Beyond Trowbridge: the future for life insurance commissions

Why commission?

The traditional model for retail life insurance sales has been built around paying commissions to intermediaries. The commission is paid for procuring and retaining customers and is unrelated to the quality of any advice provided by the intermediary. Herein lies the misalignment – financial advisers (once called life agents) provide advice to consumers on their insurance needs and suitable products; yet, they are paid by the successful life companies which provide the product. The commission is related to the size of the premium rather than the quality and scope of any advice provided.

This issue led to the development of the Future of Financial Advice (FoFA) legislation, which has banned commission as a form of remuneration in superannuation.

Is commission appropriate for life insurance?

Life insurers have been comfortable with commission models as their sales costs are then variable and not fixed. They recognise that a significant part of the work is done around setting financial needs for the consumer and then selecting appropriate products to match. So, an upfront commission pays the adviser at the time the work is done. Once the policy is in place, there is not much ongoing work unless there is a claim. Renewal commissions basically pay an ongoing retainer for the adviser (who does not get paid separately for assistance at claim time).

There has been a price war for advisers over the last 20 years and upfront commission has doubled in that time. Further, the persistency period, has relaxed from two years to one year. Therefore, the initial commission is fully earned once a single year’s premium has been paid! The relaxation has led to a doubling of lapse rates over this time, indicating that some advisers shop around policies every few years to earn further initial commission.

It would be difficult for advisers to develop a fee for service model for providing life insurance advice to consumers. The facility is already available, but few advisers use it. The initial cost of providing the advice is likely to exceed $1,000 and could conceivably be much more in many cases. Most consumers would baulk at paying these fees and most would query why they pay them on life insurance, but not on general or health insurance. Further, if commission were banned on life insurance, it is claimed that up to 50% of advisers would exit the market.

The Trowbridge report recognises the practicality of retaining a commission system, but recommends tilting it towards a renewal structure, with a maximum of 20% of each year’s premium. The main advantage of this is that advisers would have less incentive to shop around and recycle products every few years. Of course, the maximum prescribed commission will inevitably become the standard commission.

The difficulty for advisers if they earn renewal commissions is that they will not get fully paid at the time they do the work. They will need to borrow against future cash flow to pay their bills. Trowbridge recognises this and suggests a fee of $1,200 per client be paid by the insurer in addition to the commission.

It remains to be seen whether the structure will be endorsed by ASIC and then whether it can be implemented seamlessly. We may still see a number of advisers choosing to exit the market. However, the proposed structure is a necessary improvement. We can expect lapse rates to fall, making retail life insurance more profitable and possibly cheaper for consumers in the long term.

Advisers who can manage their cash flow will have an increased value on their portfolio of clients since renewal commissions will be higher.

The disruption that this change inevitably will cause in the Retail market may create an opportunity for superannuation Funds to increase member’s awareness of their ability to take up greater levels of insurance through their group life schemes.

Michael Rice, CEO