This is the text of an opinion piece by the Assistant Treasurer, Josh Frydenberg, first published in the Australian Financial Review and released publicly by the Assistant Treasurer on April 8, 2015.

Life insurance is a large and vital segment of Australia’s financial services sector.

There are 28 life insurance companies writing more than $44 billion worth of business, and more than 13,500 life insurance advisers employed in Australia.

The policies they sell ­ be it through a superannuation fund, direct from an insurer or via a financial adviser ­ provide essential financial security in the event of death, serious illness or injury.

However, it has become clear through a series of reviews that reform in the sector is needed.

Some of the reviews have been initiated by the government, namely those undertaken by the Australian Securities and Investments Commission and the financial system inquiry, while others have been commissioned by the industry itself, namely the recently released independent report by John Trowbridge, a former member of the Australian Prudential Regulation Authority.

The most significant concern revealed by the reviews is that the upfront commission model has driven a misalignment of interests between insurers, the adviser and the client.

Incentivised to encourage clients to regularly change policies, advisers in the current system are said to be creating significant churn in the market, which ultimately leads to higher fees.

This in turn exacerbates the growing problem of underinsurance.

Interestingly, when the previous government announced a ban on conflicted remuneration through the Future of Financial Advice (FOFA) reforms in 2010, they largely excluded life insurance products, particularly those sold through personal advice. The reason given at the time was the inability to fund personal advice on life insurance out of investment and super assets led to concerns led to concerns about affordability and the potential for under-insurance.

Since then, however, the subject of upfront commissions and other related issues in life insurance have been looked at in detail by the Trowbridge Report.

While its recommendations are controversial in the industry, they are worth considering.

Appropriate reform, hopefully led by the industry, is needed to restore confidence following poor levels of compliance highlighted by ASIC.

However, reform can deliver a win-win for advisers as well as consumers by strengthening the sustainability of the life insurance industry.

Trowbridge makes six recommendations:

First, he suggests replacing the upfront commission with level commissions at a maximum of 20 per cent of the premium.

This would be combined with an initial advanced payment of $1200, or 60 per cent of the premium if it is less than $2000.

The payment would help cover the initial costs incurred by the adviser in preparing the policy and would be applied on a per client basis, not per policy basis, and could not be paid more than once every five years for each client.

Given that standard upfront commissions today are about 120 per cent of the first year’s premium, and 10 per cent of subsequent premiums, this recommendation is a significant step forward in reducing the incentive for churn.

Trowbridge argues that it would also have the effect of putting downward pressure on life insurance premiums of up to 10 per cent.

While David Murray’s financial system inquiry, which also looked at this issue, did not recommend an upfront fee, it did recommend a level commission, suggesting the level should be left to the market and industry to settle.

Second, Trowbridge recommends a three-year transition period, which would impose the five-year rule immediately, and level commissions reforms, implemented on a staged timetable.

Third, it is proposed that licensees be prohibited from receiving non-commission benefits from insurers that might have an impact on the products they recommend to their clients.

These inducements, which could specifically include overseas travel or marketing assistance, have already been banned under the FOFA legislation for advisers selling investment products, so it is proposed that the prohibition be extended to life insurance.

Fourth, extend the number of life insurers on any individual licensees Approved Product List to at least half of the providers servicing the market.

Trowbridge points out that there are 13 providers in the retail life insurance market but some licensees might include the names of only one insurer on the list to their advisers.

This has the effect of eliminating any choice the adviser might have in acting in the best interests of the client.

Fifth, strengthen the standards of client engagement and education.

Creating more succinct and user-friendly statements of advice and improving the quality of client interactions can have a significant and positive impact on customer outcomes.

This recommendation also sits neatly with those that flowed from the PJC report into the professional educational and ethical standards in the financial services sector, which the government released a consultation paper on recently.

Finally, Trowbridge recommends that the industry develop a Life Insurance Code of Practice to better inform and govern adviser-customer interactions.

Similar ethical codes reflecting best practice have been adopted successfully in other industries, from law to accounting.

Wide-ranging and well informed, Trowbridge’s report does not shy away from confronting the difficult issues facing the life insurance industry.

The report is likely to represent the last chance for the industry to address these longstanding issues on its own terms. 

While Murray’s financial systems inquiry and the Trowbridge report provide the government with a number of options for reform, the extent to which government intervention is required will depend ultimately on the industry’s own actions.

It is up to the industry now to restore public confidence before time for industry leadership runs out.

– Josh Frydenberg is the federal Assistant Treasurer

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