Martin North – Page 1042 – Digital Finance Analytics (DFA) Blog

ASIC Says Life Insurance Industry Needs Higher Standards

ASIC today released their review of activity in the Life Insurance Industry, and finds that consumers interests are not always given priority. The $44bn industry touches superannuation, annuities, and other elements, as shown in a diagram reproduced from the report. We have previously highlighted the issues around annuities. They found that high upfront commissions are more strongly correlated with non-compliant advice, and we think that it is another case, like FOFA of product sales being dressed up as advice.

An ASIC review of life insurance advice has found that the industry needs to improve the quality of advice and ensure that the interests of consumers are given priority. ASIC’s review of more than 200 advice files from large, medium and small Australian financial services (AFS) licensees found that 63% were compliant. However, more than one third (37%) of the advice consumers received failed to comply with the laws relating to appropriate advice and prioritising the needs of the client. ‘This is an unacceptable level of failure, and the life insurance industry is now on notice to lift standards and professionalism. Both insurers and advice firms need to work on delivering a consistently better service for consumers’, ASIC Deputy Chairman Peter Kell said.

‘Life insurance is a key product through which consumers manage risk for themselves and their families. It is therefore important that both the products and the advice meet the consumer’s requirements. ‘There is both a need and a demand for quality life insurance advice, and our report provides examples of advisers delivering a service that meets the needs of their clients. However, this result must be achieved on a more consistent basis’, Mr Kell said. ASIC’s report sets out the various commission models that are used to remunerate advisers in the life insurance sector. The report found that high upfront commissions are more strongly correlated with non-compliant advice, including in situations where the recommendation is to switch products.

‘The industry as a whole needs to consider how remuneration and compliance practices can better support good quality outcomes for consumers’, Mr Kell said. Affordability of insurance is an important issue for consumers, and ASIC’s report includes cases where clients were recommended insurance cover that was likely to be very difficult to afford given their financial circumstances. ASIC’s report confirmed that the high rate at which life insurance policies are lapsing warrants consideration by the life insurance industry to ensure that industry practices are sustainable.

ASIC has made a number of recommendations for insurers, AFS licensees, advisers and their professional associations, including a focus on how to ensure client interests are met and balancing the issue of affordability versus cover. Mr Kell said, ‘ASIC is committed to working with the industry to address the problems we’ve identified and to improve outcomes for consumers.’ Following the surveillance work and the conduct that has been uncovered ASIC has commenced follow-up investigations in certain cases which are ongoing. ‘Where inappropriate advice was provided we are considering enforcement action or other regulatory action’, Mr Kell said.

However, DFA believes that this is part of a wider issue with consumer advice in Financial Services. The problem is the various elements within a consumer’s financial portfolio will fall under different regulatory environments, which are just not consistent. If its mortgage related, then the advice is centred on whether the loan is suitable or not (no best client interest here) and commissions are rife ; if its financial planning related, the FOFA, offers some safeguards, and also significant gaps around general advice, as we discussed recently. Now life insurance is another problematic area. It is time for some joined up thinking. A consumer will require financial service advice across multiple products including loans and investments, but all part of a single financial portfolio. There should be consist consumer-centric processes, irrespective of the products being touted. We applaud ASIC for again championing the interests of the consumer, but there is so much more to be done.

The solution is simple. Separate advice from product sales (a.k.a general advice). Exclude any incentive payments for those providing advice. Clearly disclose any product fees (including trading and transaction fees). Job done.

Macroprudential Bites in the UK – Bank of England

The Bank of England (BoE) recently published their Q3 Credit Conditions Survey. This is the first edition since the recent Mortgage Market reforms were introduced, and the macroprudential controls were tabled. Looking specifically at secured lending to households they report that demand for credit has eased, and the proportion of higher loan to value loans has reduced. In other words macroprudential is biting!

After eight consecutive quarters of expansion, lenders reported that the availability of secured credit to households fell significantly in the three months to early-September.

The contraction in overall availability was reported to be driven by a changing appetite for risk and lenders’ expectations about house prices. Many lenders noted that operational issues associated with the implementation of the Mortgage Market Review had pushed down on credit availability over the summer. And some lenders commented that they had tightened availability a little in response to the recommendations made by the Financial Policy Committee to mitigate risks stemming from the housing market.

Credit availability was reported to have fallen in Q3 both for borrowers with loan to value (LTV) ratios below 75% and for borrowers with LTV ratios above 75%. Lenders also reported that they had become less willing to lend at LTV ratios above 90% for the first time since the question was introduced in 2013, and some noted that they had introduced policies which restrict lending at high loan to income (LTI) ratios.

