You get what you pay for – the argument for continued commission
Earlier this week we addressed The Board of LUASA (The Association of Professional Financial Planners) response to National Treasury’s proposals that will have a significant impact on the life insurance industry.
In a paper titled: “Contractual Savings in the Life Insurance Industry.” Treasury suggests a number of changes to Part 3 of the Regulations under the Long Term Insurance Act (1998). Proposed changes to commissions on certain long-term produces will have a huge impact on the intermediary business model. Treasury has called for radical changes to the way in which commissions are paid and administered through the life of the insurance policy. In today’s newsletter we examine LUASA’s views on the proposed chances to commission payouts.
An unequal cost burden
Treasury proposes “a maximum of 5% of premium, with a maximum of 50% that can be made available as annualised discounted commission with the balance payable over the term of the policy (with a special dispensation being permitted for intermediaries operating in the low-income, low-premium market).”
LUASA estimates that a financial intermediary business with a single key individual expends between R2 000 and R5 267 to secure each new client. These costs consist of office rental, staffing & backroom administration, financial planning software, computer hardware and stationery and printing costs. Motor vehicle leases, fuel and other travelling costs add to the burden. And an average of five hours is required to execute the six steps required to complete a comprehensive financial needs analysis for each client. More importantly these costs are sunk regardless of whether a sale is made. The intermediary is generally remunerated for the abovementioned service by way of statutory commission determined in the Long Term Insurance Act. Advice fees are also permitted; but are not widely used at present.
In comparison, insurers “only experience direct acquisition costs once a policy (submitted by a broker or agent) is accepted and loaded onto their system. LUASA estimates these costs at “between R1 200 and R1 800 per policy, irrespective of the size of the policy premium.” The systemic business risk carried by the intermediary over the insurer is thus substantial – and something that should influence how the final commission solution is implemented.
Four arguments against changes to commission reversal period
A second proposal in National Treasury’s document is that the period for commission reversal on lapsed or paid-up policies will increase from two to five years. This move is touted as “a disincentive against intermediary miss-selling.” LUASA believes this change is a grave injustice to the majority of intermediaries and lists four major objections. They also questioned whether this change was motivated by Treasury or the LOA. If the latter proposed the change, LUASA requests that “motivations be tabled as part of NT’s public engagement process, to enable the intermediary bodies an opportunity to scrutinize the need for such an extension!”
The first is that the “majority of intermediaries are intrinsically honest, ethical and professional in their approach to financial planning and their clients.” The application of a longer reversal term is patently unfair because the reason for the policyholder’s decision to lapse a policy cannot generally be linked back to the financial advice or service provided by the intermediary.
LUASA’s second concern is that financial intermediaries will be forced to carry general economic risks. Should a policyholder lapse a policy due to “job loss/retrenchment, divorce, emigration, instant gratification, budgets being depleted by increases in interest rates, bankruptcy, debt-driven life styles, etc” the intermediary will suffer despite having committed no transgression.
Thirdly, the longer commission reversal time will have a huge impact on the local savings industry. LUASA believes intermediaries will simply stop marketing retirement annuities after 1 August 2008 and says “this is surely not in the best interests of the consumer nor the national drive to increase the nation’s savings.”
The fourth concern relates to the unfair treatment of insures over intermediaries. LUASA notes that “insurers can recoup their expenses from policyholders who lapse or make their policies paid-up.” In contrast, “intermediaries, who placed the policies on the books of the insurer, have to proportionately forfeit their income irrespective of the reason for the lapsed or paid-up policy!”
A better system for reversed commissions
Many of LUASA’s comments on the proposed changes go to levelling the field between intermediaries and insurers. For example, they suggest that reversed commission should not be “retained by insurance companies in the absence of a servicing intermediary.” Instead they should be “paid into a statutory fidelity fund (much the same as the estate agent’s fidelity fund) from which the FAIS Ombud’s office could draw to compensate policyholders where they have been wronged and the defaulting intermediary is not in a position to meet the FAIS Ombud’s financial penalty determination.”
The also urge National Treasury to pay commission to redirected intermediaries “via a “service only commission contract” with no production requirements.” This would apply “where commissions are redirected and the intermediary does not wish to represent the insurer’s products and conversely, where the insurer does not wish to have the intermediary represent the insurer’s products.”
LUASA also suggests a change in focus on the long standing section 14 transfer debate. The importance of whether commission be paid on these transfers should come second to deciding “how best to manage the current R30 billion saving funds under management to best advantage of policyholders and the nation in general.” A narrow focus on commissions means that the real problem of exorbitant costs eroding the value of savings in these policies.
Cutting the intermediaries lifeline
LUASA believes that “The lifeblood of the insurance industry is without a doubt the intermediaries who are the key drivers in getting consumers to create wealth and to protect their families against unplanned insurable events.” For this reason policymakers are urged to acknowledge the role the intermediary plays in advancing consumer protection. Continued punitive decisions on commission will have two serious consequences. It will dissuade new intermediaries from entering the profession and will result in a slow decline in intermediary numbers over time. Those who believe the LUASA is scare mongering should look no further than changes in the intermediary market in the UK and Australia in the wake of more stringent regulation in those markets
What does the changed commission structure mean for the intermediary? From the get go the current ‘up-front commission’ business model will have to be thrown out the window. With up-front commission incomes flow to the business almost immediately – while after commission legislation changes intermediaries will probably have to wait 36 months before their full income comes on line. Again, LUASA warns this could lead to a “decrease of new entrants into the industry due to cash flow restraints.”
But there are more sinister forces at work. An unwelcome consequence of National Treasury’s proposed changes is that smaller operations will be squeezed out of the industry. And new entrants to the market will need huge amounts of start-up capital or have to find financial backers to enter the industry. Enter the large life assurance companies who will be able to boost the number of ‘tied’ agents because they have the capital to bankroll them. “The downside hereto is the restricted product ranges they can offer, which impacts on the principles of “appropriate” advice, resulting in one of the basic tenets of FAIS not being fulfilled,” says LUASA.
Editor’s thoughts:
LUASA raises a number of concerns with Treasury’s proposals on the payment of commissions to intermediaries. One of the main concerns is that small independent intermediaries will be forced out of the industry while ‘tied’ agents proliferate. Will changes to commission legislation increase the life assurance companies hold on the industry? Add your comment below, or send it to gareth@fanews.co.za
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