Is the end nigh for risk advisers?

There is a broad attack on commissions in financial services. Robert Keavney considers whether the risk advice industry can survive it, and whether it should survive it.

Does the life insurance advice industry deserve to exist?

With the MySuper proposals threatening a retrospective ban of commission on insurance in superannuation, and the general attack on commission in financial services, the revenue models and business practices of risk advisers are coming under scrutiny.

Inevitability, sooner or later, change will occur or be mandated.

Any attempt to chart a future for the insurance industry needs to include consideration of a fundamental question: should it be a priority to ensure the preservation of a place for risk advisers?

Do they benefit their clients and serve the public good?

Who serves the client?

The purported role, and correct role, of the financial services industry is to serve the needs of clients. Everyone wants to make money from clients, so everyone purports to serve clients’ interests, but truthfully many financial organisations are indifferent about whether client needs are met or not, so long as they can clip the ticket along the way.

My background is in financial planning.

While some planners may be indifferent to clients’ welfare, and some lack requisite skills, financial planners who do provide high quality advice and service, and who have no conflicts of interest, effectively stand in their clients’ shoes.

Therefore, planners who uncompromisingly and skilfully seek to serve their clients are invaluable for most clients to navigate their way through their financial lives - just as good mechanics are necessary in this era when few of us can work on many functions in modern cars.

I do not suggest all planners provide value, nor all existing business practices should be preserved.

Is the position the same for those life advisers who carry out their role honourably, competently and uncompromisingly?

Death to the infidels

Some view all advisers as an unnecessary evil, which should be wiped out. Many - but not all - who work in the industry fund sector, are of this school (making an exception, for tied advisers employed by the industry funds).

We can note certain industry funds are in an unusual position in the market place.

For reasons, which can only be surmised, the Australian Industry Relations Commission chose to use Modern Awards to require the funds of the citizens of Australia be placed in the hands of selected industry funds.

They don’t need to win the confidence of non-aligned intermediaries to gain inflow.

In any case, it is reasonable to take lightly the opinions of many industry funds about advisers, just as one should take lightly the opinions of many commission advisers about industry funds - both parties have a conflict of interest against the other.

On balance: Yes!

Once insurance companies had a terrible - but deserved - reputation. Today, they generally offer better quality products and treat their policyholders with more respect. What brought about these advances?

Fundamentally, it was the need to satisfy the demands of ever more discerning advisers, which fuelled the increasing quality of definitions over recent decades.

This includes the change from ‘sickness and accident’ to modern ‘income protection’, from ‘any occupation’ to ‘own occupation’ as well as from ‘whole of life’ to ‘term policies’.

That the public does not understand these issues is shown by the ongoing direct selling mail campaigns from many financial institutions, offering ‘accident’ insurance.

The vast majority of risk advisers would never touch such poor quality products, but the general public will buy it direct.

While a small number of advisers will happily sell a poor product if the commission is high enough, most advisers do their best to identify superior quality products to recommend to clients.

This refers to policies with strong definitions, from companies who pay a high proportion of claims, where the advisers have built strong relationships with underwriters and can negotiate favourable outcomes for clients.

It must be understood that, in regard to any specific claim, the refusal to pay it directly adds to the profitability of the life company.

There is a conflict of interest inherent in claims assessment by life offices.

However, advisers who see reasonable claims denied would direct their support to other companies, which treat their clients more reasonably.

The threat of loss of support by non-aligned advisers has been a strong factor leading to the current situation where most life companies pay well in excess of 90 per cent of their claims. It was not always so.

Further, many risks advisers can recount cases where cover was obtained for a client, or exclusions or premium loadings avoided, or claims paid, as a result of effective intermediation overcoming an insurer’s misgivings.

Therefore, it can be concluded that Australians have more and better life cover than they would have had if risk advisers did not exist. The importance of this should not be understated.

I began this article asking: does the life insurance advice industry deserve to exist?

The correct question is whether; overall, advisers better serve clients’ interests than they would be by dealing directly with financial institutions.

The answer to this is a resounding yes.

Therefore, it is essential any changes to the remuneration arrangements of the insurance industry are not introduced in a manner, which destroys the risk advice profession, with its accumulated years of experience and skills.

This is not to say all risk advisers and all current business practices should survive. Much change is needed.

What are the problems?

Having established that risk advisers need to be part of the solution, we can now turn to identifying problems with existing arrangements.

The remuneration structure for risk products emerged from old life offices with tied sales forces.

It rewards sales. It was not worried about switches because if you were tied to, say, AMP you only sold AMP.

