What are the alternatives to risk commissions?

Risk commissions paid to advisers have been under attack for some time. If they were to be completely eliminated, however, what would be a viable alternative? Col Fullagar writes.

It is quite natural for people to look back and remember with affection “the good old days” and for many, the 1960s and 1970s were “the best”.

Yes, there were protests and drugs and stuff but it was the era of “Make Love, Not War” and “Hey Man, what about the music!!”

In 1968 Mary Hopkin melodically characterised our affection for the past thus:

“Those were the days my friend,
We thought they’d never end
We’d sing and dance forever and a day
We’d live the life we choose
We’d fight and never lose
For we were young and sure to have our way …”

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For most of the years since, the distribution of and remuneration for life insurance was in tune with Mary.

Distribution was straightforward, with insurance primarily only available through financial advisers operating initially under an agency umbrella and subsequently as representatives of Australian Financial Services Licensees (AFSLs). 

The products were sold either on a retail basis or through employer-sponsored groups. 

Remuneration was by way of commission paid by the insurer – and with a 12-month period of responsibility applying it almost ensured the adviser would “never lose”.

Those certainly were the days, and it was widely assumed that the singing and dancing would last forever and never end but …

Initially there were attacks on traditional distribution with the rise of industry funds, superannuation platforms and direct sales by insurers through the media and online.

To exacerbate the impact, these sales were made on a no-commission, basis making it difficult at best for advisers to compete on price.

Not satisfied with this, there followed further pressure as the traditional remuneration of commission was threatened. 

Advisers providing both investment and risk insurance advice had to cope with the complications arising from the removal of commission for the investment component.

And then the unthinkable, a series of direct attacks on risk insurance commission itself: 

• Future of Financial Advice reforms removed superannuation-based, employer-sponsored group insurance as a means of earning commission;
• The Institute of Chartered Accountants formulated the removal of commission for accountants as centres of influence or as direct advisers; and
• The Financial Services Council started to explore standard remuneration terms and clawbacks.

Things were changing, the changes could not be controlled or revoked and the changes had no apparent end.

Mary Hopkin missed the beat in regards to life insurance distribution; those days of retail and employer-sponsored group monopolies were ended.

Would Mary also be proven wrong in regards to life insurance remuneration? Were the days of commission drawing to a close? 

This question posed to a group of financial advisers is likely to draw impassioned and polarised responses such as:

• “There is no viable alternative”; 
• “Fees would not work”;
• “Commission is definitely under threat”;
• “If we do not fight it, commission will die”, but also
• “Maybe it is time to consider a change.”

Passion and polarisation naturally leads to the matter being discussed, opinions sought and ideas explored. However, there is also a healthy recognition that:

• There are few, if any, absolute rights or wrongs;
• There will never be agreement between all parties; 
• There will be no single solution appropriate to all circumstances; and
• There will be no single time appropriate for change.

One way of generating the necessary opinions and ideas is by posing several key questions and collating responses on a non-judgemental basis: ie, again recognising that everyone has a right to contribute to the discussion.

If it is accepted, for the sake of the discussion, that risk insurance commission is under threat as a viable option for the future, the first question to be asked is:

Are there alternatives to commission?

If there are no alternatives, the focus should return to commission and making the best of whatever the future holds.

In fact there are several alternatives:

• Don’t write risk insurance;
• Sell risk insurance on a pro-bono basis; 
• Become a sales-employee and be paid a salary; and
• Invoice a fee.

The question deliberately asked if there are “alternatives” rather than “good” alternatives”; however, most would agree that “invoicing a fee” is the only alternative with the potential to be “good.”

If this is accepted, it is important to do a job on fees because if they do not hold up under scrutiny, they should be rejected as an alternative and, again, we return to commission and make the best of what the future holds.

What are the obstacles to fees?

The theoretical obstacles to fees can be considered under a range of headings:

The challenge of change

The most extreme response to the suggestion of moving to fees would be that “commission is working fine so why rock the boat”.

