Monthly Archives: January 2014

ILAS Commissions Explained: A Look at How Insurers Bribe Advisers to Screw Their Clients and Why They Could and Should Be Prosecuted

The shittiest, most expensive, most complex, and purposely confusing investment products pay the highest commission. This is a logical necessity. If these lousy products weren’t accompanied by excessive commissions, then they wouldn’t exist, because no advisers would recommend or sell them.

Some countries, like the UK and Australia, have made it illegal for product issuers to pay commissions to advisers for selling their products. This is because it creates an inherent conflict of interests, whereby advisers are financially rewarded for selling unnecessary and exploitative investment products to clients, and it has led to millions of consumers being ripped off.

In Hong Kong, commissions remain a form of legalized corruption, which has resulted in the Lehman minibond scandal, the ILAS scandal, and probably other scandals that the media has failed to report on.

The Hobbins Lawsuit Awakens the Public

A growing segment of the public is concluding that ILAS commissions are actually illegal. This began happening after the highly-publicized Jeremy Hobbins lawsuit in which Hobbins argued that these commissions violate Section 9 of the Prevention of Bribery Ordinance. Anyone who reads the law can see that Mr. Hobbins was correct, and it means that thousands of people who’ve been selling ILAS have been breaking the law and could face fines and prison time.

Unfortunately, the judge handling the Hobbins case, Anselmo Reyes, lacked the testicles to speak the truth and stand up for justice. He could have single-handedly ended a $17 billion HKD dollar scam and set a precedent for ILAS victims to receive redress. But since that would have pissed off too many rich scumbags and risked political blowback to himself, Reyes instead ignored facts and spewed bullshit excuses so that he could save his own skin while hanging Mr. Hobbins and the rest of the Hong Kong public out to dry.

Hobbins Was Right, Reyes Was Wrong

According to Reyes’ contrived logic, the commissions paid to Mr. Hobbins’ adviser were not bribes because they were not in excess of the inflated commission rates paid by insurers in the rest of the self-regulated (i.e., cartel) ILAS industry. Conspicuously, Reyes neglected to admit that ILAS is a type of investment product (a fund platform) that competes with a wide range of non-ILAS investment products for investor’s money. This means the legality of an ILAS commission can only be fairly evaluated relative to commissions paid in the broader market. Since Reyes only compared ILAS commissions with other ILAS commissions, he could pretend like the commissions paid to Mr Hobbins’ adviser were not abnormally high. In fact, all ILAS commissions are abnormally high. Some are so obscene that insurers have used fraud (a criminal offense punishable by 14 years imprisonment) to conceal them. I will write about this fraud more thoroughly in my next blog post.

ILAS vs Its Competitors

Since Reyes neglected to compare ILAS with its direct competitors, I am going to do it. I hope the following analysis serves as a useful resource for anyone contemplating a lawsuit against the swindlers who create and sell the garbage known as ILAS.

Because ILAS is a fund platform, the most appropriate non-ILAS investment product to compare it with is a competing fund platform. iFAST Central is one that offers access to far more funds than many ILAS products at a fraction of the cost. Compared to ILAS, it is a fantastic bargain. In the vast majority of cases, there is absolutely no justification for an adviser to recommend ILAS over something like iFAST—except that upfront ILAS commissions can be hundreds of times higher. If these supersized commissions induce advisers to sell ILAS to clients when other products (such as iFAST Central, voluntary MPF accounts, iFAST’s Fundsupermart, individual mutual funds, or ETFs) are clearly more suitable, then it’s a clear-cut case of bribery.

Irrelevant Differences Between ILAS and iFAST

Because regular premium ILAS policies, also known as monthly savings plans, are the most criminal types of policies, I am going to compare them with monthly savings plans sold through iFAST. Before I do that, so that no one says my comparison isn’t fair, I will note that there are two main features of ILAS (besides its insane costs) that can potentially distinguish it from competing fund platforms. These features result from the fake shell of insurance wrapping the underlying funds and are called “tax wrapping” and “regulatory wrapping”. Both of these things are ethically and legally dubious. They are potentially useful only to expats and rich people and are useless to the vast majority of Hong Kong citizens to whom ILAS is sold.  Tax wrapping—ILAS can help expats avoid taxes, but in most cases it’s self-defeating since ILAS fees are so high that they devour all the tax savings and more. Regulatory wrapping—Certain types of ILAS products called portfolio bonds, which are sold primarily to rich expats, can be used to circumvent a number of SFC regulations and provide access to unauthorized funds. A lot of expats have gotten burned because unethical advisers used the regulatory loophole to screw them. One way advisers do this is by “double dipping”, which is industry slang for collecting two layers of high commissions: one from selling the portfolio bond, and another from selling a ripoff fund to be wrapped within it.

