Cause for concern?
At the Booster Conference in Wellington last week – an excellent, informative, and very worthwhile event, I might add – references were made by MBIE and FMA to life insurance commissions that are worrying.
The obsessive dogma that “all commission is conflicted” appears to pervade the thinking of both entities and it’s high time a constructive discussion took place to level the playing field and introduce a more balanced and informed perspective.
And here’s a statement to kick off the conversation – all professional services remuneration is conflicted.
Lawyers and accountants seek to optimize their fee income from as many paying clients as possible; clients wish to obtain as much from their legal/accounting professional in exchange for the least amount of outlay.
Immediately, the intentions of both parties are in conflict.
It’s also possible to abuse any method of remuneration – fees, commission, brokerage – whatever.
I don’t doubt for one minute that there are some financial advisers “gaming” the system – just as there are some lawyers and some accountants doing precisely the same thing.
However, lawyers and accountants are not faced with being regulated by financial services legislation. Indeed, they have been granted an exemption from compliance with the Bill, even though there is nothing in their training or professional development that addresses complex investment issues or complicated financial risk mitigation.
So within each of the three occupations, there are opportunities for practitioners to take advantage of the compensation methods. However, I contend that it is not the system of remuneration that is the issue, but the behaviour of certain practitioners that needs to be addressed. Just as there are a very small number of malfeasant lawyers and accountants, there is a small percentage of financial advisers queering the pitch for the vast majority of advisers who conduct themselves appropriately.
While we do not yet have a universal Code of Conduct applicable to all financial advisers, the central concept likely to feature of putting the clients’ interests first will be problematic to very few independent practitioners.
So this continuing obsession with adviser remuneration in the life insurance context is bizarre and reveals a lack of understanding of product structure, distribution strategy, and the fundamental issue of underinsurance facing NZ.
Within a net risk product, around 40% – 50% of the retail premium charged is to meet the cost of reinsurance; 20% - 30% is the product providers General Operating Expense; 15% - 20% is the insurer's profit margin; 20% - 25% is the commission element. These percentages will vary depending on the company's expense control practices and reinsurance arrangements, but the components are common to all life insurance products. Of course, there are insurance companies that have low or minimal reinsurance arrangements, but these are few and far between.
Back in the days of mutual insurance companies and tied agents – classic examples of what we now call Vertically Integrated Organisations – commission was paid as a percentage of each premium collected. During this era, agents were housed in branded offices throughout the country with support staff, systems, and administration support all provided and paid for by the insurance companies.
Through market evolution, larger companies have de-mutualised to access much-needed market capital to fund expansion strategies, and previously funded office administration and similar expense liabilities have been transferred to the distributors, i.e. financial advisers.
Running a Financial Advice business is now considerably more expensive than before.
Add to these expenses the considerable direct and indirect costs of compliance and the commission generated doesn’t look so hot.
Figures being bandied about at the higher end of the scale are seldom paid on multi-benefit products as the total premium consists of components with substantially lower commission rates attaching.
Then we were informed that disclosure of commission will be required by all advisers. This may not possible for Bank products and their (soon to be) Nominated Representatives. These good people will be salaried and disclosure of earnings would seem to be problematic.
So here’s my suggestion for independent advisers.
If you’re not already doing so, register your company as a PAYE Employer and take a salary. Commission generated can then be correctly defined as revenue to your company from which rent, rates, transport, systems, communications, compliance, legal, and accounting costs etc. all have to be deducted before your salary is paid to you.
Personally, as an Adviser operating in the UK market, I had no problem with disclosure, but there seems to be a school of thought in Officialdom that disclosure is some sort of ‘silver bullet’ – a panacea that will cure the perceived ills of the adviser/client relationship.
In truth, there is no evidence to suggest that disclosure is anything of the sort.
Operating under a similar licensing entity regime in Australia, every one of the major Banks has been targeted by ASIC following numerous customer complaints around the lack of understanding that the solution offered was not based on the wider market of products available, but limited to the Banks internal products only.
Why should NZ anticipate a different experience?
Disclosure on its own is ineffective. There needs to be clearer identification for the consumer that either market-based advice is being provided, or that a product sale process is occurring – and the functionaries need to be more easily and immediately identified by the consumer.
However, it does require independent advisers to make sure the client understands the value of the relationship. The FMA inference that appropriate product selection is a determinant of the ‘client interest first’ requirement is, with respect, myopic. Underwriting capability, processing efficiency, and claims management experience are but a few of the other factors that influence an independent adviser’s recommendation process.
A brief explanation of processes to the client and proper reference to the financial aspects involved should allow the client to make an informed judgement.
Finally, if an effective Code of Conduct provides for measures to minimise and/or prevent inappropriate replacement (so-called churn) the nonsensical Trowbridge Report and its pale imitation from MJW can be consigned to their rightful place – in the wastebasket.
Perhaps then we can apply our collective resources to addressing the scourge of underinsurance that plagues our community.