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Industry must face up to trend for commission regulation

Massey University's Michael Naylor discusses the FMA's report on insurance replacement business.

Friday, July 15th 2016, 11:51AM 8 Comments

The recent FMA “Replacing Life Insurance” report has to be viewed in the context of the overall discussion within NZ over commission and regulation. This includes the MJW and NZIER reports.

Within this context it’s interesting that the FMA choose to devote its scarce resources to investigating the policy replacement behaviour of AFA/AFA’s, indicating that either, (i) they regard the poor behaviour of small number of RFA/AFA’s as a substantial problem, or (ii) the report is part of a larger public policy strategy. From my viewpoint both of these possibilities are a worry.

The FMA report is a reasonable attempt at getting to grips with the issue of policy churn. The FMA have the advantage over other researchers of being able to “request” data from insurers. It is useful to us all that the FMA use this ability to conduct a range of reports. The report does show that a small number of insurance advisers, about 200, will have to answer some serious questions from the FMA assessors.

While the data appendix “Factors influencing insurance policy survival” does show some evidence of a link between commission structure and policy renewal, the reports do not show is any proof that policy churn is a substantive issue.

As an academic I liked the data appendix, as this helped to show that there was more to the relationships than just correlation. I do, however, have some concerns about the report.

The report ignores QFE advisers on the basis that they only sell policies from their employer, so have no incentive to churn polices from one supplier to another. Whilst this is true, it ignores the fact that QFE advisers can induce clients to cancel existing polices favour of their own. They also often use inferior reasons, like “you can see all the info on one webpage”.

The report shows that 79% of advisers only deal with one or two suppliers for at least 90% of their policies. Yet the report fails to point out that this is a problem as it indicates that these advisers aren’t considering a wide range of polices. A quality adviser doesn’t say “this is the policy my supplier has”, instead a quality adviser says, “of all the possible policies, this is the best one for you”.

Instead, bizarrely, the report implies that advisers who deal with multiple suppliers are at fault.

The report notes that a third of advisers only sold life, and did not sell other types like income protection or TPD. Despite this being a strong indicator of a poor quality adviser, and a larger issue than churn, the report fails to point to it or explore it.

The report finds little impact from volume bonuses. The result is, however, based on the average replacement per policy. The volume effect would be stronger if the FMA could have identified the adviser reaction at a marginal level. E.g.; if an adviser needs to sell 20 policies to get a bonus then selling the first 15 may show no effect. However for an adviser sitting on 18 sales close to end-of–period then the incentive to churn two more would be strong.

The report mentions with a degree of approval, the disastrous MJW and the inadequate NZIER reports. The issue here is that to mention the MJW report without acknowledging that it was an embarrassment to the consulting industry, unfortunately indicates a lack of understanding of arguments. Even if the FMA have not read reviews of the MJW report, they should have analytical skills to immediately see its deficits upon reading it. The MJW report’s stinking corpse should be left in its grave.

The FMA then quote the NZIER report as giving support to the idea that reductions in commissions could reduce premiums and increase the amount of insurance sold. The fact that my review showed that this is probably not true is ignored. Given that any decent economist reading the NZIER report should spot the flaws is an indication that the FMA did not read the NZIER report carefully enough.

The report mentions that there are only about 1100 active insurance advisers, those with more than 100 active policies. This is incredibly low for a country of NZ’s size, and the lack of access to adequate insurance advice should have been highlighted as an area of concern. The report fails to do this.

The report sometimes confuses correlation with causation. E.g.; the data only allow the authors to say that some high replacement advisers had a high number of overseas trips, these two go together. The data do not allow the authors to say that the availability of trips caused advisers to replace policies. In general the report is cautiously written but not always.
The report does highlight the data issue in NZ. Incredible as it may seem, some providers were unable to separate premiums into policy types, e.g.; life vs income vs TPD. Are NZ insurers actually this badly run? This is an issue which the FMA & RBNZ need to investigate.

The report says that there is the “possibility that NZers are paying too much for insurance .... on commissions due to churn’. This may be true, though what is not recognised that in any sensible commission reform the total amount paid for commission would not fall; instead there would be a shift from upfront commission to trail commission. If total commission falls then the number of advisers would fall and under-insurance would get worse. The best way to regulate this alternation in commission avenues is the key issue in this area, and an area which I have discussed and modelled before. This needs to be a subject of future FMA reports.

