CONSUMER CREDIT INSURANCE IN SOUTH AFRICA

April 2008

REPORT OF THE PANEL OF ENQUIRY

“Regent bent commission law to boost policy sales”by Bruce Cameron

Personal Finance 07/07/20007

“Insurers, top LOA official to face probe over payments” –

Business Day 16/07/2007

“LOA makes its voice heard against errant members” –

Business Day 18/07/2007

“Verhore kom na vergrype in bedryf”

Sake Rapport 02/09/2007.

“Probe into credit Insurance”

– The Citizen 16/07/2007

A SURVEY OF CCI IN SOUTH AFRICA

CONTRAVENTIONS OF COMMISSION REGULATIONS

MARKET PRACTICES IMPACTING NEGATIVELY ON CONSUMERS

CONSUMER EDUCATION AND AWARENESS

TERMS OF REFERENCE INCLUDE:

MEMBERS OF PANEL

Judge Peet NienaberChairperson of the Panel of Enquiry , former Ombudsman for Long-term Insurance

Moses MoeletsiChairperson of the Board of the Ombudsman for Short-term Insurance, member of the Council of the Ombudsman for Long-term Insurance

Ronnie NapierSenior partner, Weber Wentzel, former chairperson of SAIA

Desmond SmithDirector of Companies, currently chairperson of the LOA

Louis WesselsFormer head of legal and policy affairs of, and currently consultant to the FSB

METHODOLOGY

Invitations to participate: to members of public, consumer groups, other interested parties .

Initial questionnaire: members of LOA and SAIA.

Evidence: members and outsiders.

Follow-up questionnaire – wide-ranging issues.

Additional evidence from outsiders.

Meetings with FSB, NCR and NT.

Written submission from Finmark Trust.

Dependent on voluntary co-operation from members.

No powers of investigation.

No power to compel evidence from non-members.

Could only comment on what we were given.

If the information submitted was incomplete, to that extent is the report.

Mere recommendations to LOA and SAIA.

CONSTRAINTS

THE REPORT

275 PAGES, plus appendices, 15 CHAPTERS

CENTRAL THEMES:

1. CCI is different from other forms of insurance It is driven by credit-providers There is little active involvement from insurer, broker, consumer.

2. CCI is an off-shoot of credit CCI cannot be separated from the credit arrangement Without CCI there will be no credit, especially at the lower income-

end of the market 3. CCI should be treated as a separate species of insurance for purposes of commission regulation for purposes of consumer education.

CHAPTER 1: INTRODUCTION

CHAPTER 2: ISSUES AND TOPICS

CHAPTER 3: THE CONCEPT OF CREDIT INSURANCE

1 WHAT IS CREDIT INSURANCE?1.1 The ordinary meaning of credit insurance 1.2 The meaning of credit insurance in terms of the LTIA1.3 The meaning of credit insurance in terms of the STIA1.4 The meaning of credit insurance in terms of the NCA2 TYPICAL CONSUMER CREDIT INSURANCE PRODUCTS 2.1 Credit Life 2.2 Extended warranty2.3 “Top-up” or shortfall cover2.4 Minor “chips and dents” cover2.5 Asset insurance3 CREDIT INSURANCE IS DIFFERENT

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CHAPTER 4: THE CONSUMER CREDIT INSURANCE INDUSTRY IN SOUTH AFRICA

CHAPTER 5: CONSUMER CREDIT INSURANCE REGULATION AND MISCONDUCT IN THREE OTHER JURISDICTIONS

1 INTRODUCTION2 THE UNITED KINGDOM3 AUSTRALIA4 THE UNITED STATES OF AMERICA.

CHAPTER 6: CONSUMER CREDIT INSURANCE REGULATION

1. SOME INTRODUCTORY REMARKS2. THE STIA3. THE LTIA 4. CREDIT LIFE INSURANCE AS AN “ASSISTANCE POLICY”5. COMMISSION ARBITRAGE BETWEEN THE LTIA AND THE STIA 6. THE FAIS ACT7. THE FAIS CODES8. THE POLICYHOLDER PROTECTION RULES (PPR)9. PAYMENTS MADE BY CONSUMERS TO INTERMEDIARIES 10. THE NCA11. THE COMPETITION ACT12. THE LOA CODE ON COMMISSION CONTROL 13. THE SAIA CODE OF GOOD BUSINESS PRACTICE 14. RECAPITULATION

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LTIA and STIA distinguish between:

the introduction fee (canvassing new business) (pre-contractual)

the servicing fee (outsourcing administrative work) (post-contractual)

Different capping formulae for each in terms of the two Acts (arbitrage)

Root of the problem: the capping of the servicing fee

The critical words in the regulations: “independent intermediary” “rendering services as intermediary”

INTERMEDIARY REGULATION

INTERMEDIARY REMUNERATION (CONTINUED)

The so-called “intermediary” is not a proper intermediary (e.g. a broker) buta principal (e.g. furniture retailer, motor dealership, credit-provider)

The outsourced administrative work done by the so-called intermediary for the insurer is not true intermediary work but sub-contract work

Because it is capped (as if it were true intermediary work) it causes a distortion and leads to attempts to circumvent the cap

Moreover, the product supplier, credit-provider and the insurer often belong to the same group of companies and the profit stays in the group.

