Claire Mackay and Tim Mackay outline why risk products should not be carved out of the Government’s plan to ban product commissions

We
do not understand why the proposed ban on commissions by both the FPA and the
Federal Government does not also cover life risk products. In our family-owned business,
we have successfully implemented a transparent, fixed-fee approach, which our
clients support and which encompasses all financial products.

Arguments by the
industry that insurance commissions are a “special case” appear to consumers to
be self-serving, and ultimately undermine the professionalism and creditability
of our industry.

The main reasons we hear in support of commissions are that a
ban would be to consumers’ detriment, would lead to higher premiums and would
exacerbate underinsurance.

All consumer advocacy groups that we have spoken to,
including Choice, support a commission ban across all financial products.
Choice describes all commissions as “perverse incentives” and lobbies to have
them banned. So despite arguments put forward by industry, consumers themselves
do not believe banning commissions would be to their detriment.

We have not
seen logical arguments or empirical evidence that demonstrate a commission ban
would result in higher premiums in the long term.

The only credible short-term
reason for higher premiums for risk products is due to a potential exodus of
commission-based advisers who may be fearful and unwilling to implement the
reforms, which will reduce the number of advisers in the short term.

However,
we believe it is in consumers’ interests to have fewer professional advisers
who they trust rather than having more advisers operating under the broken
commission model in which consumers no longer have any faith. In the medium to
long term, we believe a commission ban will lead to increased, transparent
competition resulting in a reduction in fees for consumers.

Currently the cost
of commissions is hidden, wrapped up in the premium paid. Defenders of
commissions argue disclosure is adequate. According to a former High Court
Chief Justice, Sir Anthony Mason, when it comes to current financial product
sales practices, “Detailed and dense disclosure is often the most effective
form of concealment”.

Those who defend commissions are effectively arguing that
it is OK to continue to hide the cost from consumers. To us, this seems like an
appalling argument supporting commissions. According to Ric Battellino, deputy
governor of the Reserve Bank of Australia: “This reluctance to pay for advice
upfront appears to be a form of money illusion, whereby investors may feel that
they are somehow paying less for financial advice if the cost is buried.”

We
believe a ban on all commissions empowers consumers with a clear and
transparent understanding of how much they are paying, to whom, when, and for
what.

We believe that commissions reduce competition and drive up premiums.
While the insurance industry is competitive, we argue that competition is at
the wrong points in the value chain. Rather than competing on premium price,
insurers compete on the level of upfront commission they dangle in front of
advisers. We show the upfront and ongoing life commissions offered in Chart 1.

For
example, if a couple was advised into AMP policies with premiums of $4000 in
the first year, their adviser could receive $5200 in commission up front (130
per cent from AMP) and $440 (11 per cent from AMP) in following years. Insurers
offer advisers subsidised upfront commissions larger than the premium paid as a
sweetener to woo their business. We understand why advisers prefer commissions
to remain embedded in the premiums – if commissions were banned advisers would
struggle to justify to their clients charging such relatively large payments up
front.

If these policies were held by the couple for three years, we estimate
the adviser and their dealer group will receive between 45 per cent and 51 per
cent of the total cumulative premiums paid by the client. (This decreases to a
31 per cent to 35 per cent adviser/dealer share if the policies are held for
five years.)

So the client pays the premium and then the insurer, the dealer
and adviser all fight over that pie. It is in no-one’s interest to make that
pie smaller but it is in everyone’s interests to negotiate a bigger slice of
that pie. Therefore, competition exists at the insurer/dealer/adviser level,
but less so at the client level.

Now, if we turn this on its head and remove commissions,
the adviser must now negotiate advice fees with the client every year. The
adviser will have to demonstrate to the client that their advice is value
adding and they now will be in effective competition with the insurer for a
certain slice of the client’s wallet.

We often hear “underinsurance” provided
as a defence for life insurance commissions. However, the “underinsurance”
problem has arisen entirely under the existing commission- based system. Therefore,
to use underinsurance as a key reason to support the continuation of
commissions, to us appears nonsensical.

We believe banning commissions could
actually help address underinsurance. From Chart 2 it is clear that advisers
who receive upfront commissions share 45 per cent to 51 per cent of total
cumulative premiums. If commissions were banned and the savings were entirely
passed onto consumers in the form of reduced premiums, this could result in
premiums immediately falling by between 45 per cent and 51 per cent in price.

Price
is the key determinant of demand, not the aggressive selling techniques or
remuneration structure of the sales force. Significantly decreased prices would
lead to significantly increased demand. A ban on commissions could be an
effective way for the Government to help address the underinsurance problem.

The
FPA’s position in its 2009 Remuneration Policy is that commissions on all
financial products result in a real or perceived conflict of interest between
the adviser and the client. Consumers demand and rightly deserve life risk advice
that is free from real or perceived conflict of interest. Our industry deserves
a single remuneration regime that helps drive increased professionalism. Life
risk products should not be an exception and any real (or perceived) conflict from
ongoing commissions can only be to the detriment of consumers.

We believe that
having multiple charging regimes will be complex and confusing for consumers. We know from 2012 there will be two charging regimes for financial products -
the new rules banning commissions will apply to new investment products issued
from 2012 and the old rules allowing commissions will apply to existing
investment products.

If life insurance commissions are also excluded from the
ban, consumers and holistic financial planners will need to operate under three
different sets of rules – one for old investment products, one for new
investment products and one for existing and new life insurance products.

From
a consumer perspective, let’s assume they pay a fee for investment advice and
receive advice on life risk products at the same time. After 2012, the consumer
may believe that advice for both types of product are included in the fee. If
they understand that the adviser is remunerated separately by the provider for
the life product, this may lead to confusion and it may alter their perception
of the value of the fee.

There are obvious significant benefits to consumers
and advisers in having one, easily understood, uniform remuneration system that
applies uniformly and consistently across all financial products.

If there is a
commission ban on investment products and not life risk products from 2012, advisers
providing holistic advice could have a real (or perceived) incentive to focus
more on life risk products (where they can get paid up to 130 per cent of the
premiums upfront) at the expense of investment products (which do not attract commissions).

Sadly, this type of situation could compromise the industry’s drive for
professionalism and cause consumers to question the adviser’s real or perceived
balance and suitability of advice.

Claire Mackay and Tim Mackay are directors of Quantum Financial Services in Sydney

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