Commissions-based remuneration of insurance not the problem

Sean Graham dissects the arguments made by industry super funds and some financial planners of the commissions-based remuneration of insurance in recent issues of Money Management.

If recent industry press is to be believed, industry funds and some financial planners are of one mind: both have abandoned considered analysis of insurance in favour of generalisation and poor reasoning.

The Industry Super Network’s (ISN’s) claims that commissions motivated financial planners to sell “unnecessary or excessively costly insurance” (Money Management, 25 March 2010) ignore Rice Warner’s conclusion that industry funds account for 90 per cent of demand but only 20 per cent of what is needed.

Rather than focus on ISN’s poor reasoning, or on their underlying assumptions, some advisers simply echo ISN and assert that “insurance commissions drive over selling”, as Neil Kendall did (Money Management, 1 April 2010).

It’s tempting to dismiss the latter position as an April Fool’s joke, particularly given that the legitimate focus of Kendall’s criticisms is largely behavioural.

Commissions (high or otherwise) do not explain the failure by advice professionals to provide Statements of Advice, to make recommendations understood or to even consider clients’ needs and objectives.

Using a single incident to indict an industry, Kendall introduces a new client with a $40,000 a year life insurance premium and “the client did not even know who the beneficiary was or how those benefits would be distributed”. Interestingly, he doesn’t say the cover was inadequate or unnecessary — nor does he explain how the client could be in this position despite being issued with a Statement of Advice and policy documents.

As one of Australia’s largest advice groups, we’re well placed to suggest that a $40,000 per annum premium is hardly the usual retail client; average annualised premiums for life and trauma policies range between $1,300 and $2,000 (disability premiums are about $2,000).

So how common are the ‘$40,000 premiums’ which prove the overselling of insurance, and how endemic is the problem?

A far greater concern for us, as advice professionals, should be the significant underinsurance problem in Australia and the false confidence of consumers that their industry fund will deliver anything other than a sub-optimal insurance outcome.

Not every piece of bad advice is caused by a product’s ‘high up-front commission’; nor is every recommendation of a high up-front commission product necessarily bad advice.

As advice professionals, we should advocate for client interests but we should avoid the emotional position that defective products and strategies are only recommended because of high up front commissions without supporting the rhetoric with evidence, research and analysis.

High up-front commissions will not induce a competent, professional adviser to recommend a defective or inappropriate financial product.

In fact, arguing that commission causes overselling (and bad advice) ignores the practical reality that bad advice is less about the remuneration the adviser receives and more about the motivations of the adviser, their competency and the limits of their enquiry.

A focus on remuneration too often hides this reality and allows some commentators to assert that commissions are not compatible with professional advice.

This assertion is both ludicrous and offensive.

Receiving commission does not reduce an adviser’s competency or professionalism any more than charging fees inevitably improves the quality or appropriateness of their advice.

Most advisers understand that remuneration is only a minor component of professionalism and is not by an indicator of professional practice.

In fact, the endorsement of fee-based businesses as the solution for overselling ignores recent industry research that identified cost, affordability and expense as the main reasons why consumers don’t seek financial advice.

Consumers should be offered choices about how they pay for the advice they receive.

Transparency, clarity and comparability are essential if consumers are to be able to assess value and make an informed choice between fees and commissions.

A more fundamental concern is whether the focus on remuneration and overselling is concealing the full extent of the underinsurance problem.

Most advisers have abandoned the practice of determining sums insured as a multiple of the client’s income in favour of a detailed consideration of the client’s needs and the real cost of satisfying those needs.

Determining default sums insured only by reference to the client’s annual income (often capped at a reasonable multiple) may, in reality, not satisfy the insured’s needs and objectives.

Alleging overselling and focusing on commission may be an effective stratagem to avoid properly assessing individual needs but it promotes a false confidence in the insured and, ultimately, neither benefits the client nor our profession.

In reality, the commission paid by insurers effectively subsidises the cost of insurance advice and ensures many consumers, who could not otherwise pay for expert risk management advice, can access affordable financial advice.

Mandating fees and prohibiting commission will only rob consumers of choice and exacerbate the profound underinsurance problem.

Cynically, I also believe that eliminating commission will only increase insurers’ profits rather than reducing premiums or improving services.

Like the Financial Planning Association and advice professionals such as Kendall, Milennium3 believes that consumers need to be more actively engaged in the management of their financial affairs.

We also believe that most Australians would significantly benefit from receiving professional advice.

However, unlike Kendall, we do not believe that changes to remuneration practices are central to either consumer confidence in insurance or professional practices.

Sean Graham is executive director of advice and advocacy at Millennium3 Financial Services.