Industry still in the dark on disclosure

Commission disclosure for life insurance products is no stranger to controversy. Gareth Cosslett asks if the latest battle, concerning two pieces of key financial services legislation, will finally sound its death knell.

Long-anticipated regulations that will make the disclosure of commission on life insurance products compulsory are looking imminent. Although the Federal Government's original vehicle forglasnostin risk products, the Life Insurance Conduct and Disclosure (LICD) bill, has now sunk after floundering for the last four years, the requirement for full disclosure is an odds-on favourite to be pushed through via CLERP 6 next year.

Last month, financial advisers and life agents won a temporary reprieve after industry resistance to full disclosure successfully derailed the LICD bill. The office of the minister for financial services and regulation, Joe Hockey, says it lacked the drafting resources to respond to the comments and queries from financial industry organisations before LICD was due to be introduced to Parliament in June. The bill therefore missed its slot and has since disappeared, with the Choice of Superannuation Fund (Consumer Protection) bill rising from its ashes.

Time restrictions mean it now seems unlikely that the super choice bill will be able to fulfil the planned role of LICD and act as stopgap measure, forcing disclosure of commissions on risk products before the July 1, 2000 introduction of CLERP 6. The onus therefore falls on CLERP 6 to make disclosure compulsory and all the noises from Joe Hockey's office suggest the Federal Government is determined to cast the requirement in stone next July.

A spokesperson in Joe Hockey's office says: "Because we were specifically trying to avoid any delays, we compromised and made some changes to LICD.

We agreed that, for standalone risk products, the adviser only had to disclose to the consumer their right to request information on the commission. However, we made it clear what outcome would be reached in CLERP 6."

And that outcome is that full, up-front disclosure on all commissions including risk products will be required. Following the kafuffle over LICD, Joe Hockey's office now seems even more determined to stick to its guns on disclosure in CLERP 6.

"Our view is that the consumer's decision-making process involves a number of factors which they should have full knowledge about," the spokesperson says.

"This includes any potential biases or conflict of interest as to why an adviser might be pushing one company's product as opposed to another's. We have had a wide range of support for this; not just from consumer organisations. We do intend to put in place some legislative-based consumer protection in life insurance."

However, Joe Hockey's office is still "open for consultation" and is currently working through about 115 submissions on CLERP 6. John Hibberd, national president of the Association of Financial Advisers (AFA), says "hard, persuasive arguments" from FinPrac (the lobbying group backed by the AFA as well as the National Council of Financial Adviser Associations) was successful in throwing LICD off track - and could still beat CLERP 6.

"The jury's still out on this. There are a number of people in the political process that need to approve it," he says.

LICD was put into limbo after considerable backbencher opposition to full disclosure and pressure groups will continue their intensive lobbying - and lunching - of backbencher sympathisers.

Hibberd stands by the AFA's original rationale for opposing full disclosure. "A risk product is a commodity and the price of the term insurance contract is the only thing that has an impact on the consumer," he says.

"The commission is fixed and doesn't effect them. If they do see the commission then it will only lead to confusion. Consumers may pick policies on the perceived commission paid to the agent rather than the best combination of policy values and service."

There are also fears that the self-employed small business advisers will lose out to salaried employees of providers and distributors such as Colonial that would not have to disclose commission when supplying products over the counter.

"Unless we have total cost disclosure then the process will be distorted. All costs - including the management charges of the suppliers - should be revealed. We could sell that to the politicians," Hibberd says.

Many observers find certain quarters of the industry's resistance to full disclosure puzzling. FinPrac itself says that only 1 per cent of consumers inquire about commission and proponents of full disclosure argue that, if there is nothing to hide, then why hide it?

AMP has made a full disclosure compulsory on its risk products for about three years. "Part of giving good advice is full disclosure so that everyone knows that all the cards are on the table," says Steven Helmich, managing director of AMP Financial Planning.

Helmich says practices such as churning, where clients are encouraged to switch life insurance products so the advisers can enjoy the front-end loaded commission regularly, reached their peak in the late '80s.

"It was a fairly voracious industry back then and people were looking to make a dollar at any cost. However, churning is not really a big issue any more. There's some risk that, by churning, the client may be rendered uninsurable if their health has deteriorated since setting up the last policy."

Despite these claims, churning does undoubtedly take place. The old argument that reams of application forms and medical examinations make it too inconvenient - and too risky - to churn clients were as relevant in the late '80s as they are now. And the pro-disclosure lobbyists will be telling the politicians in the run up to CLERP 6 that full disclosure of commissions will actually reduce the risk of churning.

The current fee structures of up to 100 per cent of the annual premium paid up front to the adviser followed by a small trail commission will almost definitely change if disclosure becomes compulsory. A flat annual rate of about 15 per cent will seem far more palatable to the consumer.

AMP's Steve Helmich says he is considering switching from the current pay structure of 70 per cent of the first year's premium up front.