FSB’s “INTERPRETATIVE NOTE” DECEMBER 1998

heavily relied upon by industry to circumvent limitation of intermediary remuneration in terms of section 48(1) of the STIA

the note seeks to distinguish between “ordinary meaning” of intermediary and “ordinary functions” associated with it, as against the words used in section 48(1)

conclusion of note: insurer may pay any remuneration to a person “other than an intermediary as ordinarily understood” – thus enabling outsourcing of insurer’s functions to “administrators”

the Panel disagrees: if what an outsourced administrator does is covered by either (a) or (b) of the definition of “services as intermediary”, section 48(1) is activated and capping kicks in.

CHAPTER 7: THE EVIDENCE ON INTERMEDIARY REMUNERATION

1. A SUMMARY OF THE EVIDENCE OF INSURERS ON INTERMEDIARY REMUNERATION

2. SOME COMMENTS ON THE EVIDENCE3. THE FOLLOW-UP QUESTIONNAIRE4. SOME COMMENTS ON THE RESPONSES TO THE FOLLOW-UP

QUESTIONNAIRE

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INSTANCES OF NON-COMPLIANCE

As far as the current position is concerned, the Panel concluded that:

the LTIA, the STIA and the regulations issued in terms thereof in relation to intermediary

remuneration are unclear and in need of review and revision

in respect of motor dealerships and the furniture retail business some structures have been put in place by some insurers that are not, on the Panel’s reading of the legislation, in strict conformity with the regulations as they currently stand

this was in each case done on the basis of legal advice obtained

the Panel accordingly made no recommendations that further action be taken by the LOA or SAIA against any individual insurer save for suggesting that each of the insurers concerned should enter into discussions with the FSB pending a review of the regulations

the Panel cannot be sure that other insurers who did not participate in the enquiry may not have similar structures in place – what has been said above would of course apply to them in equal measure.

Chapter 8:THE PANEL’S RECOMMENDATIONS ON INTERMEDIARY REMUNERATION REGULATION

1 SOME INTRODUCTORY REMARKS2 REGULATION OF THE INTRODUCTION FEE?3 REGULATION OF THE SERVICING FEE?4 A SPECIAL DISPENSATION FOR THE LOWER INCOME END OF THE CREDIT INSURANCE MARKET?

4.2 Should there be a special regulatory dispensation for the lower end of the credit insurance market?

4.3 If there is to be a special dispensation, at what level should the line be drawn?

4.4 Should the LOA’s Zimele product for credit life be extended to other forms of credit insurance and in particular should separate models be devised for different credit insurance products subject to the predetermined amount of cover?

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CHAPTER 8 (CONTINUED)

4.5 By whom and on what basis should the premium rates in respect of different product lines be fixed? 4.6 Should the proposed different models, with the inclusion of a predetermined maximum premium for each product line, be made compulsory by law? 4.7 Should commission (i.e. the introduction fee) for credit insurance products with a benefit level not exceeding the pre-determined level be capped?

5 THE LEVEL OF REMUNERATION6 WHICH ENTITY SHOULD ADMINISTER CREDIT INSURANCE?7 AN OVERVIEW OF THE RECOMMENDATIONS OF THE PANEL ON INTERMEDIARY

REMUNERATION8 LEGISLATIVE AMENDMENTS

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There is no consistency about commission regulation in, for instance, the UK, Australia and the USA.

THE PREMIUM

THE SERVICING FEE

Regulating the “servicing fee” is unique to CCI and, indeed, the world.

The Panel is unanimous in its view that there is no functional need to regulate the servicing fee (for outsourcing administrative work) which is the root of all the problems in SA.

To deregulate the servicing fee will not add to the level of premiums since the administration of the policy is costed into the premium in the first place.

THE PANEL’S RECOMMENDATIONS FOR THE FUTURE ABOUT INTERMEDIARY REMUNERATION AT THE UPPER

INCOME END OF THE MARKET

On the capping of the “introduction fee” there are two views:

- market forces should determine the level of the introduction fee per product line

OR

- the introduction fee should be regulated as the most effective measure to contain improper incentives.

That is a matter of principle which must ultimately be determined by the regulators concerned.

