Add-on insurance and flex commission practices
By Acting ASIC Chairman, Peter Kell
It is tempting to wonder why a person might pay more than $6,000 for insurance cover that was capped at a maximum payout of $6,000 – or why someone would buy an insurance policy under which they were never eligible to make a claim.
But the real question should be why a company would treat its own customers that way by selling them such a policy?
There can be no justification for such behaviour. Unfortunately, ASIC has found these practices are all too common in the add-on insurance sector – and we are determined to see them disappear. Too many consumers have simply not understood what they were being sold. We have commenced a two-stage strategy of seeking large-scale customer compensation, while also working with the industry to improve its performance.
Insurance products such as the real-life example above are sold through car dealers, and are generally known as 'add-on products' or 'car-yard insurance'. ASIC decided to review this area, focusing on the five most common forms of cover: credit insurance, gap insurance, loan termination insurance, mechanical breakdown insurance and tyre and rim insurance.
What we found was a market that was failing consumers. Over the three-year period 2013-2015 we found that car buyers obtained little if any financial benefit from buying add-on insurance, paying $1.6 billion in premiums and receiving only $144 million in successful insurance claims. In other words, customers received just nine cents in the dollar.
Where did the money go? About half went in various ways back to the companies providing the cover, as you might expect. Insurers paid car dealers $602 million in commissions - over four times more than they paid to consumers in claims.
We also had identified the related car-yard practice of so-called 'flex commissions' paid by finance companies to car dealers when arranging car loans. The finance companies not only allowed car dealers to decide what rate of interest to set for the loan, they financially incentivised dealers to charge customers a higher interest rate. This was almost universal practice across the industry.
A combination of poor or misleading disclosure, allied with point-of-sale pressure, meant that customers very often agreed to buy products or services that were not in their interests. Many customers didn't understand what they were buying, or may not have even realised that the cost of these financial products was included in the overall package.
These practices caused harm in ways that was not obvious to customers. Most car buyers would be surprised to learn that when buying a vehicle on finance, the car dealer could decide whether the customer was charged an interest rate of 7% or one of 14% - regardless of the buyer's credit history. They would be surprised to learn that insurance commissions paid to car dealers could be as high as 79% of the insurance premium. ASIC has signalled to insurers and finance companies that they need to assist car dealers to operate so that the end-customer is treated fairly, including with financial products that meet their needs.
ASIC is requiring providers of insurance sold through car yards to make changes to benefit consumers. For example, following our intervention insurers have voluntarily lowered commissions on cover they sell to around 20% of the premium, and so improve the value they offer.
[Yesterday's] announcements by Allianz that it would return $48 million to approximately 110,000 customers, Suncorp's return of $17.2 million to 54,000 customers, and the Swann Insurance (part of Insurance Australia Group) offer last month of $37 million to 68,000 customers, are a good start on making things right.
This has been one of ASIC's largest compensation programs. In total, we expect to see refunds of more than $122 million paid to more than 257,000 customers for buying insurance products of little or no use to them.
The failure of the add-on insurance market to serve consumer interests highlights the importance of the new 'design and distribution obligations' that will be imposed on financial services firms. The Government is consulting on draft legislation which will require firms to identify an appropriate target market for their products and ensure that the products are being sold to the right people. ASIC welcomes this important reform, and believes it will help improve consumer trust in the financial services industry.
Insurers know they need to address this, and should be taking active steps to ensure their customers are not being sold near-worthless products. The message is simple: 'the needs of your customers must come first in the design, price and sale of your products.'
Once ASIC identified the harm being caused by flex commissions we worked directly with insurers, lenders and car dealers to see these practices could not continue – a position industry has generally accepted.
We believe the same sense of reality, however belated, is beginning to take hold with regard to selling add-on products and other financial services that are poorly designed or benefit the seller of the product more than the consumer. If not, these major remediations will not be the last.