Replacement of financial products is a key part of professional and appropriate financial advice. As product providers develop new products and change existing products to meet the changing needs of clients, it may be necessary to cancel old products and replace them with new ones.
Before doing so, consider the obligations placed on financial advisors and clients’ rights in terms of the law. Section 8(1)(d) of the General Code of Conduct (GCOC), which deals with “suitability” of advice, provides for the following after its amendment in June 2020:
Where the financial product (“the replacement product’’) is to replace another financial product (“the terminated product”), the provider (FSP) must fully disclose to the client the actual and potential, financial implications, costs and consequences of such a replacement. Where applicable, this includes full details of the replaced/terminated and the new financial product.
The information that should be disclosed to clients includes:
(i) Fees and charges;
(ii) Special terms and conditions;
(iii) Impact of age and health on premiums;
(iv) Differences in the tax implications of each product;
(v) Penalties or unrecovered expenses due to termination;
(vi) The extent to which the replacement product is readily realisable or funds are accessible;
(vii) Any vested rights, minimum guaranteed benefits or other guarantees that will be lost;
(viii) Any compensation payable to the advisor due to the replacement.
Section 8 (1)(e) of the GCOC states The advisor should take reasonable steps to enquire whether any financial product that is sold will replace an existing product. Furthermore, the advisor needs to ensure that clients understand the details of the replacement so they can make an informed decision. These are serious requirements placed on advisors.
There are two main practical issues associated with replacements: motive and product knowledge.
Some financial advisors change products to receive new commission, rather than because it is appropriate for clients’ circumstances or needs. In practice, it is difficult to distinguish between a good and a bad replacement. Where the need of the client comes first, it is typically a good replacement. Where the need of the advisor drives the replacement, it is generally a bad one, often referred to as “churning”. In this tight economy, with the suitability of advice under scrutiny, one needs to consider the reason behind a recommendation to replace a financial product.
Financial products are complex and advisors’ knowledge of financial products from other product providers varies. Clients may find it difficult to understand the intricacies of financial products and therefore rely heavily on the advice and guidance provided by financial advisors.
It is important to understand and comply with the prescribed legislation to ensure the fair treatment of clients. In addition to knowing about “suitability of advice”, it is essential to understand other related legislation, including what is regarded as a replacement.
The amendments to the General Code of Conduct introduced a definition for “replace or replacement” which means:
“the action or process of –
(a) substituting a financial product, wholly or in part with another financial product; or
(b) the termination or variation of a financial product and the purchase, entering into, investment in or variation of another financial product–;
with the purpose of meeting the same or similar needs or objectives of the client or in anticipation of, or as a consequence of, effecting the substitution, termination, or variation, irrespective of the sequence of the occurrence of the transactions.”
Examples of substituting that frequently occur in the marketplace, but often are not thought of as “replacements” are switching from one investment platform to another, because the new platform charges lower fees. In many instances the underlying funds remain the same although the fees and underlying costs may differ. It is therefore important to inform the client thereof.
Another example is where retired clients switch their living annuity to a life annuity to benefit from the guarantees a life annuity offers. These switches are being prompted by uncertainty in the financial markets, driven by the Coronavirus. In these cases, it is important to highlight the differences between the products and ensure clients fully understand the consequences of the change.
“Variation” is defined broadly. It includes:
(a) an acceleration of the contractual retirement date or other date on which benefits become available;
(b) any change to the premium or other periodic investment amount;
(c) making the financial product or investment paid up;
(d) the ending of premiums or periodic investments;
(e) the application of the policy or investment value as premiums or other periodic investment amount payable in respect of a financial product;
(f) the reduction or removal of any guarantee or benefit;
(g) any act that results in a change to a material term or condition, or the contract term;
(h) the financial product becoming static because an option to update cover, benefits, premiums, or other periodic investment amounts has not been exercised;
(i) any transfer from or of one financial product to another financial product;
(j) a non-renewal of a short-term insurance policy.
An example of “variation” is where clients renew their short-term insurance policy but, on the advisor’s recommendation, reduce their premiums by removing certain benefits/cover or by increasing excesses.
When replacing a short-term policy, which also includes varying, advisors need to compare the new and existing policies. This is usually done by comparing the sections relating to cost/premium and not necessarily considering the policy wording. Policy wording differs substantially between product providers, so it is important to cover that. Also be sure to check if the conditions or requirements for cover are the same, for example, the need to periodically test that a vehicle tracking system is working.
The above legislation applies to all financial products, including funeral/ assistance policies, credit life insurance, risk policies, investments, health services benefits and short-term insurance. It seeks to ensure that clients are treated fairly and their needs are suitably addressed. It also protects advisors, as following proper processes significantly reduces the chance of successful complaints against them.
Clients are regularly bombarded with offerings from financial advisors and direct marketers, and they may struggle to distinguish between good and bad advice. When your recommended product is being replaced, you are often in a difficult position. The client may not wish to discuss the replacement. Also, you are not always fully informed as to why the product is being replaced. You may feel the advice is inappropriate, and your client was not correctly advised.
Your recourse in this instance is limited, as you may not force a client to stay with an existing product. But you can lodge a complaint with the FSCA and the steps to do so are available on the FSCA website. Ultimately the decision to replace a product rests with the client, even though the advice may not be suitable.
Do a replacement correctly
If you are doing a replacement, make sure you gather enough information from the client to meet his/her specific needs. The client should be placed in a position to make an informed decision regarding the replacement and understands the full implication of the replacement.
If you are replacing a product of another product supplier, you need to acquire the necessary information regarding the product you are replacing. Moving from a rule-based approach to a principle-based approach makes it a practical exercise, and you may be required to motivate your replacement later.
Always act with the necessary due skill, care and diligence when doing a replacement. As a general rule, if you will not replace your mother’s policy, do not replace your client’s policy.