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Commissions: Insurers in the hot seat

04 October 2005 Dewet Potgieter

FAnews asked the life insurance companies a few burning questions.

RA Commissions: Burning questions answered by life companies

Continuing the debate surrounding The Life Office's Association's (LOA) proposals to reform upfront commissions on long-term insurance policies, FAnews asked the life insurance companies a few burning questions.

For obvious reasons the LOA's proposals sent shock waves through the industry and were not received with enthusiasm within the broker fraternity. Here are the insurers viewpoints on some of the questions our readers wanted answered.

QUESTION 1

According to Gavin Hillyard (CFP) it is common knowledge that the greater proportion of the problem of early policy termination/paid up values with regards to retirement annuities, lies with the assurers (approx. 66%). How could the assurers propose to help with the situation?

Discovery Life
Discovery Life subscribes to up-front commission to intermediaries. However, this should not be at the expense of good value provided to the policyholder. Discovery Life's products achieve the optimal balance by paying up-front commission to intermediaries but at the same time ensuring good value to policyholders by guaranteeing the minimum paid-up/surrender values.

Liberty
The above statement is not correct for long-term savings products, if the product is terminated in its early years. Commission would have mounted to 75% plus VAT of the first year's premium and 25% plus VAT of the second year's premium amounting to over 50% of premiums paid in the first two years.

However we believe that a balance must be found involving all our stakeholders, clients brokers and life companies. To this end we are continuously reviewing our product and cost structures with a view of giving the best value possible to our clients.

Momentum
The challenge facing the industry is to marry the value-for-money proposition of saving products with the income needs of financial advisers. It is important that we also understand the difference between long-term values for money versus the impact of charges on early termination values. Certainly, for a longer-term savings solution such as retirement annuity, the overall level of commission in relation to the total cost is definitely lower than for a shorter-term endowment policy.

On the Momentum Investo series for example, one has to acknowledge that the bulk of early termination cost recoveries consists of unrecouped commission paid to the intermediary.

"On the one hand, we cannot continue with business-as-usual as if we were ignoring consumerism. Unless clients are experiencing good value-for-money, they will not buy our products," says Philip du Preez, head of savings.

On the other hand, there is a perception that the LOA proposal unfairly isolates financial adviser commission as the sole cause of the problem. However, one cannot look at it in isolation without simultaneously looking at the issue of the margins of life companies. It is for this precise reason that earlier this year, Momentum set out to independently address some of the complaints levied against insurance savings policies. At the time, it labeled the launch of its Investo 4 with its Save Thru Spend philosophy as the investment range that would possibly be the watershed in how contractual savings programmes are sold in South Africa.

Momentum presented a product that changes many of the paradigms of the industry. It did so in the face of mounting media criticism of the poor value proposition that insurance policies offer, and growing disinterest by financial advisers in selling them.

Momentum's head of business solutions, Danie van den Bergh, describes the new product: "For the first time, fees have been slashed and recoveries properly explained and exposed. We've addressed the lack of transparency and poor performance of policies directly. We've given all investment vehicles equal treatment for fees - and most exciting of all, we've found a truly innovative solution to reverse the dramatic fall in savings in South Africa. It is also tax efficient."

Momentum has slashed administration costs by 30%. It did so by simplifying its fee structure to a single no matter what the policy, whether retirements annuities or unit trusts, and by consolidating all members' investments into one. Van den Bergh says this alone can save some policyholders as much as 40% of their fees.

Momentum also becomes the first life company to truly share the risk with investors, by opting for performance-based fees both on the upside and downside of investment performance on Momentum-managed funds. The only exceptions: The performance fee does not apply to external asset managers, and multi-managed funds have a slightly different pricing.

Old Mutual
Clients invested in some of Old Mutual's earlier generation retirement annuity (RA) products will be given the option of transferring to the new generation Max Investments product later this year.

Paul Hanratty, Old Mutual Deputy MD, says that two of the key objectives in developing Max Investments were improving flexibility for clients and providing a wider investment choice. "We have also been seeking ways to improve the flexibility and choice on some of our older contracts, and allowing transfers to Max Investments enables us to achieve this objective."

