Article 2: Standards 2, 5, and 7

By Marshall Ross, Acenda Partner Education Manager

Part 1: A true fiduciary duty

Exploring best interest standards in the Code of Ethics Standards 2 and 5

Acting in the best interests of one’s clients is central to the duties of a fiduciary financial adviser.

This principle is echoed in both the Future of Financial Advice legislation in 2012 (FOFA) and the Financial Planners and Advisers Code of Ethics 2019 (the Code). The latter outlines, in standards 2 and 5, a set of professional expectations for how advisers are expected to engage with their clients throughout the advice relationship.

While subtle differences exist between these two standards and the legislation in the Corporations Act 2001, advisers can best ensure they meet these standards and consistently provide great client experiences by understanding these expectations.

Standard 2

You must act with integrity and in the best interests of each of your clients.

Standard 2 relates to broader business activities than specific areas of advice. For example, advisers must consider such questions as:

  • Do I promote and market my business ethically?
  • Do I communicate and engage with my clients with integrity?
  • Is my business purpose and function aligned with the best interests of my clients?
  • Do all clients have fair access to our services?

In short, Standard 2 serves as a guiding principle for advisers and their businesses to conduct their activities in the public’s best interests.

Standard 5

All advice and financial product recommendations that you give to a client must be in the best interests of the client and appropriate to the client’s individual circumstances.

You must be satisfied that the client understands your advice, and the benefits, costs and risks of the financial products that you recommend, and you must have reasonable grounds to be satisfied.

Standard 5 also covers best interest, though it concerns constructing advice for individual clients.

This standard requires that advice be in a client’s best interest and ‘appropriate’. The language here is consistent with the Corporations Act, where s961g also specifies that recommendations must be ‘appropriate’. In both cases, the point is that advisers must recommend products appropriate for the client’s individual circumstances rather than simply being the cheapest, most comprehensive, highest rated, etc.

Beyond the delivery of appropriate advice, Standard 5 also requires that an adviser is confident their client understands the advice they are receiving – a very important ethical requirement and one that can create significant challenges.

Client understanding

Determining someone’s level of understanding on any subject can be difficult, particularly so when the subject is as complex as financial advice. This can be further complicated by clients having various levels of financial literacy, though they are often reluctant to disclose a lack of understanding about the products being presented to them.

To aid client understanding, it’s critical that advisers:

  • use simple language,
  • avoid jargon,
  • put product functions into practical examples,
  • ask clients to explain back the advice in their own words,
  • use visual tools to show financial concepts in easy-to-digest forms, and
  • ensure the pace of advice does not outstrip the client’s ability to engage.

Advice and the client file

While a Statement of Advice (or equivalent future document) is an important legal requirement, a client file is essential to evidencing a client’s understanding of the advice they’ve been provided and its consequences, plus its appropriateness to their individual circumstances. Keeping two-way file notes, transcripts, and recordings (made with consent) documenting the nature of these interactions can be helpful if they ever have to be revisited.

Summary

Best-interest practice has always been at the core of financial advice, with financial advisers taking great pride in achieving good client outcomes. By aligning the performance of one’s business and fiduciary duties with standards 2 and 5 of the Code, advisers can be confident of acting with integrity and upholding the good and reputable standing of their work and profession.

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Part 2: The price is right

Standard 7 and remuneration in life insurance advice

Standard 7

The client must give free, prior and informed consent to all benefits you and your principal will receive in connection with acting for the client, including any fees for services that may be charged. If required in the case of an existing client, the consent should be obtained as soon as practicable after this Code commences.

Except where expressly permitted by the Corporations Act 2001, you may not receive any benefits, in connection with acting for a client, that derive from a third party other than your principal.

You must satisfy yourself that any fees and charges that the client must pay to you or your principal, and any benefits that you or your principal receive, in connection with acting for the client are fair and reasonable and represent value for money for the client.

Pricing must always be considered in an ethical approach to any business. This is no different for risk advice, which may include inbuilt commissions, fees, or a combination of both. The Financial Planners and Advisers Code of Ethics 2019 (the Code) deals with this through Standard 7, which specifies that any remuneration received must be fair and reasonable, received with the client’s informed consent, and offer value for money.

Advisers must use professional judgment to assess whether the services provided justify the total remuneration received from the client's product in terms of upfront fees and ongoing costs. In evaluating this, it’s important to explore the different aspects of risk advice, the value delivered, and the associated costs. 

Commissions

In life insurance advice, commissions built into the product’s premium are the main form of remuneration. These commissions are legally excluded from the legislation on conflicted remuneration and those paid from investment under the Future of Financial Advice (FOFA) reforms. They also differ significantly from the regulations governing ongoing fee arrangements, which are subject to strict legal requirements for client management.

However, life insurance commissions form part of an adviser’s remuneration, which means Standard 7 must be considered. Thus, the question becomes how an adviser can be confident that they’re meeting all obligations under the Code, and delivering advice that’s fair, reasonable, and value for money.

New business

One key remuneration implication of recommending new insurance is that the higher the sums insured (and, in turn, premiums), the higher the provider’s commission. This makes it essential to have a clear, transparent, and conflict-free process for compiling insurance recommendations for clients.

Commonly referred to as an insurance philosophy or methodology, this process allows advisers to evaluate a client’s situation against a set of objective, externally sourced data and arrive at a quantification of insurance needs that is itemised, fact-based, and free of any potential interference of conflict.

We can often personalise this quantification according to the client’s individual risk appetite, affordability, priorities, and underwriting profile. Showing in the advice how the end recommendation was born from the original objective quantification is essential to demonstrating transparency.

The other element of new business remuneration in modern risk advice is potential fees. Whether in relation to the advice construction itself, its implementation, or as a holistic supplementary fee, the same ethical overlay of Standard 7 applies. When constructing a fee, it’s important to consider how this fee was calculated, how it fits in relation to the commission that may still be received, what services have been provided, and the value the client is receiving.

Existing business

Insurance advice commonly involves annual ongoing commissions that are payable to the attached provider. While quite different from the very prescriptive regulation governing ongoing fee/service arrangements, this remuneration still has the ethical overlay of Standard 7’s requirements.

This means it’s essential that this remuneration meets the same test of being fair, reasonable, and value for money. While it does not mean that a physical annual review must occur every 12 months, it does make it important to consider the following:

  • What communication is made (and documented) with the client?
  • What offer of review and engagement is made available to the client?
  • Has the client been made aware that they can access certain support and services?
  • Is there a documented proposition on how existing clients will be supported?

While each business will approach client management differently, having a clear strategy for engaging existing clients is essential. Creating a scalable process that uses communication tools, educational content, and prompts for further advice helps maintain consistent engagement. Technology can enhance this further by enabling efficient delivery through videos, animation, graphics, automation, and virtual meetings, making it easier to support clients throughout their insurance journey. 

Claims management

Support at claim time is a critical part of risk advice. Given the varying complexities of managing claims, it may be appropriate to include claims management fees in this service.

This requires the same considerations under Standard 7 – that advice be fair and reasonable and offering value for money on any fee. It’s therefore important to consider the support being provided, the value the client is getting from this service, the size of any fee in relation to the time and cost of providing this service, and the overall expertise that exists to effectively provide services to a client in this scenario.

Summary

Life insurance advice has many stages, each with different remuneration elements that must be considered. There is no one way to deliver risk advice and receive remuneration at each of these stages, but all must conform to the test outlined in Standard 7.

While this test isn’t prescriptive and doesn’t outline specific limits, it does ask the provider to use professional judgment in objectively assessing their remuneration relative to the services provided and to be confident that this amount is fair, reasonable, and value for money.

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