What the banking royal commission means for car buyers

Commissioner Kenneth Hayne has delivered his final report to government, making 76 recommendations, including two that will have some specific impact on the way car dealers do business.

His first recommendation from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry is a 'deferred sales model' for 'add-on' insurance products.

Essentially, the report recommends that selling these insurance products be untethered from the negotiations for the purchase of a car, which includes the financing of the car and any application for comprehensive insurance of the vehicle.

In other words, a salesperson can ask in the negotiation process whether a buyer wants finance or comprehensive insurance for the car. But insurance for anything else should only be discussed with the buyer subsequent to the finalisation of the purchase transaction.

According to the findings of the Royal Commission, some add-on insurance products serve no useful purpose. Furthermore, selling these products to a vehicle buyer leads to added out-of-pocket expenses which can mount up if the premiums are paid out of a loan arranged for the vehicle purchase.

The buyer could pay more in interest on the loan for a product such as GAP insurance, which might be redundant anyway, if the vehicle buyer has also arranged comprehensive insurance.

And unless the buyer cancels the GAP insurance within a year, the premiums will continue to be charged each subsequent year the policy is renewed.

GAP insurance (guaranteed asset protection) is a type of cover that reimburses the vehicle owner for any money owed in the event the vehicle is written off and the amount paid back by the comprehensive insurer doesn't pay out the secured loan in full.

In practice, GAP insurance would hardly ever incur a claim payable by the underwriter, for a host of reasons. GAP insurance is therefore practically worthless to the vast majority of vehicle buyers.

But in the heat of the moment, negotiating with sales staff for the purchase of a new car, a customer could be convinced he or she needs that cover.

GAP insurance was one of several different types of 'add-on' insurance products deemed by the Royal Commission to be all profit base and practically no risk to the underwriter and its agents.

The second recommendation from the report is that sales staff acting as agents of the insurance underwriter for the add-on products should be paid a commission only up to a capped amount. By insinuation, that cap should be nothing like the 50 per cent commission payable previously. More like 20 per cent...

"I consider that add-on insurance, including add-on insurance offered in connection with the sale of motor vehicles, should generally be sold under a deferred sales model," Hayne wrote in the report.

"One likely consequence of this change is that the premiums payable for policies subject to the deferred sales model could not be financed by the loan made to purchase the vehicle without specific adjustment of the loan arrangement.

"However, in my view, the potential inconvenience caused by this outcome is justified in light of the benefits to the consumer of moving to a deferred sales model.”

Later in the report, the Commissioner made this further observation: "In the current sales environment, combining the sale of the car, finance and add-on products into one process restricts the capacity of consumers to consider these matters and make rational, informed purchasing decisions.

"The deferred sales model aims to address this by inserting a pause into the sales process.

"We consider that a well-designed model would give consumers additional time to navigate the complexities of add-on products and facilitate improved decision making."

Both ASIC (Australian Securities and Investments Commission) and the Productivity Commission support this recommendation.

"In its September 2016 report on the sale of add-on insurance through dealers, ASIC noted that, in the 2015 financial year, the commissions paid to dealers for the sale of addon insurance products were as high as 79% of the premium," the Commissioner also noted.

"ASIC also observed that the amounts paid in commissions on these products exceeded the amounts paid out to customers who made claims. One reason why commissions paid to dealers were so high was that insurance companies competed with each other to gain market share of distribution networks.

"Mr Benjamin Bessell, who gave evidence about the sale of add-on insurance policies by Swann Insurance through dealers, said that Swann viewed the dealers as its customers, rather than the consumer who purchased the insurance policy.

"In 2017, in recognition of the problems created by the high commissions paid to dealers, the ICA prepared a submission to the Australian Competition and Consumer Commission (the ACCC) proposing that insurers cap commissions at 20% of the premium.

"Since then, some insurance companies have taken steps to reduce the level of commissions paid to dealers. But, because general insurance products and CCI [consumer credit insurance] products are exempt from the ban on conflicted remuneration, there is no requirement for any of those companies to limit the amount of commissions paid.

"Mr Robert Whelan, the Executive Director and CEO of the ICA, accepted that commissions and volume-based bonuses paid to dealers are a significant cause of the problems that ASIC identified in its reports about the sale of add-on insurance through motor vehicle dealers.

"He also accepted that given many dealers were dependent on revenue from commissions, commissions and volume-based payments were particularly likely to create incentives to engage in poor sales practices.

"In circumstances where the peak industry body recognises that commissions can create these issues, and where the industry has indicated willingness in the past to limit the level of commissions paid to dealers, I recommend that a cap be imposed on the amount of commissions paid to motor vehicle dealers in relation to the sale of add-on insurance products.

“Like the existing arrangements for commissions paid in relation to life insurance products, I recommend that the level of the cap should be determined from time to time by an ASIC legislative instrument."

Both the Commissioner's recommendations are likely to be implemented, with the federal government saying it will adopt all of the report's 76 recommendations.

The full report is published online at the Treasury website.

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