Since these two ILAS features are useless to most Hong Kong investors, the only difference between ILAS and iFAST that matters to them is cost. So let’s compare those costs.

iFAST Central Commissions

When selling through iFAST, advisers have the discretion to determine the amount of commission they receive. It can be anywhere from 0 to 5%. According to one of my contacts at iFAST, the average commission advisers charge for selling a monthly savings plan is 2% of the money invested at the time it is invested. This means that, on average, when an adviser sells a $1,000 per month plan, he and his company will receive a $20 commission (2% of the first $1,000 invested). They will receive additional $20 commissions each month thereafter, as long as the client doesn’t cancel the plan. Because a client pays no penalty for canceling, the adviser must keep his client satisfied or face losing future income from that client.

ILAS Commissions

Selling ILAS is fundamentally different. As reported by SCMP, an adviser and his company will typically receive an immediate commission of 4.2% of all the money a client is expected to invest in the future. If an adviser sells a 25-year plan, he and his company will receive 25 years of commissions instantly. For a $1,000 per month plan, this is $12,600 (4.2% x $1,000 per month x 12 months per year x 25 years). In other words, at the point of sale, the ILAS commission is 12.6 times more money than the client has even paid into the policy. It is a 1,260% upfront commission, which is 630 times larger than the average 2% upfront commission received through iFAST. An adviser would have to service his client for 52 and a half years to earn the same amount of commission through iFAST that he earns instantly by selling ILAS.

If an adviser quits his job shortly after selling an ILAS policy, he gets to keep his commission even though he will not provide the decades of service he was paid for in advance. (This is convenient for swindlers who plan to defraud as many investors as they can, and then abruptly leave the industry, if not the country, after a few years.)

When a client later discovers that he has been ripped off and angrily cancels the ILAS policy, the adviser gets to keep his commission while the client loses nearly everything that was invested during the first year or two, since much of that money was secretly used to pay for the adviser’s commission. Insurers deceptively call this an “exit charge” so that policyholders don’t understand what has really happened to them.

The only way an adviser will be forced to give back some of his commission (to the insurance company, not the client) is if the client cancels the policy before the insurer has collected enough payments to cover the cost of the commission. This clawback guarantees that insurers won’t lose money from bribing advisers. Only clients lose.

As I mentioned earlier, iFAST provides its service at a mere fraction of the cost of ILAS, and ILAS is so expensive that advisers must be bribed to sell it. To clarify this point, let’s take a closer look at the charges of a specific ILAS product, Standard Life’s Harvest 101, and then compare it to iFAST Central’s charges. (Harvest 101 was mis-sold to my girlfriend, whose case was reported in SCMP).

Platform Fees: Harvest 101 vs iFAST Central

Harvest 101 provides access to 290 funds with “free” fund switching. It has three main levels of fees. For the sake of simplicity, lets ignore the annual 6.0% administration charge on the initial account (since its primary purpose is to secretly recoup the commission paid to the adviser), and let’s also ignore the annual $720 policy fee. Let’s only focus on the annual 1.5% accumulation account charge.

Harvest 101 Policy Fee and Administration Charge

Harvest 101 Accumulation Account Charge

Now let’s look at iFAST Central, which provides access to 471 funds with free fund switching. iFAST only charges a single platform fee of just 0.1% to 0.3%, depending on the amount of money invested.

iFAST Platform Fee (cropped)

This is 5 to 15 times cheaper than Harvest 101‘s 1.5% accumulation account charge.

But in practice, Harvest 101 will ultimately be far more than 15 times more expensive than iFAST, not because of the other two fees I ignored, but because more than 99% of 25-year ILAS policies are terminated early (and 93% of ILAS policies in general), which results in a so-called “exit charge“, meaning that investors will not be refunded the secret excessive commissions that were paid to their advisers.

Harvest 101 Exit Charge

iFAST doesn’t have a so-called “exit charge” because iFAST doesn’t pay decades of commissions in advance. iFAST commissions are purposely designed to be pay-as-you-go so that advisers have an incentive to provide long-term quality service, not to take their clients’ money and run.

