After a scathing report by ASIC in October 2014, Review of Retail Life Insurance Advice, calling for an end to the misalignment of financial incentives offered to financial advisers and licensees (dealer groups), together with the FSI recommendation for level commissions in life insurance, the FSC and AFA commissioned prominent actuary John Trowbridge to review advice in the retail life insurance segment.

Trowbridge recommended the industry move to a level commission structure of no more than 20% of commissions together with a fee for providing the initial advice of no more than $1,200.

Late last week, Assistant Treasurer Kelly O’ Dwyer released the government’s response to the Trowbridgereport on life insurance. The result is a pragmatic compromise between the views of those who want commissions banned completely and those who see no reason for change.

At present, insurance companies pay about 120% of the first year’s premium on retail life insurance policies to financial advisers.  There is also ongoing annual commission of about 10% to 12% of premiums from the second year.

The upfront commission reflects the work done to assess the customer’s insurance needs and to find suitable policies to match.  The trailing commission is paid as an incentive to keep the policies on the books.

The government response has been to legislate maximum commission payments.  There will be a phased reduction in upfront commission to no more than 80% of premiums from July next year and then 70% a year later and 60% from July 2018.  Renewal commissions will be no more than 20%.  This will impact on all retail life business including direct sales not using intermediaries.  Volume-based payments will also be outlawed.

Through competition for advisers, the industry has moved to a 12 month persistency period, which means no commissions are clawed back as long as the policy lasts for a year (notwithstanding that the life companies need the average duration to be 7 years so they have time to recoup all their initial costs).  Trowbridge recommended a 3 year claw-back period to stop policy churning – the government has settled on two years.

The FSC will set up a Code of Practice for the industry and there will be a new standard for Approved Product Lists (APL’s) with a view to providing a wider choice of products.

ASIC will receive data from insurers on policy replacements and it will review Statements of Advice with a view to completing a review of the impact of these reforms by the end of 2018.

The impact on the industry will be significant…

We expect that the maximum commissions will become the standard default commission across the industry.  Many life agents will moan about the reduction in upfront commissions but smart dealer groups will realise that the higher renewal commissions, being recurrent income for the practice, will add value to their businesses.

It is likely that more banks will follow the lead of NAB and exit the manufacture of life insurance to release capital. Their customers will get better choice if more products are offered and the bank will take commission, which will be more stable income than profits on this business.

Finally, the government is finally going to amend the Corporations Act to facilitate the rationalisation of legacy life and managed investment products.  That will lead to improved efficiency in the segment.

In time, all these changes should lead to more competition and reduced premium rates and if ASIC still finds problems in three years, there could be further measures to improve consumer outcomes.