Why the churn debate has to change

I have watched with bemusement the recent debate around Risk insurance commissions brought into greater prominence in recent weeks by the FSC’s controversial proposal with respect to mandating responsibility periods. Advisers, many with heads firmly stuck deep in the sand argued for the status quo while the FSC initially advocating a cartel approach with its members volunteering to collectively construct commercial terms to their benefit.

The FSC proposal is not how business in a free market economy like Australia should be conducted. Cartel behaviour doesn’t work for clients in many other industries most notably petrol pricing and groceries. It certainly wouldn’t work for Insurance policy holders.

Market forces should drive changes to pricing models and commission structures and not regulation or by legalising cartel behaviour. There is no question things must change but they will without vested interest groups engaging in anticompetitive behaviours.

The Insurance model was built on average policy durations being seven or eight years. Any reduction in this will force change to remuneration models whether advisers like it or not.

I was staggered by an article I read recently saying the product manufacturers were to blame for constantly tinkering with their policies to improve them. This is not behaviour to be discouraged! This is competition in a competitive market working well and for the benefit of consumers.

Rapid and regular policy innovation is providing justifiable basis for healthy clients’ policies to be rewritten with other insurers. This is often not “churning”. It is often good advice and we should encourage advisers to keep clients in the best available products.

However, it is also not reasonable to expect insurers to pay 110% commission, admin costs, and underwriting costs and keep losing the healthy clients after only two years. It is not just unreasonable it is clearly commercially unviable.

If the industry is, as the FSC argues, unsustainable then this is because the product providers are not pricing their product properly or because they are not managing their costs. Ultimately these Insurers will be forced to either increase their prices or more likely do this in combination with changing their cost structures.

The cost that is most obviously under threat is the upfront commission which is not viable when the average policy is not being held for long enough to amortise it. If the upfront commission has to be reduced to maintain viability then this will occur without the need for Cartel formation.

If insurance books are not profitable, capital adequacy levels and reserves will fall and actuarial departments will be forced to make adjustments to pricing or put pressure on their product designers to adjust the payment of commissions. Like any healthy competitive market margins may be slightly skinnier than some would like but there is little risk of an unsustainable industry.

Current capital adequacy rules will force the insurers to adjust their pricing and commission payment structures before we have unsustainability. Those that don’t adjust will become unviable and forced to sell books to those that have been more commercially realistic.

There is nothing currently stopping insurers individually reducing the payment of upfront commissions and encouraging level commission or introducing different commission terms other than their fear of being less competitive. There are still too many insurers that are viable at current commission levels and mixes and current pricing. If this changes over time as older tranches of policies fall off the books then commission rates will start to fall.

It’s no secret to those of us in the industry that financial service businesses are drowning in red tape and overregulation. Even the best most compliant and client focussed advisers now joke about the few hours a week they have left to actually advise after we complete the ever growing compliance tasks. We don’t need any more regulation or rules imposed.

There are likely quite a number of poor advisers still around who do “churn” for little client benefit. The commission structure encourages this behaviour. Commission is conflicted but so far the consensus view prevails that the positives of insurance commission as a mechanism to encourage sales out weigh the negatives.

Insurance sales are a round peg in a square hole when it comes to them being caught up under the onerous FOFA and FSRA legislation. However FOFA in particular provides in no uncertain terms the requirement that all advice needs to be in the client best interest. This will if enforced be sufficient to deal with “churners”. If caught genuine churners will going forward be removed from the industry.

As for those who are simply improving their client’s lot well they are doing their job and market forces will over time act and ensure sustainability of the industry. Inevitably this will result in lower upfront commissions to advisers and a change in commission structuring.

The FSC members are certainly not innocent victims of this changing environment. It is well documented that many have been paying large sign on payments to financial advice businesses including risk practices on the understanding that upon coming on board the advisers will rewrite their whole insurance books (along with other products) wherever they think they can get away with it.

This practice has undoubtedly increased the policy redemption rates in the industry. When the FSC members agree to eschew such morally questionable practices they may have a platform to request consideration of exemptions to competition policy by the ACCC however in many cases the hypocrisy here is hard to miss.
Lower upfront commissions would lead to a change in business models. The high cost of providing insurance advice is exacerbated by it being caught up in a licensing regime that was largely designed to regulate investment advice.

If Governments want to assist the industry’s sustainability they should start by by reducing the red tape on insurance advice through appropriate carve outs from FSRA and FOFA. Insurance sales managed for over a century without SOAs or even CARS for those who remember without too many serious issues. With todays far more qualified, ethically trained and legally bound advisers we should be questioning whether the current compliance requirements with respect to insurance do more harm than good.

This is the debate that should be had. Reduction in compliance would reduce the cost of providing advice and in turn will allow advisers to accept lower remuneration and remain viable.

The reduction of upfront commissions would happen faster if it will become more palatable to insurance companies who won’t be afraid their distribution channels will dry up due to lack of viability.

In time lower costs will also mean fees will be more easily substituted for commissions and perhaps more business models will adapt to ultimately remove conflicts altogether.

Wouldn’t that be a great outcome for both clients and all participants in the industry?

About Jason Bragger

Jason Bragger CFP is principal of Brisbane-based financial advice firm Dolfinwise and a member of the Financial Planning Association’s policy and regulations committee.

He has a background in applied mathematics and gained several years actuarial experience at National Mutual/AXA, as well as completing studies in macroeconomics at Monash University, before commencing his advisory practice in January 2000.

He also serves as Vice President of Riverside junior rugby club in Brisbane and plays cricket with the ‘mighty Muddies.’