Significantly, says Hanratty, the transfer option may result in enhanced retirement values for members who have experienced reductions in fund values. The cost of enhancing transfer values for eligible paid-up policies will be fully borne by Old Mutual. For this purpose R225-million have been set aside.

The facility to transfer to Max Investments will be opened towards the end of this year for all Flexi and Investment Horizons retirement annuities that do not have life cover linked to them. Retirement annuities with risk cover as well as endowment policies will be dealt with at a later stage.

Sanlam

We do not share in this common knowledge. According to the analysis in the LOA proposals, the 66% represents all costs over the period of a policy. Nevertheless, we have over the past number of years succeeded to implement significant cost savings in our life business to the benefit of clients through our range of Stratus products. We recently introduced Stratus Special, a range of policies and retirement annuities that offers clients significantly improved early termination values. This was done without changing the current commission dispensation.


 

QUESTION 2

Research carried out in the industry indicates that, due to the changes of the proposed commission structures on life insurance business, up to 80% of independent brokers will be forced to shut their doors. If that is the case, what do you suggest as a solution for independent brokers to survive in such an uncertain future? Will you as product provider survive without the 80% brokers?

Liberty
We have not seen this research so it is difficult to make a comment, however, as always, we will do everything we can to help ensure the continued success of all our intermediaries whose support is vitally important to us. The intermediary has played and continues to play a crucial role in the life insurance industry. It is imperative that a solution be found.

Momentum
Momentum aims to cooperate closely with its financial adviser channel to emerge from the current financial adviser commission debate stronger than ever. The company aims to support financial advisers during any transition period that may be the result of the present wrangling.

"You cannot take the financial adviser out of the loop without directly impacting on our business-so we cannot be irresponsible about this issue," says Dr Kobus Sieberhagen, CEO Momentum Distribution Services.

"More and more financial advisers understand the need to build a practice that they base on annuity income rather than upfront fees. It's not as though financial advisers do not understand how important it is to offer value for money and that consumer interests are important - the challenge is how to get there."

Nor is it all doom-and-gloom for the industry itself should the worst case scenario materialise. Many financial advisers have sustainable annuity business built around short-term risk products, but have shunned the savings industry. This is because of its poor public perception as value-for-money proposition. Many of these advisers might be tempted back into the market if one could address those perceptions now. The question is whether these advisers would make up for those forced out of the business by the cash flow crunch-because from month one of the new post-LOA environment some financial advisers will have virtually no income.

Yet change often creates new business opportunities. When the regulator introduced FAIS, new compliance companies sprung up to handle onerous compliance requirement on behalf of financial advisers. Sieberhagen sees something similar happening in the case of commission.

"Discount houses may finance this transition period for financial advisers, provided that they properly prepare themselves to be creditworthy. Furthermore, product designs might cater for interim solutions for intermediaries to phase themselves into a new dispensation."

Old Mutual
Hanratty says while the LOA proposal helps to greatly improve early termination values, it also impacts greatly on a broker's cash flow.

Overall indications are that the LOA commission proposals could impact on brokers' cash flow by 14 %. However the impact is likely to be much higher on the broker serving the middle and lower market.

"This has serious implications for brokers and ultimately many consumers could have their access to financial services impeded if brokers cannot survive. The LOA proposal recognized that this challenge would need to be dealt with."

Hanratty says:" The process of consultation will undoubtedly lead to some refinements in the commission proposals presented by the LOA. Old Mutual is committed to finding a commission system that is viable for intermediaries and which does not deny access to consumers while at the same time improving the early termination values for customers. This will help to further the objective of getting South Africans to save for retirement."

Sanlam
For assurers to be successful they need to have successful intermediaries. Assurers will therefore have a vested interest in ensuring that intermediaries survive a transition towards an on-going commission stream. The details of such transitional arrangements can only be finalised once certainty is obtained on a future commission dispensation.

QUESTION 2

What is your viewpoint as a product supplier/provider on the following points?

  1. Do away with punitive early cancellation/reduction penalties?

    Liberty
    These are not penalties but a recoupment of expenses, the recovery of which would have been spread over the full term of the contract.

    Momentum
    In the current scenario, insurers often calculate cancellation values by reducing fund values by early cost recoveries. This includes broker commission and product provider's internal charges.