Advisory Fees: Harvest 101 vs. iFAST Central

For purposes of comparison, we can largely ignore advisory fees, since these are fees ultimately charged and received by advisers, not Standard Life or iFAST. But I will mention them anyway. Advisory fees through iFAST range from 0 to 2.25% annually, and, according to my contact at iFAST, the average is 0.97%. The Harvest 101 brochure does not state the average advisory fee, but it does say they range from 0 to 2% per year.

Harvest 101 Advisory Fee

It should now be clear that Harvest 101 is a ripoff in comparison to iFAST, since it offers 181 fewer funds and is multiple times more expensive. It’s no surprise that Standard Life bribes advisers to sell it using upfront commissions that can exceed 1,000% of clients’ initial investments.

The Real Reason Long-Term ILAS Contracts Exist

Most ILAS products have contract lengths that range from a minimum of 5 years all the way up to 30 years. Harvest 101 ranges from 5 to 25 years. My girlfriend and several other friends were sold 25-year contracts. Superficially, the longer contracts seem to exist for the convenience of clients with longer-term investment horizons (i.e., younger people), but I believe this is a deliberate misrepresentation meant to disguise their real purpose of juicing up commissions at the expense of clients, providing advisers with a motive to flog the hell out of ILAS.

Remember that ILAS commissions are 4.2% of all the money a client is supposed to pay in the future. This means a 30-year policy pays advisers a commission exactly 6 times higher than a 5-year policy, while simultaneously increasing the cost of an “exit charge” by a corresponding amount. It also makes the likelihood of early exit a statistical near-certainty. There is absolutely no good reason for clients to sign longer-term policies, which means advisers are accepting bribes and breaching their fiduciary duty when they sell them. I believe contract lengths are a minimum of 5 years because it takes at least 5 years worth of upfront commissions to successfully bribe advisers to sell a regular premium ILAS policy. Anything less and most advisers wouldn’t be be tempted to take the reputational risk of abusing their clients. Even if a regular premium ILAS policy were suitable for a client, an adviser would still have no justification for recommending anything other than a contract of minimum length, since this contract would carry lower risk and could be renewed after it matured.

The Real Purpose of “Bonus Allocation”

Many ILAS policies come packaged with “bonus allocation” intended to deceive inexperienced investors into believing they are getting “free” fund units for buying the policy. If they sign longer contracts, they receive a higher percent of these “free” fund units. As I will argue in my next blog post, these fund units are fundamentally fraudulent and serve no purpose except to make it easier for advisers to mislead clients into believing that longer policies offer better value, (while also temporarily hiding the damage caused by front-loaded fees, so that investors don’t notice it, shit their pants, and cancel the policy). This makes it easier for advisers to sell longer policies that pay higher commissions, which provides additional motivation to flog ILAS.

Essentially, longer-term contracts are not just a convoluted means of offering larger bribes, they are also a means for advisers to indirectly steal from investors—without investors realizing it. Bogus “bonus allocation” facilitates this process.

Lawsuits in the Pipeline

Because Hong Kong’s legislature is firmly in the grips of self-interested corporate bastards, class action lawsuits still do not exist in Hong Kong. Nevertheless, I am planning to help organize the nearest equivalent of one on behalf of ILAS victims, in hopes of receiving a fairer trial and more justice than Mr. Hobbins. I will write more about this soon.

While insurance companies have been using fraud and bribery to rip off investors, in the process, they have also been stealing potential clients from competitors like iFAST. Consequently, I encourage iFAST to consider taking legal action of its own. If iFAST decides to do so, I hope they seek compensation in a way that will benefit exploited investors as well. This would be an opportunity for iFAST to earn the good will of the public, build an unparalleled reputation, garner positive media attention, and potentially help catalyze much-needed regulatory reforms.  It’s a potential win-win opportunity, both for iFAST and the general public.

One of the Most Disgraceful Regulatory Responses in the Developed World

To ILAS Regulators, the Office of the Ombudsman, the Independent Commission Against Corruption, the Legislative Council, and the Media:

Hundreds of thousands of Hong Kong investors have been exploited because ILAS regulators have collectively refused to properly regulate commissions (by not keeping them reasonable and requiring full disclosure), the qualifications of brokers and agents (by not requiring them to thoroughly understand ILAS and how it compares to alternative investment products in the market), and the ILAS sales process (by not implementing a system to prevent ILAS from being mis-sold to clients and to hold brokers and agents accountable when they give deceptive information and self-serving advice; this would most notably include mandatory audio recording).

