAS don’t even come close to outweighing its costs. The second thing I’d say is that there are pure fund platforms, such as Fundsupermart, that provide access to hundreds of funds, free fund switching, minimum contributions of $1,000 HKD, and no exit penalty. In other words, Fundsupermart offers the same benefits of an ILAS policy without any of the drawbacks.
Fundsupermart is designed for do-it-yourself investors. iFAST Central is essentially the same platform but designed for investors who want an adviser to help make their investment decisions for them. Many banks and IFA companies have business agreements with iFAST Central and can use it to manage their clients’ investments. However, banks and IFA companies also have business agreements with insurance companies that supply ILAS products. Unsurprisingly, because of the much higher commission, unethical advisers systematically steer their clients into fund investments through ILAS as opposed to iFAST, even though portfolios of funds of essentially the same quality could be constructed with either platform. The main differences between ILAS and iFAST is that ILAS is much more expensive for clients and carries catastrophic risk. If IFAs and banks have any fiduciary duty whatsoever, then that duty is clearly breached every time they encourage a client to buy ILAS when an equally suitable portfolio could have been constructed with pure fund platform such as iFAST Central. If regulators would bother to investigate, they would find that this abuse has been systematic.
Most funds in MPF and Fundsupermart are actively managed. These options are much better than investing through ILAS, but they are not the best. Numerous academic studies have shown that the most rational way for average investors to invest in stocks is through low-fee passively managed index funds. ETFs are the most convenient way to access index funds. The minimum purchase will depend on one’s broker, but in many cases it won’t be higher than $1,000 HKD. ETF shares can be sold at any time, just like a stock, so fund switching is effectively free (minus a small brokerage fee). Fee-only advisers (ones who don’t accept bribes from product providers) recommend ETFs to their clients because they know, over the long run, no other investment is as likely to offer a better return.
In summary, there are plenty of pure investment options on the market with low entrance thresholds and free fund switching. Consequently, agents and brokers have no ethical excuse for selling ILAS to consumers when it doesn’t satisfy a tax or insurance need. Both the Hong Kong Monetary Authority and the Securities and Futures Commission have echoed this in recent circulars.
“Hence, it would be necessary to look into the circumstances of individual cases before one can conclude if the specific ILAS product is suitable for a specific client.”
I’ve already refuted this claim. When a particular ILAS product is a blatant ripoff, one doesn’t need to know anything about the client to judge the product’s suitability.
In a case where a particular ILAS product could be a rational investment for a person with specific tax or insurance needs, it still wouldn’t be suitable for the vast majority of Hong Kong citizens. One would only need to look at a couple of data points in the financial needs analysis form to verify whether a mis-sale had taken place. 1) Did the client indicate that he or she only had pure investment or savings needs? If so, then ILAS wasn’t suitable, and the adviser should have recommended a pure fund investment. 2) Did the client indicate that he or she had little or no investment experience? If so, then it’s clear the adviser took advantage of the client’s trust and lack of knowledge to sell him or her an unsuitable insurance product, simply because it was far more profitable.
If it’s true that roughly 75% of investment products sold in Hong Kong are ILAS products, then probably well over a million mis-sales have taken place over the years. I believe this state of affairs warrants a total revue of all ILAS sales that have ever taken place, combined with an efficient and fair means of redress for mis-sold consumers.
“Banks and non-bank insurance intermediaries not only have different operating environment, their relationship with customers is also different as banks have access to the personal financial data of their customers that are not available to non-bank intermediaries. As such, the regulatory requirements for banks’ selling of ILAS products may not be appropriate for non-bank intermediaries.”