"We might offer both an up-front premium and a level-loaded flat rate so both the advisers and the clients can decide. The real key to the future is to have commissions replaced entirely by fees. The consumers that are particularly worried about commissions will probably buy their business over the Internet."

However, one anonymous life agent claims the suppliers are as much to blame as the advisers for a lower flat rate of about 15 per cent not being phased in earlier.

"Agents have suggested this to the insurance companies but they wouldn't buy.

They are worried because their managers are paid commission on new business coming in. The front-end loaded commissions mean both sides encourage churning as the agents receive higher commissions more regularly and the insurance company executives also feed their own bonuses."

Offshore conferences laid on by insurance companies for agents that meet new business targets are also undoubtedly an incentive to churn.

Michael McKenna, chief executive of the Financial Planning Association (FPA), maintains that churning is not an issue.

"You don't churn in risk. Clients stay with the policy unless something drastic happens. There are usually better premiums available for renewals and, usually, the younger you are when agreeing to the policy, the better the terms are."

McKenna says all members of the FPA are required to disclose commissions on risk products. "It has been a requisite of the FPA since its inception. We were well ahead of the legislation and all our members are required to disclose all commissions - including risk."

However, the AFA's John Hibberd says that in reality, not all FPA members disclose. "There are a large number of people, including members of the FPA, not putting commissions down on pure risk products. The reason is, under the current insurance code of practice, commission on risk business is not required to be disclosed," he says.

Neil MacDonald, manager of the Wallis implementation team at Mercantile

Mutual, says many advisers are actually keen to move on from up-front, large commissions.

"Traditionally, life insurance has been a transaction business: find the customer, sell the policy, move on," he says.

"They operated like hunters. But the better advisers see that it is wise to build a

portfolio of clients and enjoy a steady flow of trail commissions."

However, Graham Currie, managing director of IFMA, one of Australia's largest independent distribution companies with around 800 agents, says full disclosure is a "can of worms".

"With investment, people understand how the commission of their financial adviser impacts on them," he says.

"Here, it is different. We work on a sliding scale where different advisers get paid different commissions according to the size of the producer. It virtually starts at zero and can go up to, say, 95 per cent of the premium for a high producer. That has no impact on the consumer but are they likely to understand that? Probably not."

And that is the argument in a nutshell. Agents are concerned because full disclosure will put them at the mercy of that most unpredictable of animals: the consumer. Whether the consumer actually cares is another story entirely.

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"If Australia did bring in full disclosure then it would be out of step with the rest of the world. It is not compulsory in most countries including the US. In the UK, where it is compulsory, it had an enormous impact on the industry when it was introduced and coverage went down." John Hibberd, national president, Association of Financial Advisers (AFA).

"Commissions on risk products are pretty good and a lot of agents fear there may be a commission war if disclosure is compulsory. That is unjustified and risk would not follow the drop in commissions on personal super products as it is not coming out of the consumer's pocket in risk. But there would be scope for one supplier to make a marketing ploy of saying there's no commission on its products and step up its direct dealing." Daryl Currie, managing director, BOSS.

"Consumers have the right to know what they're paying in commission and, if they feel like they are getting a value service, then so be it. We tell people that price is not the only thing to go on, but the more you know about what you're spending, the better judgement you'll have on value."

Dan Coyne, finance policy officer, Australian Consumers' Association.

"The government is trying to lump together legislation on risk and personal superannuation and risk is getting caught in the crossfire. Self-employed agents will have to explain every time that the commission is not money that ends up in their pockets; that they have to pay professional indemnity insurance and cover all the other costs of running a business. It just puts up another unwelcome barrier of suspicion between the adviser and the client." Graham Currie, managing director, IFMA.

"Advisers face a three and a half year shortfall in their income if there's an instant transition from up front commissions to level commissions. Rather than a knee-jerk reaction on July 1, 2000, it will be better to keep a level head and implement a fee-based regime over five or six years." Neil MacDonald, manager, Wallis implementation team, Mercantile Mutual.

Wheeler dealers

The case of the anonymous real-estate agent who bought a 35-year life insurance policy in the early 1990s reveals some of the shadier practices in life insurance sales - and some of the huge commissions on offer for the salesman.

The real-estate man agreed to pay a whopping premium of $100,000 a year on a new life insurance policy, which would earn the life agent $80,000 in commission after the payment of the second annual premium and the potential to make around $40,000 in bonuses and trail commission.

A special provision in the policy allowed the policyholder to borrow back up to 92.5 per cent of the policy's cash value back from the insurer. The policyholder and the agent also entered into a private arrangement whereby the policy holder only paid $8833 of the annual premiums and the salesman would pay the balance, to be repaid at a later date agreed by the men.

The life insurance company became concerned about its exposure to this type of product and on the day of the payment of the second annual premium, it paid off the policyholder in return for surrendering his policy.

The only reason why this case came to light is because the property agent was disputing the fact that his $18,000 pay-off should be subject to tax at an Administrative Appeals Tribunal this year. He won his case and enjoyed a one-off, tax-free perk.