Consistent with a tightening in credit availability, credit scoring criteria for granting household loan applications were reported to have tightened in Q3 and the proportion of household loan applications being approved fell.

Seasonally Adjusted Employment Data Not Reliable – ABS

Today the ABS confirmed what we already knew, there was something weird about the employment data. When the last set came out, showing major and surprising movements, we highlighted the figures were probably not reliable. See the chart below.

Now the ABS has said

The ABS has concluded that the seasonal pattern previously evident for the July, August and September labour force estimates is not apparent in 2014. This assessment was made while preparing labour force estimates for September 2014 and relates to all seasonally adjusted labour force estimates other than the aggregate monthly hours worked series.

As there is little evidence of seasonality in the July, August and September months for 2014, the ABS has decided that for these months the seasonal factors will be set to one (reflecting no seasonality). This means the seasonally adjusted estimates (other than for the aggregate monthly hours worked series) for these months will be the same as the original series and this will result in revisions to the previously published July and August seasonally adjusted estimates.

“It is critical that the ABS produces the best set of estimates that it can,” said acting Australian Statistician Jonathan Palmer “so that discussion is on what the estimates mean, and not the estimates themselves.

“To assist in this, the ABS will commission a review with independent external input to develop an appropriate method for seasonally adjusting October 2014 and following months’ estimates.

“The report on the results of this review will be presented in due course.”

The ABS has not made this decision lightly and believes this approach will result in a more meaningful set of seasonally adjusted estimates.

The ABS will continue to produce trend estimates and, as always, encourages users to use the trend estimates to help understand underlying movements in the labour force series.

This admission will increase the level of uncertainty about the accuracy of the data, at a time when unemployment and underemployment are set to remain high (as the IMF stated today). This is exacerbated by the recent cuts to the ABS budgets, making the sample smaller, and less reliable. We are flying somewhat blind at a time when good reliable data is essential if we are to chart a path through current uncertainties. Or maybe the inconvenient truth about rising unemployment will be muted as a result, and this was not entirely without intent.

Ireland Joins The Macroprudential Bandwagon

In the paper released by the Central Bank of Ireland, it is clear they have gone macroprudential! According to the Irish Times new rules will be applied to mortgage lenders in Ireland from 1 January 2015. A 2 month consultation period now starts, so they may get tweaked before implementation. The UK had announced parallel measures earlier.

New mortgage rules published today mean that most house buyers will have to have a 20 per cent deposit when applying for a home loan. The regulations come into force on January 1st.

The Central Bank is proposing that no more than 15 per cent of all new mortgages for private dwelling homes should have a loan to value (LTV) ratio above 20 per cent. This means that most first-time buyers are now going to be expected to have at least a 20 per cent deposit when buying a home.

In addition, it has also decided that just one-fifth of new mortgages should be issued above a level of three and a half times income (LTI).

In the case of buy-to-let properties, no more than 10 per cent of the value of all new loans should have an LTV above 80 per cent.

The Central Bank’s deputy governor said these measures should help to avoid another property crash in Ireland and dampen the rate of price rise currently being experienced in the market.

“Our research has shown there is strong evidence that mortgage losses are much higher where borrowers have a high LTV or LTI rate,” he said. “We believe that measures such as these are a standard part of a well regulated financial system and introducing these precautionary measures should contribute to a stable and well-functioning mortgage lending market.”

The regulator said the income caps would be “more binding” than the LTV ratios in a period of boom as pay levels could never keep pace with soaring property prices.

The LTV caps are not “completely counter-cyclical” as loan values will rise in line with property prices.

Certain exemptions are proposed to the new rules. These cover residual debt from home loans in negative equity, switcher mortgages, and home loans in arrears. Buy-to-let borrowers will also be exempt from the income restrictions.

Here is the Economist’s comparison chart, showing UK, Ireland and Australia – and we thought we had a problem!

IMF On Macroprudential – It Works!

In the just release IMF World Economic Outlook, as well as revising down growth estimates, they discuss macroprudential, highly relevant in the light of RBA comments. The main observations are:

there is evidence that macroprudential can assist in manage house price growth, and credit growth. Different settings should be applied to different types of purchases, e.g. differentiate first time buyers from multiple investors, but
it is less effective if the cause of extended price rises stems from overseas investors, who bypass local controls and credit policy, so specific separate measures may need to be used to target foreign investors
need to make sure business is not simply redirected to the non-bank sector, and
supply side issues also need to be addressed.