The regulatory requirements for banks is equally appropriate for non-bank intermediaries. HKMA started requiring audio recordings after the Lehman minibond scandal. The new regulation was a direct response to the fact that intermediaries were mis-selling unsuitable investment products on a massive scale. Audio recordings were the only way to ensure compliance with the rules. Similarly, ILAS is being rampantly mis-sold, and audio recordings are the only way to reign in misbehaving agents and brokers. It’s not necessarily the case that bank intermediaries have more personal financial data about their clients, since non-bank intermediaries usually sell ILAS to friends whom they also know a lot about. But whatever, it doesn’t matter who knows more. Non-bank intermediaries are selling ILAS indiscriminately, regardless of their clients’ financial needs and circumstances, and it must be stopped.
I suspect OCI might reply that it is too difficult for non-bank intermediaries to do audio recordings in their different “operating environment” (a euphemism for coffee shops, restaurants, and homes). I will reply with two points. First, this is not true. Myself and others have used our mobile phones for ILAS-related recordings in such environments, and the sound quality was always fine. Second, OCI shouldn’t allow ILAS to be sold in these types of informal and intimate places anyway. Because ILAS is usually sold from a friend to a friend, consultants brazenly cut corners, break regulatory rules and guidelines, correctly assuming that their friends, the uninformed clients, will never report them for regulatory violations that they aren’t even aware of. These types of abuses won’t stop unless the ILAS sales process is conducted professionally and properly monitored.
Recently, an ILAS victim filed a complaint alleging that her consultant misrepresented an ILAS product to her. The consultant denied the allegation. As is usually the case, this could have been the end of the story, with no hope of justice for the victim, because it was her word against her consultant’s word, and there was no way to prove who was telling the truth and who was lying. Fortunately, this victim was wise enough to audio record some conversations with her consultant, in which the consultant admitted to misrepresenting the product. This story demonstrates perfectly why audio recording should be mandatory for the ILAS sales process. Not only does audio recording discourage consultants from misrepresenting ILAS products (for fear of getting caught), audio recording gives mis-sold consumers a chance to receive justice. Sadly, I know multiple ILAS victims whom regulators have refused to help, specifically because they had no audio recordings to prove that their consultants had lied to them.
It’s instructive to note that most banks have now stopped selling ILAS after implementation of HKMA’s new ILAS rules. According to HKMA, “When explaining or recommending ILAS products to customers, AIs [Authorized Institutions] should give balanced views. Where direct investment in the underlying investment assets (e.g. unit trusts and mutual funds) can be the alternative of indirect investment through ILAS products, AIs should explain to customers the pros and cons of ILAS products compared with direct investment in the underlying investment assets and taking out a life insurance policy separately.” HKMA also says, “Where a customer indicates that he or she does not need/want insurance/investment products, AIs should not recommend ILAS products.” Because bank intermediaries are required to audio record the sales process and follow these guidelines, it’s nearly impossible to conduct a mis-sale in a bank without getting caught. Consequently, if banks can’t mis-sell, then they can’t sell ILAS, since ILAS is unsuitable for practically everyone in Hong Kong. If OCI held non-bank intermediaries to the same standards that HKMA holds the banks to, then the ILAS industry would immediately collapse. OCI’s refusal to implement adequate rules exposes an apparent hidden agenda of protecting the insurance industry’s ability to rip off consumers. This is exactly why I have argued that, if ILAS is not banned, OCI should at least be stripped of its authority to regulate ILAS, and that authority should be handed over to the SFC. This would put Hong Kong in line with international standards. In America, for example, ILAS is called a “variable annuity”, it is defined as a security, and it is regulated by the SEC (America’s counterpart to the SFC). Hong Kong’s regulatory structure should be no different.
“While banks are required to make audio-recording of the sales process for ILAS products, audio-recorded post-sale confirmation calls are required for non-bank intermediaries.”
