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Commissions - upfront and pendulum

The discussion on high trails and lower upfronts, while this is quite aspirational, frankly it is somewhat of a misnomer.

Wednesday, June 5th 2019, 6:29AM 9 Comments

The average policy on the books in New Zealand is a little under seven years. Which means that going a pendulum commission model generally means you have a hard row to hoe as you establish this revenue model, about ten years, and there is a good chance a significant portion of that doesn't make it to the upfront break-even point.

Mostly from experience, this is higher value clients and the business client having changes and reducing or removing significant parts of their cover as their wealth accumulates and they reduce their insurance needs. Not to mention the 50 plus age group who find premium increases hefty and reduce and drop protection.

When I was a BDM with Sovereign, we talked pendulum to help flatten the curve and help advisers build better cash flow because it made a lot of sense then.

Year 1 upfront commissions were about 170% for the established producing adviser, but the trail was 2.5% for level benefits and 4% for indexed covers. This is circa 2006.

When Sovereign pushed their 7.5% trail model through not long before I left, this changed the pendulum landscape considerably.

On the same upfront commission model, it now made pendulum as an option have a break even point of year 8 when compared to upfront, longer than the average policy lasted... And on top of that, you still had the establishment pain to get through.

The harsh reality, starting at $0 book value, running at $100,000 new business API with a 170% commission rate and a 92% persistency, you're only looking at a $43,000 per annum difference in income, less than 10% in the 10th year.

If you look at total income over that time, pendulum commission has a net $200,000 lower revenue level in that first ten years. A considerable amount of income to give up when we look at the running costs of our businesses. After that, yes, it is better, however, only if your average policy is greater than eight years, contrary to the industry averages.

If fast forward to today and look at the landscape today, it is quite different again.

Now I'm using a persistency calculation that excludes new business. Because it is the inforce book that determines your trail and renewals, not the inforce plus new business. So this is more the Sovereign persistency calculation than the others... The others are about measuring your value in terms of API revenue to the insurer, and measures little real understanding of inforce book, outside taking total API and removing New Business premium in the last 12 months, which they don't do.

Now if I am to work through the same model as above, but use the Partners Life comms model, 180% comms, $100k of new API, a book persistency of 92% and pendulum at 25% rather than 20% in the previous model, we get to a different place.

Break even year is year 7, the ten-year income earning rate is much the same at $43,000 more for pendulum than upfront. However, the difference in earnings for the business across this time is now $300,000 less on pendulum than taking the upfronts.

I don't know about you, but most businesses work on a three-year revenue projection, not a ten year one, banks and lenders look at the previous 2 -3 years and don't care about the future.

So building a business on future earnings projections ten years out is somewhat of a challenge and even then, there is so much that can get in the way.

If you are an adviser in your 50's, then it's going to be your 60's before you reap the benefits of taking on the pendulum model.

Which is going to coincide with the bulk of your client base hitting their retirement years and dropping their covers. It's more likely that you won't achieve the projections because of the localised age of adviser clients to the advisers' age. +/- 10 years of the adviser age.

So what do you do?

The Partners Life option of pendulum 75 is a middle ground approach that class the total revenue gap to $200,000 over ten years and is more in line with what I talked about above for the 7.5% trail model with Sovereign.

Another approach is to look at how you structure your upfront commissions. If you were to look at discounted premiums, you're going to maintain the affordability for clients for a longer period of time, including increased loyalty discounts with those providers that have them.

If you presently have an 89-90% persistency rate, this could lift it to a 93-94%, or better, persistency rate. This alone will add $40k per annum to your trail earnings over the same ten-year timeframe.

However, you do trade off higher annual upfront earnings for that bump in more longer-term passive earnings, which over ten years could be $700,000. However, the upfront earnings are assuming that you have a genuine 89% persistency of the book, not a propped up calculation based on new business which in reality could be significantly lower than the real persistency.

What's the right answer?

I don't know, but it's not fees and no commission. That doesn't do clients any favours at all.

Tags: Commission Jon-Paul Hale

« Advisers put in hours of unpaid workKiwiSaver and risk, how far out of bounds are we? »

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Comments from our readers

On 4 June 2019 at 10:27 am BayBroker said:
The upfront vs pendulum commission conundrum is a good conversation. One which we are having in our business at the moment. I've always been a fan of pendulum however you do make good points in your article.

