Despite growing calls to “de-commission” risk products, Wayne Leggett argues that doing so would only undermine the role played by financial planners.
The momentum of the campaign to eliminate commissions from the world of financial planning, while disconcerting to members of some quarters of the industry, is an inevitable consequence of the endeavour to transform financial planning into the profession most of its practitioners would wish it to be. Hand in hand with this campaign is the introduction of the obligation on financial advisers to become “fiduciaries” – although few could argue with the suggestion that, if we weren’t already acting as such, we should have been. The Future of Financial Advice paper suggests that the legislation will require advisers to take “reasonable steps” to ensure their advice is in the “best interests” of the client.
While this is an obviously beneficial development in the industry, try explaining to a client why you don’t already operate on that principle. While most of the proposed changes have been largely met with the approval of industry participants, one issue that is proving a “bone of contention” is that of the retention of commission on risk products. There may be an element of inevitability in the ultimate demise of commission payment for insurance products. However, in the short term, at least, this is an area in which we need to exercise caution. Proponents of the case for removal of risk commissions, not surprisingly, include Choice, who are lobbying for the banning of commissions, which they suggest are “perverse incentives”.
However, one would suspect that they hold that view about commission on any product. In their article “Insurance is not a special case” (Professional Planner, June-July 2010), Claire and Tim Mackay suggest that because Choice holds this view, that indicates “consumers themselves do not believe banning commissions would be to their detriment”. However, the flaw in this argument is that, although they lay claim to doing so, Choice do not represent the average consumer. This is because the premise behind Choice is that of doing your own homework and making decisions for yourself based on the research you have conducted. Thankfully for us, however, the majority of consumers prefer to engage the services of a qualified expert. Therefore, to suggest that the views of Choice mirror those of the typical consumer, and to then use their opinion to suggest all consumers agree with the idea of eliminating commission, is perhaps not an accurate reflection of reality.
In the same article, the Mackays suggest “it is in the consumers’ interests to have fewer professional advisers who they trust…”. It is difficult to fathom how having fewer advisers better serves the interests of consumers, given that we already have a well-documented problem with underinsurance – something they acknowledge in their article. In fact, they suggest that underinsurance has “arisen entirely under the existing commissionsbased system”, as if commission is the reason for the underinsurance. The reality is that underinsurance has always been a problem; but one that would, in all likelihood, be worse if not for the incentive that commissions provide to recommend insurance. The Mackays state that “currently, the cost of commissions is hidden, wrapped up in the premiums paid”. Unless an adviser is failing to comply with their disclosure obligations, clients are clearly told how much commission is being paid, both in dollar and percentage terms; there is nothing “hidden” about that.
They also suggest that eliminating commissions would help solve the underinsurance problem because it would result in “premiums immediately falling by between 45 and 51 per cent”. Call me a cynic, but I wouldn’t be holding my breath waiting for a halving of premiums in the wake of the removal of commission. Without an incentive to do so, why would insurers immediately pass on the entire savings on commission in the form of premium reductions? Currently, commissions are a legitimate marketing expense. If, or when, they are removed, it is almost certain that the insurers will look to alternative methods of marketing and promoting their products to retain market share. Hence, the likelihood of seeing any substantial reduction in premiums is remote.
Furthermore, it is hard to see how a reduction in premiums would resolve the underinsurance problem, given that evidence suggests that the primary reason for underinsurance being such a problem is lack of initiative to address the issue rather than reluctance to meet the premiums being asked. If the above assumptions are correct, it is likely that insurance premiums would, in fact, not reduce greatly in the “no commission” universe. So, if we already have a chronic underinsurance problem, how much worse will it become if consumers are asked to pay advice fees in addition to the premiums? Claire and Tim Mackay state that, “Rather than competing on premium price (sic), insurers compete on the level of upfront commission”. If this statement had any validity whatsoever, the insurance company paying the highest commission would be the recipient of the bulk of the new insurance business written; the reality is that there would appear to be little, if any, correlation between commission levels and premium inflows.
To suggest there is an inordinate focus on commission to the exclusion of other factors completely discredits the thousands of risk advisers who ethically and professionally analyse client needs and match them to available product – the majority basing their decisions on the outcomes determined by independent comparison software. Commission may be one factor in the decision for some advisers, but for a great many advisers, it doesn’t even enter into consideration. Furthermore, a comparison of commission levels suggests that, in the long run, there is very little difference between the commission rates offered by different companies. Another factor that puts the relevance of commission in perspective is that most insurers receive a significant amount of their new business written under either “level” or “hybrid” commission terms.
If commission were the inordinate focus that the Mackays suggest, there would be very little business written in any form other than upfront commission. If commission is such an incentive to write risk business, why do we have such a paucity of planners recommending risk? Financial advisers are on the horns of the proverbial dilemma in their endeavours to be recognised as a true profession. Unlike other “professions”, an integral element of financial advice is the recommendation of financial “products”. Some have suggested that there should be a distinction in law between an “adviser” and a “salesperson”. However, such moves would be both divisive in principle and difficult in application.
The introduction of “fiduciary responsibility” should, in theory, at least, eliminate such considerations and obviate the need for the consumer to seek financial advice from one source and be forced to go elsewhere to implement the advice. As stated at the outset, the disappearance of commission from the financial planning landscape, including risk, is inevitable. In time, the public can be educated as to their insurance needs to a sufficient extent as to increase their preparedness to address these issues. Perhaps this increased awareness can be provided, in part at least, by increased advertising by insurers (funded by the removal of commission, perhaps).
However, until such time as the industry has developed the resources to market risk products under a different remuneration model and the public has become accustomed to paying for financial advice – risk insurance included – let’s not rush into an environment that has the potential to exacerbate the underinsurance problem, create an exodus of ethical senior risk advisers from the industry and undermine the value of risk-based advice businesses. After all, no claimant ever complained that their adviser had sold them too much insurance!