RBA please note! The comments in full from the IMF are below, and worth a read. In particular they cite a number of success stories, so macroprudential is perhaps more proven than many would like to admit.

Many countries—particularly those in the rebound group—have been actively using macroprudential tools to manage house price booms. The main macroprudential tools employed for this purpose are limits on loan-to-value ratios and debt-service to-income ratios and sectoral capital requirements. Such limits have long been in use in some economies, particularly in Asia.

For example, Hong Kong SAR has had a loan-to-value cap in place since the early 1990s and introduced a debt-service-to-income cap in 1994. In Korea, loan to-value limits were introduced in 2002, followed by debt-service-to-income limits in 2005. Recently, many other advanced and emerging market economies have followed the example of Hong Kong SAR and Korea. In some countries, such as Bulgaria, Malaysia, and Switzerland, higher risk weights or additional capital requirements have been imposed on mortgage loans with high loan-to-value ratios. Empirical studies thus far suggest that limits on loan-to-value and debt-service-to-income ratios have effectively cooled off both house price and credit growth in the short term.

Implementation of these tools has costs as well as benefits, so each needs to be designed carefully to target risky segments of mortgage loans and minimize unintended side effects. For instance, stricter loan-to value limits can be applied to differentiate speculators with multiple mortgage loans from first-time home buyers (as in, for example, Israel and Singapore) or to target regions or cities with exuberant house price appreciation (as in, for example, Korea). Regulators also should monitor whether credit operations move toward unregulated or loosely regulated entities and should expand the regulatory perimeter to address the leakages if necessary. For example, when sectoral macroprudential instruments are used to limit mortgage loans from domestic banks, they can be circumvented through a move to nonbanks (as in, for example, Korea) or foreign banks or branches (as in, for example, Bulgaria and Serbia). Macroprudential tools may also not be effective for targeting house price booms that are driven by increased demand from foreign cash inflows that bypass domestic credit intermediation. In such cases, other tools are needed. For instance, stamp duties have been imposed to cool down rising house prices in Hong Kong SAR and Singapore. Evidence shows that this measure has reduced house demand from foreigners, who were outside the loan-to-value and debt-service-to-income regulatory perimeters. In other instances, high house prices could reflect supply bottlenecks, which would need to be addressed through structural policies such as urban planning measures.

RBA Leaves Rates On Hold, Again

At its meeting today, the Board decided to leave the cash rate unchanged at 2.5 per cent.

Growth in the global economy is continuing at a moderate pace. China’s growth has generally been in line with policymakers’ objectives, though some data suggest a slowing in recent months. Weakening property markets there present a challenge in the near term. Commodity prices in historical terms remain high, but some of those important to Australia have declined further in recent months.

Volatility in some financial markets has picked up in recent weeks. Overall, however, financial conditions remain very accommodative. Long-term interest rates and risk spreads remain very low. Markets still appear to be attaching a low probability to any rise in global interest rates or other adverse event over the period ahead.

In Australia, most data are consistent with moderate growth in the economy. Resources sector investment spending is starting to decline significantly, while some other areas of private demand are seeing expansion, at varying rates. Public spending is scheduled to be subdued. Overall, the Bank still expects growth to be a little below trend for the next several quarters.

Labour market data have been unusually volatile of late. The Bank’s assessment remains that although some forward indicators of employment have been firming this year, the labour market has a degree of spare capacity and it will probably be some time yet before unemployment declines consistently. Growth in wages has declined noticeably and is expected to remain relatively modest over the period ahead, which should keep inflation consistent with the target even with lower levels of the exchange rate.

Monetary policy remains accommodative. Interest rates are very low and have continued to edge lower over recent months as competition to lend has increased. Investors continue to look for higher returns in response to low rates on safe instruments. Credit growth is moderate overall, but with a further pick-up in recent months in lending to investors in housing assets. Dwelling prices have continued to rise over recent months.

The exchange rate has declined recently, in large part reflecting the strengthening US dollar, but remains high by historical standards, particularly given the further declines in key commodity prices in recent months. It is offering less assistance than would normally be expected in achieving balanced growth in the economy.

Looking ahead, continued accommodative monetary policy should provide support to demand and help growth to strengthen over time. Inflation is expected to be consistent with the 2–3 per cent target over the next two years.

In the Board’s judgement, monetary policy is appropriately configured to foster sustainable growth in demand and inflation outcomes consistent with the target. On present indications, the most prudent course is likely to be a period of stability in interest rates.

