Although replacements generally have a poor reputation in the financial services industry, one must always measure a replacement against what is best for the client. Arguably there are cases where clients are led to believe that it is in their interest to replace when this is not the case. But, one cannot overlook the fact that with the advent of new and better products or changing customer needs, there are certainly many instances where the interests of the client are better served by a new or different product.
In this article we do not focus on whether a replacement is right or wrong for a client, but rather on what is required of a financial advisor when recommending a replacement.
General Code of Conduct spells out the information that advisors need to share
There is no formal definition of a “replacement” in the FAIS Act or the General Code of Conduct (GCoC). However, Section 8(1)(d) of the GCoC sets out a detailed list of the information that an advisor should disclose to a client “where the financial product (‘the replacement product’) is to replace an existing financial product wholly or partially (‘the terminated product’) held by the client, …”
The FAIS Act’s definition of a financial product includes many different products such as shares, bonds, bank deposits, medical aids, long term and short term insurance, unit trusts etc. This means that whenever an advisor makes a recommendation to a client to change from their current financial product (and this applies to any type of financial product), either in whole or in part, the requirements set out in the legislation must be met.
Steps must be taken to ensure the client is able to make an informed decision
The GCoC is also very clear that “reasonable steps must be taken to make sure that a client understands the advice and that the client is in a position to make an informed decision.” It is not enough to simply give the information to the client and leave them to decipher how the replacement will impact on their situation.
Providing your client with understanding and a detailed explanation, however, does not end with a conversation or a discussion. An advisor must follow through with documented evidence of the information given, the various aspects of the products which were compared and the advice provided to the client. The record of advice must include “the reasons why the replacement product was considered to be more suitable to the client’s needs than retaining or modifying the terminated product.” It goes without saying, that in order to provide appropriate advice, information should first be gathered from the client and an analysis conducted. Without documented evidence, an advisor will not be able to show that the client was treated fairly, that the client was adequately informed or why the replacement was suitable and appropriate for the client, leaving the advisor exposed in the event of a client complaint.
After considering a complaint lodged with the office of the FAIS Ombud relating to a replacement, which was eventually settled, the Ombud’s office stated that, “A thorough exercise of comparing the material terms of the contract underlying the purchase of the replacement product, and explaining this to the client must be undertaken by the advisor” . Advisors often complete a comparison form because they “have to” without always considering whether a client would be able to follow or understand the information recorded. Make sure that your documentation is clear and easy to understand from the perspective of the client.
The different factors which an advisor must compare and explain to a client when proposing a replacement or a switch are listed below. These are broad requirements set out in the GCoC which must be applied to the specific type of financial product/s in question.
- Fees and charges
Clients should understand the different types of costs such as policy charges or other fees, asset management fees, annual performance fees, trailer fees or portfolio fees.
- Special terms and conditions
This could be anything from whether disability or income protection is linked to the client’s own occupation, if there are any special terms linked to value added products such as Multiply or Vitality, the number of loans or withdrawals applicable to an Endowment, etc.
- Exclusions of liability, waiting periods, loadings, penalties, excesses, restrictions or circumstances in which benefits will not be provided.
There have been FAIS Ombud Determinations where the advisor could not show that the client was informed that different short term insurance product suppliers required different tracking devices. Other examples – Are there any pre-existing conditions, such as cancer, which are excluded? Is there a waiting period before the benefit will pay out? Does a 2-year suicide clause apply? Is there any information relating to the client’s health or occupation which may impact on how the product performs? Are there differences in the excesses, both standard and additional? Excesses stipulated in a short term insurance policy are one of the first things that a client will have to pay in the event of a claim. Failure to inform the client of any change or difference between the two products may result in the advisor staring down the barrel of a client complaint.
- Impact of age and health changes on premiums payable
Will the premiums become unaffordable for the client in the future? Does the client understand this and can the advisor demonstrate that this was explained?
- Tax implications
Make sure your client understands whether there will be capital gains tax payable as a result of the replacement or switch or other tax payable.
- Material differences of investment risk (if this is applicable to the product)
An advisor should understand the risk appetite and tolerance of the investor and make sure that there is documented evidence of the client’s agreement and understanding of the level of risk, and the difference, if any, between the replaced and replacement product.
- Penalties or unrecovered expenses
The penalties or unrecovered expenses deductible or payable due to the termination of the terminated product. Your client should understand any penalties or other expenses which will have to be paid before making a decision to replace.
- The extent to which the product is readily realisable or the extent to which the relevant funds are accessible. For instance, is there a redemption notice period or can the client only access a certain amount of the investment at maturity?
- Vested rights, minimum guaranteed benefits or benefits which will be lost as a result of the replacement.
- Any fee or commission received by the provider on the terminated product and the replacement product. Clients should be informed if the advisor earns a fee or commission on both the replaced and replacement product.
The overarching principle of the GCoC is that advisors must provide a financial service to clients with honesty. They must be fair and act with due care, skill and diligence and in the interests of clients and the integrity of the financial services industry. Treating Customers Fairly supports this and requires that the outcome for the client is appropriate and that suitable advice was provided taking into account the circumstances of the client. The process of providing this advice should include making sure that the product is suitable to the client and their needs and that all information given is clear and in plain language. When providing replacement advice, follow the required process carefully and don’t take short cuts – you may regret it down the line.