The pitfalls of investing in ILAS
A mystery shopping exercise reveals inconsistencies in the sale of insurance-linked pension plans. So investors beware, write Nicky Burridge and Jasper Moiseiwitsch
In 2010, Li (who asked that her full name not be revealed) started a new job with a higher salary. Her wealth planner, who worked for a global bank, advised Li to invest in a pension plan sold by a major insurance firm.
She agreed to the idea and committed to pay US$4,200 a month into a five-year pension investment.
In 2011, Li was assigned a new relationship manager and met her to find out how her investment was performing. She was told that she was making money on one of her funds but losing money on the other. After some digging she found out that, if she cashed in her fund that day, she would take a big loss.
"I went home and looked at the numbers, but it made no sense. How could I be making 40 per cent gains on most of my funds, but the cash-in value was still lower than the amount I had invested?" she says.
Li asked her relationship manager for a line-by-line breakdown of her statement, with an explanation of what happened to her missing money.
"She told me she was not trained to read the statement. Then she told me she had no way to check how much my investment was worth."
During the following nine months, Li continued to try to get a valuation for her investment, but the bank failed to provide her with one, eventually telling her she needed to speak to the person who had sold her the instrument, who had left the organisation.
Li's story is not an isolated case. She bought an investment linked assurance scheme (ILAS), which is one of the most popular investment and pension plans sold in Hong Kong. The instrument is also a common cause of investor grievance.
ILAS make up almost one-quarter of all complaints made in Hong Kong about insurance instruments, according to the Office of the Commissioner of Insurance.
When making such complaints, investors typically complain ILAS fees are too high, that returns are too low and that the plans are too restrictive (people can be locked into making big annual payments for as long as 25 years, with stiff penalties for early withdrawal).
Most problematically, people tend to only find out about their problems with ILAS long after they sign a contract committing to the plan, because ILAS can be very difficult to understand, particularly the tricky matter of fees.
"I used to be a senior performance analyst and even I found it difficult to work out what the fees were," Mathew Bate, of fee-based independent financial adviser Private Capital, says of ILAS.
ILAS are everywhere. They are sold at banks, by insurance agents and brokers, and financial advisers. Typically, they take the form of a long-term savings scheme involving monthly or yearly contributions, with funds invested in an array of mutual funds. The plans are hard to recognise. Sales agents probably won't use the word "ILAS".
The key giveaway is that they are investment plans linked to insurance. So if an adviser or bank salesman pitches you on an investment plan sold by an insurance company, they are likely pitching an ILAS plan.
The Office of the Commissioner of Insurance earlier in the year performed a mystery shopping exercise for ILAS, visiting banks, brokers and insurance agents, posing as a customer and secretly monitoring how these instruments were sold to the public.
The results were not encouraging. On November 23, the office sent a letter to the Hong Kong Federation of Insurers, an industry body, saying it was "extremely concerned about the sale of ILAS products".
This letter coincided with a meeting called by the office in which Annie Choi Suk-han, commissioner of insurance, met with the Hong Kong chief executives of the big insurance firms, partly to discuss the findings of the survey.
Choi says the mystery shopping survey found "substantial variation and inconsistencies" in the sale of ILAS.
The rules require that ILAS salespeople ask a series of questions to get a sense of a client's financial needs and risk appetite. This is done to ensure a person understands and wants an ILAS before they sign a plan, as these can involve a heavy commitment of cash.
Choi says that, because salespeople typically pitch insurance instruments in informal settings, such as in restaurants or people's homes, the selling process can get interrupted or be cut short. Her office found that ILAS salespeople cut steps, often not asking all the questions necessary to understand a client's needs and risk appetite, or by asking questions out of order over several meetings.
"We see a lot of variations [in the ILAS selling process]," says Choi. "Sometimes, if you are talking in a McDonald's, you talk about needing to complete [a set of questions], and the server hands you a dish, which might disrupt the whole thing. They might talk about other things and then come back again [to a line of questioning]."
Moreover, while ILAS salespeople are required to probe a client's financial needs and risk appetite before selling a plan, the insurance sector is self-regulated. It is up to the industry to ensure people stick to the rules, and to punish rule breakers.