If it is to be regulated the level of regulations should be settled by the industry in conjunction with the FSB, the NCR and NT.

THE INTRODUCTION FEE

RECOMMENDATIONS ABOUT INTERMEDIARY REMUNERATION AT

THE LOWER INCOME END OF THE MARKET

If the consumer is one’s only concern the premium should be capped, especially at the lower income end of the market.

The Panel seriously considered that option but eventually resolved to follow the lead of National Treasury in its recent discussion paper on micro-insurance, namely that there should be no commission capping at this end of the market, in the same way that there is no commission capping for funeral business.

(This would not add to the cost of the premium. The danger of abuse is at the upper end of the market where commissions and

incentives are more meaningful).

CHAPTER 9: CELL CAPTIVES, UNDERWRITING MANAGERS AND PROFIT SHARING ARRANGEMENTS

1. LEGAL REQUIREMENTS2. MARKET OPPORTUNITIES FOR CELLS3. BACKGROUND TO CELL CAPTIVES4. TYPICAL OPERATION OF A THIRD PARTY CELL5. THE INITIAL QUESTIONNAIRE RELATING TO CELL CAPTIVES6. THE FOLLOW-UP QUESTIONNAIRE RELATING TO CELL CAPTIVES7. CONCERNS ABOUT CELL CAPTIVES8. UNDERWRITING MANAGERS 9. PROFIT-SHARING ARRANGEMENTS

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CHAPTER 10: INSTANCES AND ISSUES OF NON-COMPLIANCE WITH INTERMEDIARY REMUNERATION REGULATION

1. THE PANEL’S APPROACH2. PAYMENT OF REMUNERATION IN EXCESS OF THE STATUTORY MAXIMUMS3. NON-MONETARY GIFTS AND VOUCHERS4. CONTRIBUTING TO AN INTERMEDIARY’S MARKETING COSTS AND

INFRASTRUCTURE 5. PAYMENT FOR THE USE OF AN INTERMEDIARY’S DATA BASE6. PAYMENT OF ROYALTIES FOR THE USE OF AN INTERMEDIARY’S BRAND

NAME 7. PAYMENT MADE FOR ADVICE8. INCREASED PREMIUM RATES9. PRE-DELIVERY INSPECTION AND REPAIR WORK

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CHAPTER 11: MARKET CONDUCT REGULATION

1. SOME INTRODUCTORY REMARKS2. THE STIA3. THE LTIA4. The FAIS ACT5. THE FAIS GENERAL CODE OF CONDUCT6. THE POLICYHOLDER PROTECTION RULES (PPR)7. THE NCA

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MARKET CONDUCT

As appears from chapter 5, other jurisdictions are constantly engaged in improving market conduct regulation. South Africa should take note of the studies being conducted especially in the UK and Australia to improve market conduct regulation generally.

Having said that, the Panel believes that its market conduct regulation, in the Insurance Acts, the FAIS legislation and particularly the NCA is adequate and on a par with market conduct regulation elsewhere.

The problem lies with monitoring and investigating instances of non-compliance.

MARKET CONDUCT (continued)

The recent decision of the FAIS Ombud in the Gumede matter is a prime example. The determination is discussed at length in chapter 12.

Other common instances of market misconduct are listed and discussed in chapter 12.

The emphasis is on transparency and proper disclosure

A key recommendation is that the LOA and SAIA create a permanent standing committee to look after credit insurance matters and liaise with the FSB, NCR, ombudsman’s organisations and other role players about all aspects of credit insurance in South Africa.

CHAPTER 12: MARKET MISCONDUCT

1 SOME INTRODUCTORY REMARKS2 THE GUMEDE DETERMINATION3 LACK OF PROPER DISCLOSURE

3.5 Not disclosing costs and charges 3.6 Not highlighting sensitive terms and conditions 3.7 Not highlighting the health declaration3.8 The need for a follow-up letter3.9 Not informing complainants of their recourse to Ombudsman’s offices

4 PRE-SALE MISSELLING BY INTERMEDIARIES5 LACK OF AWARENESS BY CONSUMERS OF THE EXISTENCE OF THE CREDIT

INSURANCE POLICY6 FAILURE TO EXPLAIN THE TERMS OF THE POLICY, THE LIMITATIONS AND THE

EXCLUSIONS OF COVER7 FOISTING POLICIES ON CONSUMERS

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CHAPTER 12 (CONTINUED)

8. AMBIGUOUS AND OBSCURE POLICY LANGUAGE9. EXCESSIVELY WIDE LIMITATIONS AND EXCLUSION CLAUSES10. EXTENDED WARRANTIES11. DIRECT MARKETING12. TIME BARS 13. CONFLICTS OF INTEREST14. SINGLE PREMIUM MALPRACTICES15. PREMIUM COLLECTION16. DISTRIBUTION CHANNELS

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WHICH REGULATOR SHOULD ASSUME PRINCIPAL OVERALL COMMAND OF CREDIT INSURANCE REGULATION AND

COMPLIANCE?

