ILAS From the Point of View of Mis-sold Hong Kongers

1. ILAS From the Point of View of Mis-sold Hong Kongers

2. ILAS: What Is It? • A mutual fund investment wrapped in a life insurance policy • Most policies provide little life protection • Originated in the UK several decades ago as a means for reducing taxes. Most of the tax benefits no longer exist. • ILAS does not help Hong Kong citizens reduce taxes, so there's no apparent reason for a Hong Kong citizen to own one. • The types of ILAS policies sold in Hong Kong are now illegal in the UK. • ILAS products continue to be aggressively sold in places with poor regulation, a lot of wealthy people, and a lot of British expats (e.g., Hong Kong, Singapore, Dubai).

3. ILAS Statistics • About 2.5 million policies sold in Hong Kong over the past 15 years • About 1.7 million policies in force right now • Insurers have collected over half a trillion HK dollars in premiums since 1997

4. Why Have ILAS Products Been Sold to So Many Hong Kongers? • Insurance companies pay very large commissions, much larger than fund companies • Commissions are not adequately disclosed in the way other investment products are (as required by SFC & HKMA) • The fee structure hides the upfront costs (by making costs appear to be spread out over several years) • Most people don't know they have better investment options • Gullible investors are lured in by “free” fund units • Investors are led to believe that their account value shows how much money they've earned (it doesn't)

5. ILAS on the Outside (Why did Zurich choose this picture for the cover of its policy brochure?)

6. ILAS on the Inside Zurich Vista “Surrender” Charge (Why are the charges so complex? Is this necessary?)

7. Multiple Layers of High Charges Example: Harvest 101 Investment Plan(Sold to Ms. Leung) • Policy Fee: 6% of Every Contribution ($60 / $1000) • Administration Charge: 6% per year, deducted from Initial Account • Exit Charge: Up to 100% of Initial Account • Accumulation Account Charge: 1.5% per year • Fund Management Fees: 1 to 2% • Advisory Fee: 0 to 2% She paid fees greater than 13% during the first year. She then paid an 86% exit charge after the 13th month.

8. A Direct Fund Investment Is Significantly Cheaper • ETF index funds (Management fees as low as 0.05%) • Fundsupermart (A fund platform for do-it-yourself investors. Offers about 500 funds with free fund switching. 2% upfront charge for stock funds. 0.2% annual platform fee for bond funds. No other charges besides underlying fund charges.) • iFAST Central (A fund platform for investors who want to pay an adviser to manage their funds. Platform fee is 0.1 to 0.3%. Advisory fees are determined by the adviser. Operated by the same company as Fundsupermart.) • MPF special voluntary contributions (Over 500 funds. Free fund switching within limits. Average FER is 1.65%.) Note: None of the above options have the massive, hidden upfront charges that many ILAS products have.

9. ILAS Commissions are Excessive • Before indemnity commissions were banned on 1 Jan 2015, a 25 year ILAS policy paid an upfront commission equal to more than 1 year of the policyholder's savings. • A 25 year policy paid 5 times more than a 5 year policy. • A 25 year ILAS policy paid an upfront commission which was 630 times larger than the average upfront “commission” received when selling mutual funds through iFAST Central. (1260% vs 2%) • A 25 year ILAS policy paid an upfront commission which was 4200 times larger than the upfront commission received when selling MPF funds via special voluntary contributions. (1260% vs 0.3%) • It's not yet clear how big ILAS commissions are after Jan 1

10. Conflict of Interests Insurance intermediaries constantly face a moral dilemma. Do they offer advice which is in the best interests of clients? Or do they give advice that earns them a bigger commission at their clients' expense? (Note: Clients are not told how much commission different investment products pay. This makes it very difficult for clients to know when their intermediary might be taking advantage of them and giving biased advice. The relationship between client and intermediary is necessarily based on trust, a trust which is easily betrayed.)

11. ILAS: Is It Suitable for Anyone? • Four regulators (SFC, OCI, HKMA, and HKFI) have stated that ILAS policies are not suitable for investors who have no insurance needs • Most ILAS policyholders did not indicate any need or desire for insurance before being advised to purchase the product • Even if policyholders had indicated insurance needs, ILAS policies provide such a small amount of life coverage that the policies are not suitable to meet those needs. • One's “insurance needs” is the amount of life coverage one needs to take care of one's dependents (such as children) in case one dies. An extra 1 to 5% of the account value is not adequate.

12. In the Best Interests of Clients? • Legally, brokers are supposed to be held to a higher ethical standard than insurance agents, and their Code of Conduct requires them to act in the bests interests of clients. • There is no obvious scenario in which ILAS would be in the best interests of a Hong Kong citizen. • If a Hong Konger has insurance needs, he/she would be better off buying a term life insurance policy and a pure investment product separately. (The same argument applies to whole life, universal life, and endowment policies as well.)

