The physical reality of the risk reforms
Newton’s third law of motion states that for every action, there is an equal and opposite reaction, so what will be the reaction to the Life Insurance Framework?
The current proposals are encapsulated by two main points. First is the reduction to the upfront payment product providers pay to advisers and the second is the imposition of a much longer responsibility. The result of these two points alone will result in less insurance being written on a commission basis.
Mathematically, we are looking at a regulated reduction in the quantum of upfront commission of potentially 50 per cent (based on current level of upfront commission). The reduction is even 25 per cent if based on the current upfront payment associated with the typical hybrid commission model. However, given the increase in responsibility periods to three years, these ‘real’ income figures are actually lower.
For existing risk advice businesses to remain operating in the same way post the introduction of the reforms, the expense side of their ledger will need to decrease by the same size. Given that FOFA requirements are the law which financial advice is regulated under and there are no proposed changes here, there will be no regulatory relief to what is currently required. Advice businesses will not be granted similar reductions in the level of staff wages, rent and other expenses as they are determined by the market.
Given the aforementioned points, the only logical conclusion is that those who want to stay in business need to adjust their insurance advice business model. This article does not deal with whether the market can absorb such changes, but is simply looking at the financial viability of these insurance advice businesses as a result of the proposed reforms.
Obviously, the proposed framework is telling financial advisers that they need to change how they receive remuneration for life insurance advice. By making such drastic changes it is making the viability of commission-only businesses far lower than [that represented by] the hurdle today. It also has to be remembered that current businesses have legacy business. However, new entrants will be exposed to the reforms immediately, placing them under a greater financial strain in ‘start-up’ phase and, in turn, making them less prevalent should they stick to a commission-only model.
I see these proposed reforms impacting insurance advice businesses in two ways over the long term.
Insurance advice will need to become predominantly or at least significantly in part a fee-for-service offering. Advisers will need to be able to demonstrate their value and be able to charge a direct fee to the client for that service. It is proposed that the insurance companies will provide a funding mechanism for such fee arrangements so this fee is built into the premium structure for the client. In my opinion, this is the main benefit of commissions as it enables people who otherwise would not be able to pay for advice the opportunity to receive it. Arguably, if the changes are structured correctly this will not change.
The second major way this will impact insurance advice is that it will see the end of the risk-only specialist. Advisers will have to offer a more holistic service so as to be able to command a sizeable enough fee from the client to justify the expenses which include the regulatory requirements.
This will ultimately lend itself to larger advice firms being able to use their scale to absorb the reduction in insurance commission revenues. Naturally, the institutions that have not just operating scale but larger balance sheets will be able to employ a sales distribution force. The fact they can then be compensated by the revenue made in other areas including the provision of the very same life insurance products puts them at a distinct advantage. I think this scenario is very similar to when the banks collectively went to war on mortgage brokers by uniformly reducing commission rates in an attempt to reduce their influence on consumers. With fewer mortgage brokers in business it made it more likely that consumers would end up getting any “advice” from the institutions themselves.
The important question is: can the life insurance advice industry as a whole make the necessary adjustment?
If the industry cannot make the adjustment, then Newton’s third law tells us there will be consequences. These consequences will include a range of outcomes that are contrary to the Financial Services Inquiry and other expert findings as being crucial to the improvement of financial advice. These include:
• Concentration of insurance advice within vertically integrated business models;
• The hopes of attracting better educated and qualified advisers will be erased as industry participants’ future earning capacity falls off a cliff; and
• As revenue falls, the only release valve is cutting expenses. If this results in short cuts in the advice process including the quality of SOA production, then the quality of advice will get worse not better, offsetting economic gains – if there are any – for the consumer.
Rob Coyte is chief executive of Shartru Wealth
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