The prudential control of the credit insurance industry should clearly remain with the FSB.

As for market conduct and compliance, the recommendation is that it should be placed under the principal control of the NCR.

- consumer credit insurance is an off-shoot of credit rather than of insurance.

- it serves primarily the interests of the credit provider rather than the consumer.

- whoever exercises regulatory and custodial control over credit should logically and functionally also do so over credit insurance.

The NCR has the infrastructure to do so.

The implementation of the proposals of the Panel would require amendments to several pieces of legislation, more particularly the Insurance Acts and the NCA.

CHAPTER 13: PRODUCT VALUE PROPOSITION

1 VALUE FOR MONEY?2 THE PUBLIC PERCEPTION OF CREDIT INSURANCE IN SOUTH AFRICA3 PRICING4 CONSUMER AWARENESS5 LEVELS OF REPUDIATION6 THE SCOPE OF COVER7 THE USE OF EXCLUSIONS AND OTHER UNDERWRITING PRACTICES 8 DISCLOSURE 9 CLAIM NOTIFICATION PERIODS 10 CONCLUSIONS

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Credit insurance has a bad name, not only in South Africa.

This may be due to a number of factors and perceptions.

Credit insurance is multi-faceted.

Credit insurance is the enabler of the credit transaction - especially at the lower income end of the market.

A conclusion on whether credit insurance is “exorbitantly over-priced” would require a comprehensive actuarial investigation.

THE VALUE PROPOSITION

High repudiation levels are an indicator of lack of value in policies.

Lack of awareness on the part of consumers, wide exclusion clauses and short claim and notice periods in polices may detract from the real value of credit insurance.

Credit insurance has a sustainable value proposition, provided that the weaknesses in the system are properly addressed.

THE VALUE PROPOSITION (continued)

CHAPTER 14: CONSUMER AWARENESS AND EDUCATION ABOUT CREDIT INSURANCE

1 SOME INTRODUCTORY REMARKS2 PROVIDERS OF FINANCIAL LITERACY PROGRAMMES IN SOUTH AFRICA 3 ALLOCATIONS FOR CONSUMER EDUCATION FUNDS4 CONSUMER EDUCATION IN RESPECT OF CREDIT INSURANCE5 THE FOLLOW-UP QUESTIONNAIRE 6 RECOMMENDATIONS

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As a result of the current socio-economic developments in South Africa consumers are increasingly exposed to new and sophisticated financial products and services.

Consumers must be educated to understand these products and to appreciate and enforce their rights.

There is an urgent need for representative and strong consumer organisations. Greater consumer activism is an imperative for truly effective market regulation.

A number on instances are active at present with financial literacy consumer awareness programmes generally. These efforts are, however, fragmented and largely unco-ordinated.

Consumer awareness programmes dedicated to credit insurance in particular are lacking. Consumers should be educated about

- different credit insurance products- their value for consumer- potential pitfalls.

CONSUMER EDUCATION AND AWARENESS

Credit insurance should be treated separately from other forms of insurance

The dedicated subcommittee of LOA and SAIA should ask for a separate budget allocation for credit insurance

The committee should co-ordinate consumer education initiatives of the LOA and SAIA and devise new strategies for credit insurance education of consumer

The committee should liaise and co-operate with the FSB, the NCR and the Credit Information Ombud to co-ordinate a consumer awareness campaign dedicated to credit insurance.

CONSUMER EDUCATION (continued):

RECOMMENDATIONS OF THE PANEL

CHAPTER 15: CONCLUSIONS AND RECOMMENDATIONS

1 IN GENERAL2 INTERMEDIARY REMUNERATION 3 REGULATION REVISION 4 MARKET CONDUCT5 WHICH ENTITY SHOULD ADMINISTER CREDIT INSURANCE?6 THE MAIN RECOMMENDATIONS OF THE REPORT7 END-NOTE

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END-NOTE

The report is wide-ranging. The Panel sought to deal with a number of controversial issues on

which opinions may legitimately differ. Some of the recommendations may not be popular. It will require further action on several fronts. Many insurers and others have spent much time and effort in

responding to questionnaires and queries from the Panel. There responses have been of high quality. Much valuable material has thus been collected which deserves to

be preserved. Irrespective of whether its recommendations are accepted in

whole or in part, the Panel trusts that its report will serve as a contribution to a better understanding of consumer credit insurance in South Africa.

THANK YOU!