13. A Savings Plan or a Savings Scam? • Longer Lock-in = Bigger Upfront Losses • If you were sold a 25 or 30 year policy, then you just agreed to give away all of your savings for the next two years. • Most of the fund units purchased in the initial period, including the “free” fund units, will be taken back by high charges (either an exit charge or annual administration charges). • The only way to prevent the insurance company from taking back your fund units is by dying. • 2 million regular premium policies sold in HK

14. Do insurers immediately pocket most of the policyholders' initial contributions? Do most of the initial units and “bonus” units exist only on paper? If so, since ILAS offering documents state that insurers buy real fund units, would they be committing fraud?

15. Sky-High Termination Rates • According to an expert interviewed by SCMP, 93% of all ILAS policies are terminated early. • According to an expert interviewed by International Adviser, 99% of 25 year ILAS policies are terminated early. • According to the book, The Great Expat Financial Planning Ripoff, policyholders only maintain payments on ILAS policies for 7.2 years (on average). • According to my estimates, based on OCI's data from 2013, 90% of 30-year policies will be terminated early, and half of them will be terminated by the 9th year. • ILAS policies are currently being terminated about twice as fast as they are being sold. The trend has been accelerating.

16. Hazardous to Your Financial Health • Early termination results in exit penalties as high as 100%. • 25 and 30 year policies have the highest exit penalties, yet these policies are the most likely to be exited early. These policies are the most dangerous for investors and the most lucrative for insurance companies. • Insurance companies do not disclose early termination rates. Instead, they keep this information secret and promote 25 and 30 year policies most aggressively, paying bigger commissions and using extra “free” fund units as an enticement. • A pharmaceutical company or doctor would likely face criminal charges if they knowingly sold and misrepresented expensive medical products that had little or no health benefits but had a very high likelihood of damaging a patients' health.

17. Undisclosed Indemnity Commissions:Deceptive, Arguably Illegal, andHarmful to the Interests of Policyholders • Before 2015, when brokers sold a 25 year ILAS policy, the insurance company secretly paid 25 years of commissions upfront. • The broker had (and still has) no incentive to provide the 25 years of service (such as investment advisory service) which he/she agreed to provide. The broker can take the money and disappear (which often happens). • Policyholders were given the impression that their broker's commission came out of the fees which were deducted monthly from the underlying funds. • The Prevention of Bribery Ordinance requires brokers to obtain permission from clients before receiving a kickback from product issuers. Clients did not give their brokers permission to receive decades of payments upfront. When brokers accepted these secret payments without explicit permission, they arguably committed a criminal offense.

18. HKFI Explicitly Approved Deceptive Commission Disclosure Practices In a circular issued on 22 Oct 2013, HKFI told intermediaries that it was “acceptable” to not disclose whether commissions were indemnified (even though this would significantly magnify the intermediaries' conflict of interest). HKFI only required intermediaries to disclose that they would receive, for example, 3% of premiums to be paid over the premium term. Intermediaries did not have to disclose that all commissions would be paid upfront on Day 1, thereby creating a massive incentive to sell (rather than provide long-term service).

19. Screenshot of HKFI's 22 Oct 2013 Circular

20. Unauthorized Advertisements On 4 June 2007, OCI stated: "It is incumbent upon authorized insurers and insurance intermediaries to ensure not only that the materials used for marketing and promoting ILAS to the public have been authorized by the SFC, but also that when communicating with prospective customers either verbally or in writing, they must not depart from the information contained therein. Failure to comply with this requirement might constitute a criminal offence under section 103 of the SFO."

21. Examples of Unauthorized Advertisements • ILAS is a “fund platform”, a “tax wrapper”, a fund investment with free insurance, no credit risk • You can get your money back after the ICP • Fees are understated/misrepresented, potential returns are exaggerated • Promoting unauthorized funds via portfolio bonds • Claiming that you will earn money immediately even though the policy's cash value will be less than what you pay (for up to a decade or more) • Claiming that a special offer of extra “free” fund units will compensate you for the losses incurred by twisting policies

22. ILAS “Mis-Selling” Cartoon was mis-borrowed from Martin Shovel

23. Exploitation of Fresh Graduates • ILAS products are hard to sell to someone who doesn't know you or trust you • Companies constantly recruit new graduates, pay them no salary (just sales commissions), and train them to sell to all their friends and family • After the young grads have sold ILAS products to everyone they love, the grads run out of people to sell to and have to find a new job • Relationships are destroyed in the process • Companies repeat the cycle, ad infinitum