If the need for change is accepted, however, there will still be a natural apprehension about change and a reluctance to move away from commission – particularly if the way forward is unclear

This apprehension might manifest as, “The concept of fees is different and advisers will have difficulty adapting” and “It would be a hard call having to work with fees”.

Also, with fees, the focal point of the cost to the client alters from “this is what the insurer is charging you” to “this is what I am charging you.” Many clients are used to advisers receiving commission and the clients may be averse to this system changing.

The word “fee” itself might be seen as having a negative connotation. Is the term “brokerage” an acceptable alternative?

Even if individual advisers were accepting of the need to change, some might question the ability of the industry to move in a co-ordinated way; “The industry is disjointed and co-ordinating a move to fee-based remuneration would be difficult”.

Inequity of fees

Concerns about the equity of fees may arise. For example, if a fixed advice fee was charged, this might be seen as inequitable for low-cost clients and advantageous for high-cost clients.

On the other hand a variable fee may also give rise to concerns:

An adviser may have a large premium case; how could a fee be charged to equate to the commission that would have been paid?

An adviser may have a complex case; would a large fee be acceptable to the client?

Would a small premium client be able to afford a fee, and thus would the client be able to afford the advice?

Issues of impracticality

Many issues revolving around the practicality of fees could arise.

Affordability: If a client had to pay a fee on top of the premium, would the insurance be too expensive?

Collection of fees: Collecting fees could be an issue resulting in additional administrative work chasing bad debts.

Inappropriate: We are often reminded that insurance is sold, not bought, and fees do not fit in with this.

The thought of paying a fee may turn people off seeking advice and drive them into industry funds and direct or on-line insurance.

Some might also cite that “Taxation is not conducive to the charging of fees”.

Business challenges: If fees were mandated this might impact on existing arrangements – and then what would happen to an existing book of renewals?

The issue of transitioning a commission-based business to fees would have to be considered, planned and managed.

Would the level of fees be sufficient to maintain an adviser’s business profitability?

Product challenges: Would the current tranche of retail products be appropriately fee-friendly?

How would advisers explain the fact that level commission is around 30 per cent, but when this is sacrificed the premium only reduces by 20 to 25 per cent?

Industry challenges: Advisers faced with the daunting task of working with fees might leave the industry. Can we afford to lose this talent pool and would this exacerbate the under-insurance problem?

The adviser value proposition

Some may see the adviser value proposition as the core issue.

There may be problems in convincing the client about the value-add of the adviser or the value-add of the advice.

Are clients prepared to pay for insurance? For advice? Can the value be demonstrated?

Clients know they cannot do their own legal or tax advice, so they are willing to pay a fee to an accountant or a solicitor – but they may think they are able to do their own insurance.

How do advisers work out what they are worth?

If quoting a fee, how do advisers work out how much work is required to get a policy in place?

Then there is the challenge arising from technology; will clients see insurance as a commodity and therefore will they get the advice and then go direct to purchase the insurance?

And what about ongoing service; what is to stop the client deciding not to use the adviser after the initial advice?

No doubt other “obstacles” to fees could be listed, but even taking the above into account, there are clearly some issues in regards to fees.

To be fair, however, the follow-on question to the “obstacles” to fees should also be asked:

What are the advantages of fees?

And again, these can be considered under a number of headings.

Client advantages

Transparency: The client will be able to assess the value of the advice they receive against the fee being charged. A double-edged sword perhaps, but an opportunity nonetheless.

Perception: The transparency of fees removes any perception of advisers being overpaid, fees will remove the perception of insurer or any other bias, and, of course, the concept of churning for commission advantage would no longer apply.

Affordability: The removal of commission will reduce premiums, resulting in the provision of advice being more affordable in the long run.

Service: The charging of a fee provides a financial incentive for the adviser to perform regular and thorough reviews and there is a natural incentive and inclination to “do it well”, to improve skills in areas where fees are being charged.

Preference: Some clients may in fact prefer fees and certainly some centres of influence may prefer fees: for example, accountants.

