A Cautionary Tale regarding Life Insurance Commissions.....

The Herald carried an interesting article by Diana Clement on Saturday, outlining the dangers of insurance policyholders switching insurers, running into difficulties with subsequent claims, and being advised by a greedy intermediary chasing additional commission. While the thrust of the article was well-intentioned I'm sure, there are other critical factors at play which need to be taken into account.

Many years back, on taking over management of AIA in Auckland, I found 25 Life Companies reporting statistics to the (then) ISI. Of that 25, AIA - or Alico as it was then known - sat 24th in the production league table.

American International Assurance

So what was the one outstanding difference which the others had over AIA?

The other companies all paid upfront commission - while AIA paid 'as earned' commission. Certainly, the 'as earned' model was - and remains - a great way to avoid commission clawback and to build an ongoing income stream for an adviser's practice - providing you have the capital to sustain the business while the income levels build.

However, commercial reality determined that few advisers had the capital to fund a practice of this nature, so I duly made the case for tackling the competition and paying upfront commissions. The howls of protest from Hong Kong Regional Office were strident and plentiful. "Never pay more than 100%" - came the reply. Never is a big word and should be used with extreme caution! Nevertheless, some perseverance and committing the lives of my children and their children's children extracted a competitive upfront commission payment which, in part, laid the foundation for AIA's success over the next decade or so in NZ.

Of course, the truth is that the actuaries in Hong Kong realised fairly quickly that considerably more profit emerges from the upfront commission model, than from the 'as earned' model. The latter causes a continual impairment of profits, while the former, subjected to DAC (Deferred Acquisition Cost) practices, stretches out the impact of upfront commission payments, and renders the negative effect on profits relatively insignificant. So my colleagues were ultimately quite happy to agree to the request for up front commission payments to match local market practice.

The point of that tale - in the context of the Herald's article - is to provide a background to the commission payment levels which prevail in the NZ market today.

Whatever commission levels are payable are at the sole, complete, and exclusive behest of the product manufacturers. Therefore, while Diana Clement's article is accurate in the substance of the content, it might be better to direct attention towards the Life Insurance Companies which make such terms available to advisers in the first place.

Even the opening line that "commissions on offer encourage advisers to move their clients" is only applicable because the insurance product providers, in an attempt to grab market share, make replacement policy commissions available to the same extent that the sale of a new policy to a  new client. It doesn't actually matter whether absolute commission levels are too high (which they are in NZ) or whether they are relatively low (as they are in Asia) the inappropriate 'churn' of insurance policies will continue to exist as part of the system.

Unless, that is, the insurance companies agree not to pay upfront commission for a straight replacement. That is, a policy replaced with another with the same face value and benefits attracts nil commission. If the new contract has a higher value of benefits, then the adviser is paid commission based only on the additional premium payable.

Naysayers will wail about commission being a distortion and unethical..yadda yadda yadda.

There is nothing intrinsically wrong with commission payments as part of a life risk product sale.

Take out the word 'commission' and substitute 'distribution cost', and selling a life insurance product becomes no different from selling any other product. Each has a margin for profit, each has a cost of manufacture, and each contains an allowance to cover distribution costs. The pricing structure is similar, so all those holier-than-thou moaning minnies who call for the abolition of commission and for fees to be charged for life insurance advice should try spending a year with their own financial model charging fees for risk product advice exclusively. Good luck!!

Of course, there are firms which charge fees for advising on life insurance, but they do so as an adjunct to another, likely main, line of business.

Picking on advisers is an easy target; working out where the source of the issue is to be found takes a good deal more insight, but is nevertheless essential for the consumer to gain a balanced perspective of the adviser - and his/her remuneration - in the decision-making process.


The Laird