24. Convoy Financial Services Limited

25. Convoy Financial Services Limited • Has an army of about 2000 commission-based ILAS sellers • Advertises itself as an “independent” financial advisory company, despite conflicts of interest • Likely violating Section 114 of SFO • Aggressively recruiting young Mainlanders

26. Portfolio Bonds & Unauthorized Funds • Insurance brokers use ILAS portfolio bonds to distribute offshore funds which have not been authorized by SFC. • The unauthorized funds pay very high commissions. Over 80 have collapsed or been suspended since 2008. Many have been exposed as frauds. • Portfolio bonds pay 6-8% commissions • Unauthorized funds pay commissions as high as 15% • Total commission is as high as 23%. • Selling unauthorized funds through ILAS without a Type 1 SFC license is probably a criminal offense • Marketing unauthorized funds to retail investors is also a criminal offense

27. Secret Fund Commissions • Some portfolio bond victims claim that their insurance broker denied receiving commissions for promoting the underlying unauthorized funds. Industry insiders have confirmed that this is common. • Insiders say that the fund commissions are received, but the commissions are paid to a different company, typically offshore, in order to evade corporate taxes and the SFC (Section 114 of the SFO). • The above activities may involve criminal acts of fraud, bribery, and money laundering.

28. LM CEO Peter Drake

29. The LM Scandal • 12,000 investors scattered across the world lost their life savings. • 35 in Hong Kong are registered with LMIVC. • Signs that the MPF fund was a Ponzi scheme as early as January 2009. • MPF was popular with expat insurance brokers because it paid high commissions (up to 15%). • Insurance companies knew the MPF fund was troubled, but they helped distribute it anyway because they wanted to maintain “market share”.

30. Mis-sold Policyholders Do Not Trust the SROs • Mis-sold insurance policyholders are required to file their complaints with self-regulatory organizations (SROs). • However, the top executives of the SROs run companies which have been mis-selling ILAS to consumers and possibly committing criminal breaches of the Securities and Futures Ordinance. • Mis-sold policyholders (with justification) have little faith that an SRO will assess their complaint in an unbiased and fair manner. • What should victims do? Wait for the establishment of the new regulator, the Independent Insurance Authority (IIA)?

31. Controversy Over SFC's Regulatory Role • The Lehman Minibond scandal was a public relations nightmare for SFC. The SFC was probably eager to avoid being blamed for a second mis-selling scandal, particularly one related to ILAS. • On 13 August 2009, the SFC issued a circular denying that it had a duty to regulate ILAS sellers, despite the fact that several insurers and corporate insurance brokers believed the law required them to be licensed and regulated by SFC. • SFC urged these companies to leave the SFC alone, signaling that it would not cause them any problems if they did not cause the SFC any problems.

32. Lehman Minibond Victims

33. Lawyer Criticizes SFC • In 2010, a lawyer, Timothy Loh, published an article criticizing SFC's “disturbing” guidance on ILAS and warned sellers that they should probably get an SFC license if they had any reason to believe that they may need one. • Carrying on a business in an SFC-regulated activity without an SFC license is a criminal offense. • Loh claimed there was a “real possibility” that unlicensed ILAS sellers could be found guilty of a criminal offense.

34. CIB Warns Brokers that They May Need an SFC License

35. PIBA Advises Brokers to Obtain an SFC License if They Sell Portfolio Bonds

36. German Court Ruled that ILAS Is an Investment (Not Insurance) According to an article published on 8 Aug 2012 by the law firm, Norton Rose Fulbright: “In a series of landmark decisions, the German Federal Court (BGH) held for the first time that unit-linked life assurance policies often qualify as investment products, and are therefore retroactively subject to much more stringent case law rules developed by German courts over recent years. As a result, a large life insurer is likely to be liable for hundreds of millions of euros…in mis-selling charges”

37. A Potential Path to Justice • If a court decides that ILAS sellers are required to be licensed by the SFC, it could potentially impact almost every ILAS that has ever been sold, possibly leading to compensation for policyholders. • This could be the best chance for all ILAS victims to receive justice. • It would also mean that ILAS sellers can no longer be self-regulated. They'll be under the watch of SFC.

38. Mr. Hobbins' Lawsuit Revisited According to the judgment of Anselmo Reyes: “it has long been settled at common law that commission paid to an insurance broker by an insurer does not constitute an illegal secret profit unless it is in excess of what is normally paid within the insurance market.” “there is no evidence whatsoever that the commission or fees which Clearwater received from Skandia or any other insurer (Zurich, Generali, Aviva) was otherwise than that normally paid in the insurance market.” If ILAS is an investment product, then it should be evaluated against other investment products. Reyes' judgment would be wrong, since ILAS commissions are in excess of what is normally paid within the investment market.