The post-sale confirmation call is pitifully inadequate to stop mis-sales, and I wouldn’t be surprised if it was purposely designed this way, with the rules being written by lobbyists from the insurance industry. Insurance companies do not ask (and are not required to ask) whether clients understand that they are buying an insurance product which is significantly different from a pure mutual fund investment. They don’t have to explain how pure mutual fund investments are different, nor do they have to state that ILAS is unsuitable for people who only have pure investment needs. They also do not have to ask whether the client has any needs that justify purchasing an ILAS product. Insurance companies are only required to ask whether clients understand facts such as how much they need to pay, for how long, and that there is a surrender penalty. Supposedly, it’s the adviser’s job to determine whether ILAS is suitable for a client, but since advisers are not audio recorded, they can get away with omitting key facts, lying about the product, and encouraging a client to buy ILAS even though the product is clearly not suitable. In short, agents and brokers can break rules without consequence, while insurance companies don’t have meaningful rules that they need to follow. No one is held accountable for mis-sales, which is why mis-sales are rampant. It’s a massive regulatory loophole seemingly designed to allow the insurance industry to exploit uninformed consumers.
“Similar to the requirements for banks, insurers and insurance intermediaries are not allowed to offer gifts (other than a discount of fees or charges) in promoting a specific life insurance product or an ILAS product. If you have information about possible violation of such requirement, please provide us with the relevant information for follow-up action.”
I already informed OCI about two apparent violations, one that was specific to AXA’s Swiss Privilege, and one that seems to be industry-wide. OCI has neither commented upon or even acknowledged what I said. It seems as if I have been ignored, and I consequently wonder whether OCI is dodging my questions in order to protect cronies in the insurance industry at the expense of justice for mis-sold consumers.
I will repeat myself now so that my points are clear.
Violation #1: AXA’s Swiss Privilege uses free luxurious and exotic trips to induce clients to contribute tens of thousands of US dollars to new ILAS policies. I know a former Swiss Privilege client who received a phone call about one of these trips. The client was interested in the trip, but she told her consultant that she didn’t have tens of thousands of dollars of spare cash to contribute to a new ILAS policy. She asked if she could go on the trip if she paid for the expenses directly, rather than indirectly by buying an ILAS policy. The consultant said that this was not allowed. The trip was only for those who bought a new ILAS policy.
Violation #2: The entire ILAS industry has been using “bonus allocation” to entice clients to buy unsuitable ILAS policies. In some cases, clients are advised to surrender an old policy in order to shift money to a new policy. They are told that they will be given free “bonus allocation” as compensation for surrender penalty losses on the old policy. They are also falsely told that the “bonus allocation” is so generous that they’ll be in a better financial position after buying the new policy.
It’s not clear whether intermediaries or product manufacturers should receive the most blame when “bonus allocation” is used to fleece clients, but its clear that both parties are guilty of violating regulations against giving gifts. One only needs to examine the meaning of the words “bonus allocation” to reach this conclusion.
In the dictionary, “bonus” is a synonym for “gift”, and it is defined as “something extra or additional given freely”. (See attachment.) A “bonus allocation” is thus a gift of free fund units. Consumers interpret it this way, and insurance companies and intermediaries present it this way. There is nothing to indicate that “bonus allocation” is a discount in fees, as opposed to a gift, which means it’s a clear regulatory violation.
At the moment, I don’t have a complete list of all the companies offering or who have previously offered bonus allocation (Zurich and Standard Life are two product issuers; Bank of China, Sun Hung Kai, and Convoy are three intermediaries), but I do know that this is a common practice throughout the industry. I would appreciate if OCI will clarify, perhaps issue a circular, on how it plans to address these widespread regulatory violations, with special emphasis on how swindled clients will be compensated.
Three Reasons Why the New Commission Disclosure Rules Will Be Ineffective at Stopping Mis-Sales
What I have to say here is not a response to anything in OCI’s last letter, but it is a problem that OCI needs to acknowledge and address.