This structure is an anachronism in the modern risk industry where non-aligned advisers have relationships with multiple providers.

There is an old principle that if you espouse one set of values but reward another - the other will always prevail. The life industry currently pays advisers for moving policies from company to company, in other words it pays advisers to churn.

It makes sense for each life company to pay an adviser to bring clients to it, yet it is against the interests of the life offices in aggregate to repeatedly pay for policies to be shuffled around between them.

This is an anomaly, which can only be addressed by the industry in aggregate - or by government action, perhaps by an outright ban on commission.

The threat of the latter is real. This is recognised by the industry but to date, no effective action has been taken.

Churning versus gently stirring

The proportion of the risk advice industry, which systematically churns its client base from company to company, is small.

Some quality life offices won’t deal with these individuals but some will. Everyone would be well served if these individuals were exposed and forced out of the industry.

However, there are many cases where more subtle ethical and business practice dilemmas are presented. Let’s assume that life offices A and B offer similar quality policies and premiums.

Assume a client has cover of $1 million with A, but this needs to be increased to $1.5 million. If the adviser moves the cover to B, there will be payment of commission on the full $1.5 million.

If the cover remains with A, commission will only be paid on the $0.5 million increase.

Often the adviser will ask A to also pay commission on the full amount, rather than lose the client. Yet, it could be in the client’s interests for the cover to remain with A, as this avoids any inconvenience.

The adviser could truthfully claim to merely be creating a situation where commission is the same from both life companies, so it does not distort advice.

Please don’t misunderstand: I’m not accusing advisers of extracting money with menace, simply highlighting the absurdities and ethical complexities, which inevitably arise from the willingness of the industry to pay multiple initial commissions on the one cover.

Some companies are willing to pay a repeat initial commission on policies, which stay on the books for seven years.

Let’s not forget that, ultimately it is policy holders who fund these recurrent up front commissions from moving or retaining policies.

In its current form, the practise of the industry paying repeated initial commissions on cover — to reward it being moved between companies or reward it not being moved - must cease.

Valuing X but paying for Y

Col Fullagar (‘Unlocking Profit Based Commissions’, Money Management, May 21, 2009) points out life companies reward sales rather than rewarding behaviours, which add to their profitability or rewarding advisers for services which are in the companies’ and in clients’ best interest.

He notes advisers who deliver quick and efficient completions, with a higher completion rate, a low lapse rate and low levels of complaints, supported by effective claims handling are far more profitable to life companies.

They also provide better service to clients.

Yet life companies offer them the same commission on a sale as advisers who deliver sloppy paperwork, with low completions and high lapses.

This makes no sense. It is a relic of times long gone.

Fullagar is giving directions on how the commissions system could change, rather than disposing of commission altogether. If the industry wants to convince regulators and the public that commission should not be banned, remuneration models need to change to reward behaviours other than sales.

Fees v commissions

I believe the long-term future of risk advice will be to charge clients fees-for-service and I believe any commission system will introduce anomalies.

If higher commissions were paid on policies, which did not lapse, it would discourage moving cover even when this was appropriate.

But a total move to fees cannot be brought about overnight without the decimation of the existing body of risk advisers.

An immediate commission ban, as some are calling for, will set back the delivery of risk advice by many years.

It took two decades from the beginning of fee based financial planning advice in Australia for it to become mandated. I do not believe such a protracted lead-time would be warranted, or would be allowed, for risk advice.

However, some reasonable period will be necessary for life companies and risk advisers to develop different business models.

Yet, if the industry waits around, hoping for slow spontaneous evolution, or dreaming that scrutiny on commission will go away, and does not begin to address its anomalies, it increases the likelihood of a solution being unilaterally imposed.

Act or be acted upon

In the past, it was looked down on to sell life insurance. It should be so no longer. Quality risk advice is a high value service requiring professional expertise.

Nonetheless the risk industry is structurally flawed.

An industry that will pay repeat initial commissions of say thousands of dollars every three years, to shuffle its clients from company to company — many of which, offer good quality policies - risks its clients and the regulators beginning to smell a rat. But then, there is a rat there to be smelt.

There are exceptions but many clients would be better served by taking out a level premium policy with a quality company and holding it for the long term.

Every life office understands the issues, but each is afraid to be an early adopter of a fundamentally changed commission arrangement.

This makes it likely that change will not come until the law mandates it. Whether this law would allow risk advisers a reasonable opportunity to transition their businesses is unclear.

It is far better for the issue to be taken up by the industry.

Robert Keavney is an industry commentator.