Even though regulators know they are responsible for allowing the insurance industry to wreak havoc on the savings of countless individuals and families, they are now pretending like they have no moral obligation to help restore these innocent victims to the financial position they would be in had they not been swindled by fraudulent products and corrupt behavior that regulators have collectively sanctioned.

I don’t know how to explain this disgraceful performance, except through a combination of corruption, incompetence, and self-delusion.

Below are the most recent responses I have received from ILAS regulators, followed by my reply to each. Regulators have unanimously expressed a willingness to do nothing. The most perplexing response of all is the response from the Office of the Ombudsman.

Although the Ombudsman is not an ILAS regulator, it has a duty to hold regulators accountable when they fail the public. Unfortunately, if the Ombudsman refuses to do its job, no organization exists (that I know of) to hold the Ombudsman accountable. I am therefore urging journalists to contact the Ombudsman for further questioning.

I am also cc’ing this letter to the Independent Commission Against Corruption, since it is the only watchdog left that hasn’t indicated a determination to do nothing. Because players throughout the ILAS industry have been violating Section 9 of the Prevention of Bribery Ordinance, they are already valid targets for investigation by the ICAC. LegCo member Kin-Por Chan acknowledged this in a recent SCMP article.

 Response from the Ombudsman

Dear Mr Lucy,
We refer to your emails of 4 to 11 November.  You considered that investment-linked assurance scheme (“ILAS”) products are not suitable for most investors.  However, the regulatory authorities in Hong Kong have failed to play their roles thereby leading to frequent mis-sale of such products in Hong Kong. You therefore asked this Office to conduct an investigation of the ILAS regulators, with special emphasis on the Office of the Commissioner of Insurance.

2.             The function of The Ombudsman is to investigate complaints of maladministration by the Government departments and public organisations listed in The Ombudsman Ordinance.  However, how ILAS products should be regulated are matters of professional judgement.  They are not administrative matters subject to The Ombudsman’s investigation.

3.               We regret that we would not take your case forward.  Thank you for writing to us.

Yours sincerely,

( Barry Chung )for The Ombudsman

Reply to the Ombudsman

I was never given time to file the official complaint letter that I said I was going to file. I was still in the process of writing it when I received the above response. The Ombudsman rejected my case before it even knew what I had to say. This was unfair, not just to me, but to the countless thousands of victims who have suffered financially.

I disagree with the claim that no maladministration has taken place. The regulation of ILAS is decades behind the UK’s, and this has been publicly and scathingly criticized for a very long time. There must be hundreds of thousands of ILAS mis-selling victims who don’t understand what happened to them, yet regulators have refused to do anything to identify, notify, and help these people. It’s inexcusable. The persistent refusal of regulators to address the devastation caused by ILAS is a straightforward matter of maladministration, maybe even corruption. The Ombudsman’s denial of this is extremely puzzling.

I request that the Ombudsman allow me to submit a complaint letter that describes the situation more extensively. I also request that it reconsider opening an investigation (case number OMB2013/4618). 

Response from the Insurance Authority

Dear Mr Lucy,

We refer to your e-mail of 4 November 2013 below, the contents of which have been noted.

As mentioned in our previous email of 15 October 2013, the assessment of the suitability of an ILAS policy for a particular client should be based on a totality of the circumstances.  We have no further comments to supplement except that we are working with the insurance industry on the enhanced quantitative remuneration disclosure for ILAS policies, which is expected to be implemented next year.

As insurance regulator, we will promptly follow up any complaint cases lodged with our office and take actions as considered appropriate.  If you have further information concerning misconduct of any insurance intermediaries, please provide us with the relevant information for our follow-up actions.

Regards,

Helen Ho
Office of the Commissioner of Insurance

Reply to the Insurance Authority

It’s obvious the entire industry has been engaging in misconduct. Here are three reasons why:

1) ILAS products are fraudulent. The Rube Goldberg fee structure and bogus “bonus allocation” are designed to conceal massive upfront commissions and give the appearance of value where there is none.

2) Insurers have been bribing intermediaries with commissions that can be hundreds of times higher than the commissions paid for selling competing fund products, such as those offered by iFAST.

3) ILAS has been flogged to Hong Kong citizens, even though it clearly isn’t suitable for them. The main attraction of ILAS is the ability to avoid foreign capital gains taxes, but Hong Kong citizens don’t pay them!