    For example, the insurer levies early cancellation charges since there is a huge mismatch between the occurrence of expenses (mostly upfront) and the fees (mostly throughout the term).

    The latest savings products have generally moved away from high early cost recoveries that cannot be justified. For example, the paid-up basis for the Momentum Investo flexible range does not levy any charge against the fund to cover upfront expenses that Momentum incurs. The only charge relates to upfront commission that it paid.

    The way in which intermediaries are remunerated will definitely influence the removal of early cost recoveries. For example, a simple as-and-when commission structure or a different commission claw-back structure over a longer term will drastically reduce early cost recoveries.

    However, if the future scenario includes a significantly lower level of upfront commission, it is indeed a very likely outcome that product providers will also slash their own charges.

    We also expect a fresh approach towards, for example, paid-up practices, as product providers introduce more flexibility to this arena o cope with clients' dynamic needs. The consumer will benefit greatly.

    Sanlam
    To do this effectively we will need a move to on-going commission, or up-front commission with claw-backs over a long period.

  2. Stop paying commission on churned/replaced RAs and pure endowments?

    Liberty
    This is very difficult to enforce.

    Momentum
    Some churn is understandable - life companies are continually bringing out new, better products which financial advisers are quite right to recommend to their clients as superior to what these clients may currently have.

    It is also important that financial advisers should receive appropriate remuneration for their financial advice and recommendations.

    However, the innovation-squeeze comes from the fact that upfront commission sometimes traps clients in inferior products, because they will lose so much value in the transfer. As-and-when commission would encourage financial advisers to churn for the right reason - putting their clients into the best product without having to lose value.

    Products do not fit this evolution: the payment of upfront commission stifles innovation. This makes it difficult for an innovative company like Momentum - and others - to come up with appropriate products.

    Financial advisers who want to transfer their clients into the new product face accusations of churn and of doing it only to earn more commission. Churn is only a problem because the consumer faces enormous early termination costs when transferring. The problem is not upfront commission, but the fact that it fully vests after two years.

    Sanlam
    That would help to address the current problem of churning in the industry. With a combination of on going and service commission the problem would be much smaller.

  3. Give the client the choice whether he/she wants to pay either fees or commission?

    Liberty
    This should be up to the intermediary and his/her client.

    Momentum
    Sieberhagen sees one factor in South Africa that militates against a deregulated environment - the lack of sophistication of a big segment of the market. Consumers need enough practical understanding to negotiate fees. At a minimum, they need to be able to read contracts.

    "A large percentage of our population needs to be protected from being taken advantage of. Ignorance breeds mis-selling and churn, and that are probably the motivation for regulation," says Sieberhagen.

    However, the ultimate goal should still be deregulation, full disclosure of fees and letting the consumer decide what he or she is willing to pay. This can only happen when the market is more sophisticated, and this should encourage participants to get more involved in educating their clients.

    Sanlam
    This option is already available to any broker, who can sell a zero-commission policy and negotiate a fee with his client. This approach is only viable in the upper end of the market, and will not work for small policies.

  4. Leave the current commission regime as it is?

    Liberty
    This option would be problematic due to the impact of commission on early termination of long-term savings products. (See answer to question 1.)

    Momentum
    "It is now the time to be rational, as far as is possible, about the potential impact of the changes and reposition accordingly. This is true for both the financial adviser and the life offices. It is our combined responsibility to ensure that consumers are convinced that savings products still offer good value for money. In this process, Momentum is committed to support our financial advisers during the transition. It must, however, happen in a responsible way that ensures good value for money for the client in the end. It must furthermore ensure that financial advisers ultimately build a practice that they base on annuity income streams. This will result in the financial adviser building a professional business with a market value. We will also have to formulate a strategy to ensure the entry of newcomers in our business.

    However, Sieberhagen does not believe it is possible to achieve what is needed from a value for money perspective, leaving the current commission regime as is. It does however create an opportunity for innovative and creative solutions.

    Sanlam
    It is not up to the assurers to take this decision. Government has clearly indicated that they are unhappy with the current state of affairs, and National Treasury, in cooperation with the FSB, will ultimately decide about a commission regime.

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