The report fails to state that commissions are simply a cost of sale. If advisers do not sell, then cost will be incurred through advertising, etc. There is no evidence that removing advisers reduces provider cost, it simply changes the cost avenue.

The larger issues, however, are in what is not said. I recognise that this is just the first report, and I assume other areas will be covered subsequently, so this is not a criticism.
The biggest issue is the general level of under-insurance in NZ, and in particular the inadequate take-up of income insurance. A secondary issue is the lack of quality insurance advisers and subsequent lack of quality advice for NZers.

A related issue is low quality of required training for RFAs and even AFAs. Why critique advisers for offering poor advice when they have never been trained properly?

A related issue is the need for a pathway to strengthen professionalism in the industry.

The development of a professional culture and ethos should be recognised as the primary aim of regulation. Hopefully future FMA reports will outline the FMA’s vison for how to achieve this. A useful start would be pan-industry discussion on how to increase industry education and professional ethics. The essence of successful regulation of financial intermediaries is the active encouragement of a “professional” culture. Without this professional culture advisers will endeavour to evade the letter of regulation. Regulators will spend their time chasing and prosecuting advisers, after damage has been done to consumers. Proactive encouragement of a professional culture will minimize activities which cause damage in the first instance.

As a profession develops the level of regulation should decrease, and move towards primary regulation being handled by professional bodies, rather than government bodies, like the medical profession is. The problem is that the majority of the financial adviser industry in NZ has reacted to regulation and a FMA visit as a box-checking exercise, similar to a builder viewing a building inspection, rather than an invitation to change the way they view their vocation. It needs to be recognised that “competence” is not just a matter of obtaining a one-off qualification. It is about having up to date skills and practising a professional approach.

The best way to encourage a professional culture is creation of collegial atmosphere which encourages members to promote professional ethics based attitudes and discourages non-ethical attitudes. An effective way of doing this is to encourage and support the development of those professional bodies which develop a strong culture of encouraging mutual support of ethical behaviour and condemnation of unethical behaviour.

The FMA should also engage in discussion on what is the best way to regulate commissions and other types of remuneration. The ideal solution would be a restriction of upfront commission and an increase in trails. This is the deal in Australia and handles the tendency to churn and sell, while encouraging advisers to service clients. It needs to be noted that due to a larger customer base size and superannuation arrangements adviser costs are less in Australia, so commission levels need to be set higher in NZ.

Soft-dollar and volume bonuses could be banned, though there is potential for retaining soft-dollar arrangements around training and education, subject to suitable guidelines. Common guidelines on areas like replacement business can be developed with common documentation.

The industry as a whole needs to recognise that there is a wide drift towards commission regulation. The IFA/PAA need to sit down with product providers and create a pan-industry consensus on what is an ideal  remuneration regulation scheme and present this to government and bureaucrats. While Minister Goldsmith is very pro-free market and probably uninterested in commission regulation, the next minister won’t be. The industry does need to actively and publically defend commission as an ethical method of remuneration, before it is removed in future hasty reforms.

Tags: FMA

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Comments from our readers

On 15 July 2016 at 3:02 pm dcwhyte said:
Disagree with the lats remark re "drift toward commission regulation". The Brits are retreating from the disastrous recommendations in the RDR; Trowbridge and FSC Australia appear to have some hidden agenda to promote direct insurance sales; NZ rejects the notion; the Oxera Report "Regulating remuneration systems; effective distribution of financial products ( doesn't support the conclusion that such a "wide drift" exists.

But the suggestion of an industry-wide discussion on the issue is welcome.
On 18 July 2016 at 10:14 am Dirty Harry said:
May 18 , Article "Reserve Bank calls for lower commissions"

On 20 May 2016 at 10:40 am Dirty Harry said:
I'm with the Laird here, but will go further. Be careful about simply reacting to this news in isolation.

Look at the pattern.

That the RB would even jump in here is not just disappointing, but it signals to me that there is a quiet campaign going on here. It began with the giving of airtime to the trowbridge report. Then FSC/MJW. Then we have NZIER, and now the RB. All singing the same bollocks from a badly written tune on poorly photocopied song sheets. But who wrote the tune, and distributed the copies?

I would not be surprised to hear that a small group of individuals have tenuous links to all the aforementioned. Who really stands to gain from this?