It is inexcusable that the Insurance Authority has refused to acknowledge these facts and take appropriate actions. I am investigating a potential lawsuit, and I will not change my mind unless the Insurance Authority acts soon.

Response from the Hong Kong Monetary Authority

Dear Lindell,

We refer to your email of 11 November 2013 as appended.

The HKMA’s guideline is silent on bonus allocation but para. 6.1 of the “Guidance Note on Gifts, Promotions and Incentives for Class A and Class C Products” issued by the Hong Kong Federation of Insurers (January 2012), which is available on its website, permits allocation of bonus fund units.

The HKMA requires banks to adequately disclose and properly explain to customers the nature, features and risks of ILAS products.  Therefore, the HKMA would be concerned if a bank has adopted inappropriate practices in the sale process that will result in customers’ attention being distracted from the nature and risks associated with the ILAS products.  Furthermore, the HKMA requires banks to take all reasonable steps to ensure that the recommended ILAS product is suitable for a customer having regard to the customer’s circumstances.

Should any improper sale practices or potential mis-selling in relation to banks’ sale of ILAS come to its notice, the HKMA would take follow-up actions.  Before deciding whether a case of misconduct is substantiated, the HKMA would assess the evidence on hand to decide whether there is a prima facie case for formal investigation.  After investigation, the overall circumstances of each case as reflected by the evidence collected would be taken into account before reaching an impartial judgement on each case.  If misconduct on the part of a bank and/or its staff can be established, disciplinary actions may be taken pursuant to the relevant legislation.

We hope you would appreciate that we cannot comment on matters related to individual cases or individual banks.   However, as to the assistance available to aggrieved customers with respect to intermediaries’ sale of ILAS products, our reply to you on 18 October 2013 has provided details.  We would also urge any customers who believe they have been mis-sold ILAS products by banks to lodge a complaint with our Banking Complaint team for follow-up.   The team can be contacted at 2878 1378.

Thank you.

Best regards,

Public Enquiry Service
Hong Kong Monetary Authority

Reply to the Hong Kong Monetary Authority

Please read what I wrote to the Insurance Authority above. The HKMA knows that ILAS mis-selling is widespread and that the very essence of a mis-sale is that the victim doesn’t know they were exploited. Thousands of victims will continue to suffer silently unless the HKMA takes a proactive attitude towards identifying and notifying these people. Please set a good example for other ILAS regulators to follow.

Response from the Securities and Futures Commission

 Nothing.

Reply to the Securities and Futures Commission

The SFC cannot pretend like it is not partly responsible for the ILAS mis-selling scandal. The SFC authorized many blatantly fraudulent and exploitative ILAS products. It did not require commission disclosure on marketing documents until recently (and even now, disclosure is not mandatory or complete). The SFC also designed pitifully inadequate illustration documents which don’t show the devastating long-term effects that ILAS fees inflict relative to direct fund investing, which is vital information that inexperienced investors need to know before buying an ILAS product.

As I argued in my last letter, ILAS seems to fall under the legal definition of a security, which means that people selling ILAS should comply with SFC regulations. Inexplicably, the SFC has denied this and hasn’t been enforcing the rules. I am still waiting for a response to my letter. Unless the SFC can provide a clearer and more rational defense for its interpretation of the law, I will be investigating a potential lawsuit on behalf of ILAS victims.

Response from ILAS Self-Regulators (PIBA, CIB, HKFI)

Nothing.

Reply to ILAS Self-Regulators (PIBA, CIB, HKFI) 

The whole industry is rife with criminal behavior, so this total lack of response from industry representatives is exactly what I expected. Nevertheless, there is no good excuse for PIBA not having reached a conclusion to its investigation into the cases of Leung Chung Yan and DeAnn Tsang. Both of these ladies have been patiently waiting for more than half a year to receive their money back, along with an apology from Convoy. I ask that PIBA please provide a concrete update immediately.

I called PIBA’s office last week only to be told that one of the cases is in the “final stages” of investigation and that PIBA was “still collecting information”. The lady on the phone gave me no time-frame for when PIBA would be finished, even though there’s already enough public information to potentially put thousands of people in prison. I’m convinced that PIBA is not really conducting a genuine investigation but is instead buying time with its excuses.

Concluding Remarks
 

The longer that regulators refuse to appropriately address the ILAS mis-selling scandal, the more that public awareness and outrage will spread. I’m confident that it will be a hot-button issue with protesters this summer at Occupy Central.

Lindell Lucy