And, of course, a reasonable question to ask is, “Do clients think about fees as much as advisers think they do?”

The bottom line is that fees are directly linked to the value provided within the advice process, which has little correlation with the premium.

Adviser advantages

Cash flow: Fees will give advisers better control over their revenue stream as they can invoice in line with the time they spend.

Also, invoicing can occur along the way as time is expended, rather than waiting for an application to complete and commission to be paid.

A policy lapse or a claim occurring would not result in the clawback of fees, which again provides greater certainty around revenue streams.

With low renewal commission policies, an ongoing fee might provide a higher ongoing remuneration.

With fees, advisers can set their price rather than have it set by the insurer, thus providing greater flexibility and ability to structure earnings rather than simply take what the insurer designates.

Differentiation: Fees will enable advisers to differentiate themselves from others by way of service and the fees charged.

Accountants, solicitors and other professionals may be more likely to treat as equals those who are remunerated on an equal basis.

The charging of fees more appropriately enables the charging of a claims management fee, for example. In other words, advisers can tailor their business services to the fees they charge.

Business advantage

Efficiency: Whilst the issues associated with the collection of bad debts must be acknowledged, there is a counter position:

“Is it better to have 500 clients at $100 in renewals or 100 clients at $500 in renewals?”

In other words, there are economies of scale if working with fewer and more profitable clients, which in turn reduce business overheads.

For advisers providing holistic advice, a single or split fee can be charged and the need to integrate fees and commission would no longer be necessary.

And just ask any adviser who has been exposed to erroneous insurer payments arising from systems issues; at least fees enable the adviser to be responsible for their own destiny and are likely easier to track if errors occur.

Risk reduction: An important offshoot of client consolidation is the mitigation of business risk associated with the retention of non-serviced C and D clients. If clients are retained and servicing commission received but services not provided, problems related to inappropriate insurance cover can arise at the time of a claim.

Also, if the average renewal commission for C and D clients is $100 and an annual retainer of $250 was charged, only four in every 10 clients need to be retained on a fee basis to maintain the previous level of renewal remuneration.

Profitability: Fees overcome the problems associated with commission being insufficient to cover the cost of the advice provided and, on the counter side, fees give advisers the ability to undertake selective pro-bono work either by way of full or partial fee waiver.

Fees can improve the capital value of the adviser’s business and, in turn, improve the resale value.

Transition: The transition to fees can be phased in: for example, by initially only charging fees for new clients.

Independence: Fees mean the adviser is “independent” of the insurer.

Industry advantages

Arguably fees would reflect in a more positive way on the industry.

A thought ...

If each client of an adviser’s business implemented their risk insurance through an industry fund, a superannuation platform or direct, the adviser would receive no commission.

Few would argue, however, that these clients would absolutely and unequivocally require adviser advice in regards to:

• The amount and type of insurance required;
• An analysis of what is and is not covered;
• A regular and thorough review to ensure insurances remain appropriate;
• Assistance with any ongoing administrative issues; and
• Assistance at the time a claim is made.

Thus, when considering the value of the adviser and the advice process, there can be no question:

• The value clearly and comprehensively exists;
• The value manifests not only in the above ways but in many other, less obvious ways as well; 
• The value is independent of the products used; and
• The value is such that it warrants the charging of a fee.

There are some serious hurdles to be overcome if fees are to be a viable option; however, there is one last rhetorical question to be asked:

“If a fee-based remuneration model could be designed that:

• Did not add to the adviser’s administrative burden;
• Reflected well on the adviser, the adviser’s business and the insurance industry; and
• Did not impact adversely on the adviser’s financial bottom line; would advisers be interested?”

The answer is likely to be “yes” – which gives rise to the premise that the issue is possibly not one of fees versus commission but rather the apparent lack of a viable fee-based model…and yet, apparently an increasing number of advisers are charging fees and doing it successfully.

(The contribution of advisers from the RI Advice Group and Fortnum Financial Advisers to this article is gratefully acknowledged) 

Col Fullagar is the principal of Integrity Resolutions Pty Ltd.