It's obvious someone wants commissions cut. And they are being quite clever and influential about it. MJW, Trowbridge et al have published many words, but the real reasons for seeking this are yet to be published.

David disagreed with that, too.
I'm not always Dr Mike's biggest fan, but do enjoy debating with him, and appreciate him and his colleague's contributions. In this case, he raises several valid points.

Quote of the month: "The issue here is that to mention the MJW report without acknowledging that it was an embarrassment to the consulting industry, unfortunately indicates a lack of understanding of arguments. ... The MJW report’s stinking corpse should be left in its grave.
On 18 July 2016 at 8:10 pm Steven Popodopolus said:
Mike Naylor has always puzzled me a bit, but this is bang on.

He shows a true understanding of the difference between causation and correlation, finally, after the embarrassingly amateur MJW and FMA to a degree.

An example, the main crux is that if commissions are cut premiums would drop. However there are at least 2 banks that are also manufacturers where the price is exactly the same. Thus in the only real life examples that are verifiable, no commission paid, price the same. Therefore, a reduction in commission in no way gurantees price drop.

Maybe a look at Inusrance companies closing off books and ramping up the premium might show more cause of replacement business, but who knows, no one ever looks at those policies apart from independent advisors.
On 19 July 2016 at 6:10 pm dcwhyte said:
Harry - have a look at this from Oz - - dirty deeds done dirt cheap!
Steven - the new commission rates have been adopted by at least on life company in Oz - I'm not aware of any retail premium reductions.
On 20 July 2016 at 8:55 am Backstage said:
I wholeheartedly agreed with David's comments and especially on statistical relationships and that was my first observation in the FMA report. Aside from the missing pieces... I am constantly surprised that these reports are given as much weight as they get given in my mind they are either not complete or done right. This does not take away from some of the hypothesis... but in my mind hasn't really lifted it past hypothesis... We all know that "clearly defining the problem" is the best way toward a solution. My experience in corporate is that so many managers attacked symptoms considering they were taking care of the problem.... many managers do not understand or know how to analyse sets of data statistically to be sure that there is a relationship..... i could probably sell them on the fact that everyone that drinks water dies :). Someone should ensure before reports are published that they are robust and or have enormous amounts of disclosure that explain how they came up with their hallucinations. Just as Mike i am unsure as to why you keep focusing on commission. Also as a start i think insurers should remove vesting of renewals as an interim... phase this out, we never used to have this and this will cause advisers to possibly better preserve their clients and remove some need for churn if a client moves.
On 7 August 2016 at 3:15 pm Aurora said:
"The report ignores QFE advisers on the basis that they only sell policies from their employer, so have no incentive to churn polices from one supplier to another. Whilst this is true"


This is absolutely not the case, I was in a QFE before becoming an AFA and could sell 7 different providers products (although I generally only use 2-3). The issue here is the QFE's look down on using other providers and have % quota's you're asked to work to. Alternatively they welcome/reward business brought to them from other providers so the incentive is absolutely there.

I left the QFE because they wouldn't let me be an AFA and remain a member. How backwards is that!

I think if someone could put a $ number of all costs since we began this whole restructure of the industry most would agree to date it has been a monumental waste of time to the consumer and a ton of big salaries to people and high turnover in the governing bodies.
On 8 August 2016 at 9:40 am dcwhyte said:
To Backstage and Aurora - I believe there is an element of 'Groupthink' present in certain quarters regarding commission and that this has been promoted by Trowbridge, the MJW Report as if this is the accepted orthodoxy. In fact, the reverse is the case as the Minister concluded in his report to Cabinet. What is, and should be accepted, is that behaviour and conduct need to be more closely examined and clear parameters established and agreed among all stakeholders to protect the interests of consumers. By doing so, attitudes toward the industry will improve and the focus on remuneration will be placed in perspective along with the other costs associated in the transaction.
My personal view on overseas trips is well known and I suspect that all CEOs would dearly like to abandon them in favour of more cost-effective measures. But as has been pointed out elsewhere the commission structure in NZ has been responsible for achieving the level of penetration delivered thus far. Removal would only serve to exacerbate the under-insurance problem and push the unfortunate members of the community who suffer illness, injury, or death to become dependent on state benefits for their or their dependents continued well-being - as has happened in Europe.
On 21 February 2017 at 12:42 pm Simon Hassan said:
... and as an example of clear and concise communication from a regulator, see

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