39. Mr. Hobbins' Lawsuit Revisited (2) Reyes also stated: “By PBO [Prevention of Bribery Ordinance] s.19 the mere fact that a practice is customary within a trade will not constitute a defence to an offence under s.9. But in the present case there is more than just a customary practice within the insurance brokerage industry. That is because the practice has been validated by over a century of judicial authority.” Reyes was wrong about the practice “being validated by over a century of judicial authority”. ILAS products were invented only a few decades ago, and the 2012 German case undermines his point.

40. Non-Linked “Insurance” Products • Experts around the world, such as Suze Orman in the United States, assertively state that most life insurance products (other than term life insurance) are “ripoffs”. These “ripoffs” include not just ILAS, but also whole life, universal life, and endowment policies. • Like ILAS, these other products contain very little insurance, and they pay excessive, undisclosed commissions. The products are primarily savings and investment vehicles. • Policyholders' return on investment is often negative for up to a decade, due to the excessive upfront costs. • In 2013, Hong Kong insurers earned 99% of new life insurance premiums by selling products which are widely regarded as “ripoffs”.

41. Mis-selling of Non-Linked Products • In 2013, after discovering an alarming amount of mis-selling, HKMA forced banks to start disclosing ILAS commissions. In response, banks stopped selling ILAS. • In Dec 2014, HKMA published the findings of its Mystery Shopping Programme. HKMA found that banks had shifted to mis-selling non-linked insurance products, using the same tactics they had previously used to mis-sell ILAS. • In 2013, ILAS accounted for 21.5% of new life insurance premiums. 77.8% of new premiums came from non-linked products (excluding term). • The numbers suggest that non-linked products are probably mis-sold a lot more frequently than ILAS products.

42. Commissions Should Be Banned • Even if full commission disclosure was mandatory, intermediaries would still push whichever products pay the highest commission. • The UK, Australia, and some other countries have already banned product issuers from paying commissions to intermediaries. • The British regulator recently reported that the country's commission ban had no negative impact on consumers. “Product bias” has been reduced. Fees have been driven down.

43. What Can OCI Do for ILAS Victims?

44. What Can OCI Do for ILAS Victims? • Publicly state its views on when and whether ILAS sellers need to be licensed with SFC. • Refer ILAS complaints to the SFC instead of the SROs when there has been a potential breach of the SFO. • Get the IIA set up as soon as possible. • Hold SROs accountable until the IIA is set up. • Other ideas...

45. Conclusion Main takeaway points: • ILAS has been used to exploit Hong Kongers • ILAS was not suitable for the vast majority of people it has been sold to • ILAS sellers should have been regulated by the SFC (not self-regulated) • ILAS victims deserve to be refunded • Hopefully OCI agrees and will help

46. Questions from Victims Unable to Attend 1. If you (Annie Choi) were a "consultant" with only a PIBA license, and you were eager to sell an ILAS to a prospective client who has little knowledge of mutual fund investments, how would you sell the product? What would you say to the client to get this deal without providing any sort of investment advice regarding the fund pool within the ILAS? As the Commissioner of Insurance, how can you assure that those PIBA licensed "consultants" will not regard themselves as investment professionals when selling ILAS, which in fact to most people is an investment product?

47. Questions from Victims Unable to Attend 2. What have you done, what system has OCI built to ensure that PIBA, as an SRO, in their investigation process for a complaint, places policyholders' lawful interests above their member companies, and follows up the case in a timely manner? 3. Why do you allow those insurance brokers to refer to themselves as "independent financial advisors", or “IFAs”, for so many years to fool the public, given the obvious conflicts of interests between their commission and their clients' real needs?

48. Questions from Victims Unable to Attend 4. Since [an SRO executive] already said his company does not need to follow HKFI regulations (i.e., the requirement about insurance need and investment horizon), does Annie Choi think there is a need for the IIA (a truly independent regulator) to conduct an examination on the ILAS sales committed by these brokers over the past years? If no, why not? Does Annie Choi think the IIA should be given the power to re-open the closed cases by SROs? If no, why not?

49. Questions from Victims Unable to Attend 5. Is it appropriate for an insurance company, within the context of HKFI's Code of Conduct for Insurers, to process an ILAS application when it knows the customer does not have insurance needs and therefore, is aware that the ILAS is not in compliance with HKFI regulations. How is that considered fair, honest, and consistent with the public's interest?

50. Questions from Victims Unable to Attend 6. OCI issued a new circular in 2014 to ban indemnity commissions and unfair charges on existing ILAS products, which implied that the previous products and remuneration structure were not fair to customers. From this perspective, should insurers refund money back to customers, within the context of the HKFI Code of Conduct for Insurers, given that it is the view of OCI that customers were being treated unfairly with those previous product terms and remuneration structures. If no, why not?