The new ILAS commission disclosure rules are an implicit acknowledgement of the fact that the commissions on ILAS policies are outrageous. The rules also constitute an implicit statement that consumers have a right to know how badly they are being ripped off. Unfortunately, the new rules will do little to protect consumers who are not aware of cheaper, more suitable investment options. This includes almost everyone who is at risk of being mis-sold ILAS. I suspect the only reason the new commission disclosure rules were implemented is because the industry was willing to agree to them, since it’s unlikely that the rules will significantly affect sales.
To summarize the new rules, non-bank intermediaries are now required to disclose the amount of commission they receive ONLY if a client asks. Bank intermediaries must disclose their commission regardless of whether or not a client asks. It seems the only reason non-bank intermediaries have a lower regulatory standard than bank intermediaries is because the insurance industry is OCI’s master, while HKMA maintains a higher degree of independence.
Here are three reasons why I think the new rules will not significantly reduce the number of mis-sales.
1) Many clients will think it is impolite to ask the intermediary how much the commission is. They will find it too inappropriate and embarrassing to ask, even if they want to know the answer.
2) Many clients have no idea that the commission is so obscenely high and that it creates a huge conflict of interests. Because clients falsely assume that the commission is reasonable, they won’t feel a strong need to know its exact amount. So they won’t ask about it.
3) Even if intermediaries told clients the amount of the commission, most clients are too uninformed to be able to evaluate whether the level of the commission is appropriate. If clients don’t know that the commission on pure fund investments is many times lower than the commission on ILAS, they won’t know that they’re being ripped off. Moreover, a significant number of people falsely believe that their consultant’s advice is “free”, no matter how high the commission is. Consequently, commission disclosure is pointless unless clients are explicitly told that they pay the commission indirectly through ILAS fees and that the commission is many times higher than if they were to invest in funds directly.
The new commission disclosure rules were seemingly just a ruse to convince the public that something was being done to protect consumers, while in reality, the only thing being protected was the profitability of the insurance industry. Until there is a complete ban on commissions, as in the UK and Australia, mis-selling will not be significantly reduced, and the public should have little faith in advisers or their regulators.
ILAS has been massively over-sold and mis-sold to the Hong Kong public. Victims deserve redress, and the present regulatory framework needs a complete overhaul. I hope an investigation by the Ombudsman will help awaken OCI from its slumber.
As always, I’ll be copying this letter to the media and other ILAS regulators. I’m also sending it to the entire Legislative Council. I hope OCI’s next response will be more substantive than the last one.
Dear Mr Lucy,
We refer to your e-mails of 2 and 7 October 2013 addressed to the HKMA and ILAS regulators.
We are unable to comment on the suitability of an ILAS policy for a particular client in a specific case on the basis of only one page of an FNA without considering the totality of the circumstances and facts. We should be most grateful if you could pass us all the information related to the alleged case so that we can take follow-up actions.
ILAS products are in essence insurance-cum-investment products and hence a popular option for those with both investment and estate/tax planning needs. However, we understand that some clients may acquire ILAS for pure investment reasons, because, for instance, they cannot invest direct in mutual funds due to the substantially higher entrance threshold. Through an ILAS product, these clients may invest a much smaller amount in a number of funds at the same time. There are also clients who choose ILAS because of the free fund-switching service. Hence, it would be necessary to look into the circumstances of individual cases before one can conclude if the specific ILAS product is suitable for a specific client.
Banks and non-bank insurance intermediaries not only have different operating environment, their relationship with customers is also different as banks have access to the personal financial data of their customers that are not available to non-bank intermediaries. As such, the regulatory requirements for banks’ selling of ILAS products may not be appropriate for non-bank intermediaries. While banks are required to make audio-recording of the sales process for ILAS products, audio-recorded post-sale confirmation calls are required for non-bank intermediaries.
Similar to the requirements for banks, insurers and insurance intermediaries are not allowed to offer gifts (other than a discount of fees or charges) in promoting a specific life insurance product or an ILAS product. If you have information about possible violation of such requirement, please provide us with the relevant information for follow-up action.
Office of the Commissioner of Insurance