This system of self-regulation stands in stark contrast to how the sale of other investments - such as mutual funds, stocks or bonds - are sold in Hong Kong. For such instruments, the Securities and Futures Commission regulates the selling practices of brokers and fund managers, and the Monetary Authority oversees the banks.
Regulators can penalise rule breakers with fines or by suspending their licences, or by referring cases to the courts for criminal prosecution.
When an employee sells an investment in a bank, the bank records key conversations, such as the assessment of a client's financial needs and comfort for risk.
This imposes a discipline on bank employees. They need to follow a script. Certain questions must be asked. If they skip steps, the oversight will be recorded. If the client then complains, the bank will be legally exposed.
It's a different regime for the insurance industry, where sales are done in much more informal and unstructured settings, and where insurance firms police themselves, even on the sale of high-profit products such as ILAS.
For example, there is no requirement for agents to record their conservations with clients on the sale of ILAS, as most of these discussions happen in noisy, public settings where recording would be difficult.
Choi says the system for insurance industry self-regulation began 20 years ago, "when the number of intermediaries was much smaller, and the products were less complex".
"We do see that public's aspirations have changed. People are more aware of their rights," says Choi. "We believe it is time for Hong Kong to move on from the self-regulatory regime."
Changes are under way. As a result of the mystery shopping survey, Choi has asked the insurance industry to follow up every ILAS sale with a formal phone call from the firm behind the sale. This call will be recorded. It will follow a standard script, where a potential investor will be asked a full set of questions, in order, asking about the suitability of the plan according to an investor's financial needs and risk appetite.
Choi says this post-sales call will be implemented in early 2013.
Meanwhile, after much delay, Choi says the insurance industry recently agreed to require selling agents to disclose the fees they earn from selling ILAS. This is a controversial matter. Because agents can make so much commission selling ILAS, they are open to criticism that they sell ill-suited instruments just to earn fees.
ILAS are unusually lucrative fee-payers because they can involve commitments for anywhere from five to 25 years. Insurance firms commonly pay selling agents a fixed percentage of all expected contributions into the plan, in one upfront lump-sum payment.
"People get sold these products on the wrong basis," says Sheila Dickinson, senior wealth manager at the advisory firm Fry Group. "Particularly with long term contractual savings plans, people don't realise they are tied into them for 20 to 25 years, and would have large redemption penalties if they pull out or stop contributing."
Choi says the insurance industry is moving towards commission disclosure on ILAS sales, likely by April 2013.
Finally, the system for self-regulation is ending.
A new body called the Independent Insurance Authority will come into existence, probably by 2015, with exclusive powers to regulate and licence insurance firms.
In the meantime, while all these changes wind through the system, investors need to take care when taking out a long-dated and complicated plan such as ILAS.
One investor (who wants to be known only as Paul) was talked into taking out an ILAS after questioning the amount of commission his financial adviser had earned on a mortgage he had arranged for him.
"The adviser said he would talk to his boss about reducing the commission, but it would help to pave the way if I took out an ILAS," he says.
Paul was saving HK$10,000 a month on his mortgage, so the adviser suggested he invest this money into an ILAS with a major international insurance company for the coming 12 months.
"He told me that at the end of the 12 months I could cancel it and get all my money back. He said there was no risk," says Paul. "It was sold to me as a short-term product with a guarantee that I would get all of my money back."
Despite only planning to have the investment for a year, Paul was persuaded to sign up to a 15-year term.
After 12 months he received a statement that said the investment was valued at just 15 per cent of the contributions he had made.
"I challenged it, but the person who had advised me had left the company and there were no records," he says. "All of the management costs were front-end loaded and that is why it was worth so little."
Paul's adviser would have earned a HK$75,600 commission on the sale - three times more than if he had sold Paul a five-year instrument.
Paul pulled out of the instrument three years after he had first taken it out, and managed to get HK$240,000 back, although he had contributed HK$360,000.
"I was stupid. I should have read the small print," he says. "I trusted the adviser and thought I could get out of it after 12 months without any clawback, but I was mis-sold."