This was in line with expectation, despite some calling for a rise to signal the markets in relation to speculative housing. However, these ultra-low rates cannot last for ever, and the average mortgage rate is closer to 7% rather than the current 4.75%.

SMSF Property Investment Continues – DFA Survey

We updated our household surveys with the September data. Today we focus in on SMSF property transactions, which is a small, but rising factor in the market. We start by looking at the reason why trustees for SMSF’s are considering retail property. The strongest incentives are the tax efficient nature of the investment, and appreciating property values. Low rates also have part to play. I have excluded commercial property from the analysis.

We also asked where the trustees were getting advice from regarding retail property investment. Most interesting is a fall in advice from financial planners (maybe a reaction to FOFA, CBA etc?), and a rise in advice from real estate agents. Mortgage brokers also figure in the mix, alongside internet sources and own knowledge. We wonder how well qualified these sources are to provide the right advice, bearing in mind the long term nature of super.

Finally, we looked at changes in relative distribution of property in super funds, and of those who were investing in property (about 3% of all funds are investing in retail property, and another 3% are considering it). We see retail property making up quite a significant share of superannuation savings for some. The blue bar is last year, the orange bar is to September 2014.Others can decide if this a good or bad thing, but it does highlight the linkages between property and super, and demonstrates that if house prices fall, then some super funds will be impacted, just at the time house valves are also falling. The impact of the double whammy is potentially significant and concerning.

RBA Comments On Housing Have Impact – DFA Survey

We have updated our household surveys with the results for September. This forward-looking research revealed some significant changes in sentiment amongst households thinking of transacting, and many of these changes can be traced to recent comments made by the RBA in respect of investment housing. Our approach to household segmentation and our surveys is described in an earlier post. Today we will discuss some of the most important recent findings, which updates the results from our Property Imperative report.

So first we look at which segments are most likely to transact in the next 12 months. The changes over time are significant, with first time buyer ever less likely to purchase whilst investors, especially portfolio investors, more likely to buy. The impact of down-traders (remember there are more than one million households in this category) are also significant.

Demand for mortgage funding sits firmly with certain segments, especially investors, first time buyers and up-traders. Note that the bulk of down-traders do not need to borrow. This goes some way to explaining why house prices are moving faster than loan growth, and why investment loans are making up a large proportion of lending, especially in Sydney.

We found that first time buyers are still saving hard, though chasing ever higher prices, want-to-buys are saving less now, seeing the aspiration of owning a property evaporating fast.

We found that across the board, there was a little less certainty on house prices growth, though generally investors remain more bullish.

The want-to-buys find the biggest barrier relates to the high price of housing. No change here.

This barrier is also echoed in the first time buyer segment, with 50% seeing price as the main issue, the highest result in recent times.

Many refinancers will have now locked in at low rates, as the main reason is to reduce monthly outgoings. The proportion locking in at fixed rates is down a little.

We found that up-traders are still active, and there was an increase in those in this segment who are motivated by the prospect of capital appreciation, which is now running ahead, just, of buying to get more space. As shown above, the proportion of up-traders ready to transact is down a little.

Down-traders continue to seek to sell and buy smaller, driven by a quest to release capital for retirement, and for increased convenience. They were slightly more likely to incorporate an investment property in their strategy. We think the impact of down-traders on the market is understated by many observers, but the continuing release of capital from larger property, and buying smaller, plus investment, aligns with the growth in investment property demand, and yet lower rates of financing elsewhere.

Looking at investors, we see continued interest, driven by the tax-efficient nature of investment lending (a.k.a negative gearing, and SMSF investing). They remain confident about capital appreciation into the future, though less strongly than previously.

Finally, we looked at the potential barriers to investors, and we see a significant change. We ask about a range of barriers. One related to RBA warning, which this month have reach a new, high pitch. Investors are responding, and a proportion are concerned about potential regulatory changes. We also saw a tick up in the concerns about interest rates rising in coming months.

Overall then we still see demand strong, and focused in particular segments, especially investors and down-traders. However, the RBA warning are having an impact, even before they actually do anything to intervene further in the market. We do not believe that words alone will address the underlying systemic issues, but they can have a short term impact on sentiment, and may make some prospective purchasers think again – we therefore expect to see some small slowdown in coming weeks. That said, the market remains hot, and stoked by investors, and we believe there is a case for more direct intervention by the regulators. We also expect the RBA to keep up the verbal barrage.