My question is will the decision be taken out of our hands by regulators with little to no understanding of the industry?
On 4 June 2019 at 12:07 pm Murray Weatherston said:
Methodological questions JP.
Do you take the tiem value of money into account.
(a) If yes, what discount rate do you uses and why do you choose that rate; or
(b) If No, why not?
On 4 June 2019 at 1:05 pm Backstage said:
Murray, it does not appear to be factored in but depending on whatever rate you use you will mostly find that a dollar today is worth more than a dollar tomorrow. Also, consider the future and remove vesting... you now will be putting more at risk!
On 4 June 2019 at 2:01 pm JPHale said:
@Murray, 1. No, it makes both the discussion more complicated and makes the situation look even worse than I've outlined. I'm not discussing what you do with it from an investment perspective, once it is out of the business, just the impact on the top line revenue. 2. Essentially straight lined it as variations in both persistency and inflation rates will have impacts that make the TV equations somewhat more misleading.

Having observed this from a real-world perspective the reality comes back to the individual situation in the majority of situations.

If you have great persistency and want to organically grow your book and not work quite so hard in the future, it's a reasonable approach, understanding the discounted revenue it will create.
On 4 June 2019 at 2:07 pm JPHale said:
@BayBroker I've been a fan for a long time, it reduces the volatility of the revenue for the business, however, with the insurers move to increase renewal commissions it has muted the need to decide to push into pendulum further, as renewal books now grow at a faster rate on upfronts than they ever did in the 90's and 00's.

As one adviser said with the change at the time Sovereign made their change, "I used to have to sell 3 policies to have my renewal stream grow that much, the newbies have it easy by comparison" and the comment from another, paraphrased, I've been here forever why can a newbie get it now when I had to work so much harder for it?, suggesting that newbies either have their wings clipped or the historical book should be increased retrospectively...

No matter what the ultimate outcome is and who is discussing it, commission rates are always going to be a contentious subject.
On 4 June 2019 at 3:46 pm all hat, no cattle said:
Take $100k annual production, over ten years, total income? End up $200k worse off under pendulum?
Silly methodology, because of course the pendulum business written in years 6 through 10 had (so far) paid less.
Compare the 2 types for a single policy from year 1, and see how valuable each was after 5, 7, 10 years, even on level premiums.
On 5 June 2019 at 7:17 am JPHale said:
@all hat, no cattle. I have no trouble with your point that the policy written year one will have earned far more over 10 years.

Yes, I have presented an oversimplified model, the real world reality is as the renewal book grows the adviser does less new business. However, you have missed a couple of points in what I have been attempting to explain.

I have been talking about total revenue to the business, I'm not looking at a single policy over 10 years. It is the total revenue to the business that pays the bills. And in the first 5-10 years of taking this approach, there is a substantial hit on overall business revenues when compared to the full upfront model.

The average age of a policy is about 7 years, so a break even on this when it is 8-8.5 years makes the decision to go pendulum significantly riskier that policies won't stick long term.

And no I don't think this is a silly methodology as income all the way through has been muted with the lower upfront, not just years 6-10.

There is no argument, a policy that lasts longer than 8 years is more valuable on pendulum. It is the business impact getting there that is my point.

Lastly, with many advisers coming into insurance as a second, or third career, they are older, in their 50's and 60's. Which means they don't have the time to wait for a book to mature on pendulum and the potential risk of exiting earlier than planned is much higher. As many advisers are living with health conditions that brought them to insurance advice in the first place.

And the reality is the resale of a book in the first 5-10 years is not going to make up the lost revenues the business has sustained against full upfront commissions.

From a business perspective, talking to any decent CA, their advice would be the money upfront is the better option, no clawback after 2 years, you get the majority of it up front, and the deferred long term risk is a daft approach. Yes, it is more valuable long term, however, there's more risk of it not happening than happening, so take the money and run.

On 24 June 2019 at 11:35 am Paul J Burns said:
Thanks J.P. While I agree that your caveats are valid, as I'm increasingly investing into the "long game / relationship building" model, I'm finding the pendulum 25 has worked well for my business. That my persistency is fine - certainly helps too. Contrary to prevailing experience I'm finding that as 55 y.o plus (esp wealthier) clients resonate well with my estate planning message, they are happy to take out extra insurance. However, best ROI bang for buck (under pendulum 25 model) tends to be for business on clients under age 55.
On 25 June 2019 at 6:08 pm Paul J Burns said:
BTW folks, just as there's a diverse range of investment vehicles and pathways (for investors), so too there ought to be a fair range of remuneration options - be they fee only, commission (upfront, pendulum etc) only or whatever hybrid that an adviser can best leverage off. I celebrate the wide range of remuneration options because it pays due respect to the fact that it is the adviser who ought to be able to access the rem' model that delivers the best outcome to them and their clients. I can also see clearly (& gladly too) - the day when more and more advisers will prefer to be remunerated according to the value they offer to the client and therefore be less reliant on what the insurer's pay them. I sense a change of tide, where the clients' all important trust and loyalty is becoming increasingly tied to a broker/adviser being more transparent (if at the risk of being less product focussed). Hence if your business revenue (and valuation) rides on the back of providing demonstrable transparent value proposition to clients, "you're pretty much through to the semis without dropping a set".

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