If you ask questions like “What is the mission statement for an income protection insurance policy?” or “What criteria is used to assess whether an insured event should be added to a trauma insurance policy?” you will likely receive something between a blank stare and a very strange look.
Yet questions like these help shape the fundamentals of product development. Without an understanding of the answers, it is likely risk products will contain inconsistencies such that providing appropriate advice is more difficult.
Even if the product ends up being designed correctly, without a clear understanding of what it is meant to achieve, it is unlikely that a compelling justification or value statement could be made.
It is much the same with the financial planning business of a risk insurance adviser and adviser commission; to get the best result, the purpose of the former should drive the structure of the latter.
A generic mission statement for an adviser’s business might be to service the risk insurance needs of clients and to secure longevity of the business by making a profit.
Servicing the risk insurance needs of clients includes:
- obtaining and analysing relevant information such that the extent of the risk exposure of a financial plan can be assessed (fact-finding);
- identifying appropriate solutions in order to mitigate the risk exposure (risk insurance research);
- putting recommendations to clients in a way that facilitates the making of informed decisions (giving advice);
- completing and submitting documentation such that optimal underwriting terms are offered (field underwriting);
- working with clients and insurers to ensure as many submitted applications as possible convert to insurance coverage (completion rate);
- working with clients and insurers to ensure insurance coverage takes effect as quickly as possible (completion time);
- assisting clients with standard administrative issues (administration);
- working with clients and insurers such that conflicts are resolved quickly and efficiently (complaint resolution);
- adjusting in-force policies such that replacement only occurs when it is materially advantageous to the client (lapse rate); and
- working with clients and insurers such that claims are handled in a timely, empathetic and contractual way (claims management).
If the adviser services the risk insurance needs of clients in an efficient and cost-effective way, the chances of running a profitable business should be greater than would otherwise be the case.
Unfortunately, the current basis of risk insurance commission does not directly support this premise.
Premium-based commission
The current risk insurance commission model is essentially premium-based.
Advisers receive new business commission when a new premium is introduced to the insurer and renewal commission when the in-force premium is retained by the insurer.
In simple terms, commission covers the expenses arising from:
- fact-finding;
- risk insurance research;
- giving advice;
- field underwriting; and
- standard administrative services.
Because the business is remunerated for providing these services, the adviser has a sound business reason for doing them well.
In contrast, if an adviser spent inordinate amounts of time providing services for which the business was not remunerated, the adviser would endanger profitability, which would breach the second part of the business mission statement.
The current model of risk insurance remuneration also provides for three commission types:
- upfront — this enables an adviser to better fund the business if it has a greater need for capital. For example, a newly established business or one that is in expansion mode;
- level — this provides for a higher ongoing revenue stream and thus is ideal for a more mature business that wants to build its revenue base over time; and
- hybrid — this is ideal for a business where a mix of the above two needs exists.
None of the commission types is intrinsically good or bad. Notwithstanding, they each have the potential to be used inappropriately.
Also, none of the above will intrinsically lead to a business being in a better financial position than if an alternative commission type was used. If the business has a capital need and an adviser takes level commission, the business may fail.
On the other hand, if the business is in a position to build a strong revenue stream, to not utilise level commission may seriously reduce the future value of the business.
When actuaries calculate commission rates, they make assumptions about various factors including:
- expenses;
- lapse rates;
- earnings; and
- profit.
If these assumptions are borne out over time, my understanding is that an adviser will not be materially better off financially simply because they take level rather than upfront commission.
An advantage of one commission type over another would, however, arise if one party influenced the assumed factors — for example, an adviser taking an upfront commission when they knew the policy would only stay in force for one or two years.
On the other hand, an adviser would be disadvantaged if level commission was taken and the client had the ability to redirect or stop renewal commission after one or two years.
Profit-based commission
As indicated, a premium-based commission model facilitates a financial incentive to the adviser for providing only some of the service needs of clients — for example, fact-finding, risk insurance research, giving advice, field underwriting and administration.
There is no financial incentive for the adviser to be proficient in or focus on:
- completion rate — yet a high completion rate likely reflects efficient administrative practices within the adviser’s business;
- completion time — yet the faster business completes, the better it is for the client as they will be covered under their policy rather than under interim cover;
- lapse rate — particularly when the habitual ‘churning’ of in-force business has such an adverse impact on life office profits, premium rates and claims;
- complaint resolution — yet misunderstanding between clients and insurers should be resolved quickly, equitably and to the satisfaction of both parties; and
- claims management — yet this is when the value of the initial advice either shines through or is discredited.
These services are important to the client and, in turn, they have a direct profit impact for the insurer.
So, if one adviser’s business does them well but another does not, why should they both receive the same level of commission?
The manifestation of a profit-based commission model might be:
- a commission increase to recognise greater insurer profitability arising from an adviser business where the completion percentage is high, completion time is quick and lapse rate is low;
- a licensee bonus to recognise the greater insurer profitability arising when the licensee takes an active and effective role in complaints resolutions that might otherwise be referred to the ombudsman or require legal intervention; and
- the inclusion of additional insured amounts under lump sum policies and optional benefits within revenue policies that enables payments to advisers who provide mandated services to clients at the time of claim (see article ‘Seeing the light: transparency in claims management’, MM, March 5, 2009).
In this way, advisers are encouraged to provide better service, which in turn drives improvements in the risk insurance experience for all parties.
Also, if disclosure of (i) and (ii) above were necessary, the statement might be, “We receive additional payments of $X from the insurer in recognition of our business efficiencies”.
Food for thought!
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Col Fullagar is the head of life risk at Genesys Wealth Advisers. This article represents his thoughts, which may not necessarily represent the position of Genesys.
