Conflict of interest : The fees vs commissions debate will significantly impact the industry

One of these is the insurance industry and the global movement away from a commission remuneration model towards a fixed fee model. There has been mixed global reaction as to whether this has benefited the industry or not with reports from the UK showing that brokers and advisors feeling the pinch of a constricted market.

 

While this debate rages on, there is a growing movement in South Africa to adopt a similar program, which will have significant consequences for the industry.

 

There is no doubt that there will be a significant impact on the industry which may rock its very foundations. The only way to mitigate this impact is for brokers and advisers to adjust policies accordingly and implement systems which will sustain the effects of this change.

 

Speaking to the FAnews, Barry Taylor, chair of the Short Term Insurance Executive Committee at the Financial Intermediaries Association of Southern Africa (FIA) says that Short term insurance commissions are currently paid to the broker on an ‘as and when’ basis. This model is acceptable to the regulator and we don’t anticipate any changes in the immediate future. Corporate business is transacted, in the main, on a fee basis as is some top end commercial business.

"Given the nature of the personal lines and smaller commercial (high volume and relatively low premium) business – and where a lot of this business is transacted on monthly policies – changing to a fee basis would have a hugely negative impact particularly with regards to contracting with policyholders. In my view intermediaries in the short term space should continue to adhere to a fixed percentage as opposed to having to ‘bargain’ with each policyholder,” says Taylor.

 

Peter Atkinson, National Technical Director at the FIA, adds that the main debating point in the fees versus commission debate occurs in the risk insurance space which covers life, critical illness and disability.

"The main issue here is the proposal to move from a largely ‘up front’ basis of income, where risk advisors receive a large proportion of the commission income on a policy sale in year one and year two, to an ‘as and when ’commission model, where commission would be paid over on each premium collection.

Atkinson continues: "The impact of such a change will vary from one financial practice to the next. A newish operation is likely to struggle more than an operation that has been going for some time and has built up a good client base, many of whom will be amenable to conduct business on a fee basis. An operation that already has a reasonable flow of on-going trail commissions , monthly commissions earned on policies held by existing clients, would certainly have less trouble with the change. Businesses targeting the higher income sector would adapt more easily to fees, while those serving the middle to low income groupings would be harder hit and may have to change their target market.”

He adds that it is also likely that the independent financial advisors would find it more difficult to adapt to a shift to ‘as and when’ commission as opposed to so-called "tied” agents who have the benefit of an employer that can offer bridging finance during the transition… Tied agents would be able to make interim plans without directly affecting their short term cash flows. Depending on the decision as to how fees could be collected there may be considerable extra costs to intermediaries including those associated with a fees collection system. Bad debt and provision for bad debt would also have to be considered.

Frank Schutte, MD Retail Product and Marketing at Liberty, points out that it’s important to note that the FSB’s initial proposals do not speak of a fixed fee. "Rather, the proposals suggest that commission on investment and retirement products be replaced by a client negotiated fee. The form of this fee is not prescribed, and is free to be negotiated with the client. In other words, an advisor could negotiate a fixed, or a variable fee or indeed a combination of both. The key difference is that the fee is explicitly negotiated with the client, and is paid by the client, rather than paid as commission by the product provider,” he says.

Schutte adds that Liberty’s view is that client negotiated advice fees are totally appropriate for single premium investment and retirement products. They will promote transparency, and good service and advice to customers.

 

"However, we are concerned with the introduction of advice fees on recurring contribution savings and retirement products. In reality, given that it takes many years for a reasonable asset base to be accumulated in these contracts, the value of an advice fee that is a percentage of assets will not make it worth an adviser’s time to sell these contracts.

In effect, advice will become unaffordable to middle market South Africans and we expect to see a significant reduction in the sales of these important policies in the future. Liberty fundamentally believes in the value of appropriate financial planning and advice to the average South African consumer, and the initial proposals present a real threat to the sustainability of such advice to the consumer,” says Schutte, "the ASISA (Association for Investment and Savings SA) gap study showed we are underinsured as a country overall. Thus there is a need for advisors to talk to people to ensure adequate coverage.”

While it seems as if there is a debate in the industry to accept either one model or the other, there is a possibility that some of the industry concerns can be resolved through a hybrid model which incorporates both fees and commissions.

 

Ian Middleton, MD of Masthead, reports that a hybrid industry model is feasible as long as certain conditions are maintained. He says that ongoing compensation (fees) will address many of the concerns that have been highlighted by the regulators. The trick is striking the balance between reasonable compensation for the upfront work and reasonable compensation for the ongoing work, while at the same time not destroying small financial advisory businesses through a cash-flow squeeze.

Because of the intangible nature of the products (whether this is the advice or the actual life policy or investment) brokers take to customers, the industry (including brokers and advisers) has work to do in highlighting the need for advice and creating awareness and appreciation amongst consumers that financial advice is necessary and has a value.

"For me, adequate ongoing compensation in the long-term risk space (eg. at the same rate as ST insurance commission) together with sufficient lead time (eg. two years) to change their business model, can work. This will enable brokers to build annuitised income streams while retaining their customer base and is a sure way of creating value in their businesses. I believe that a model incorporating an upfront payment plus ongoing payments is acceptable to customers as long as they know who they’re dealing with (disclosure), what they’re paying (less about form and more about quantum) and what they’re getting for that payment (value),” says Middleton.

There is no doubt that there are uncertain times ahead in the industry when it comes to compensation. The problem that a fixed fee model will cause is a cash squeeze among smaller brokers and advisors who don’t have an established client base, and are not backed by a big brokerage firm. Current indications are that this debate will intensify before it goes away and that there will be a lot of consultation between the FSB and industry before firm guidelines are established.