On Thursday, the FSC and the AFA released the Trowbridge report. John Trowbridge was appointed as chair of a Life Insurance and Advice working group to review the misaligned incentives identified in ASIC’s damning report from last year. The group was asked to make recommendations on how the industry can respond to the issues identified to ensure that Australians are adequately insured and receive world-class financial advice.
In the executive summary of his recommendations John Trowbridge said:
The package as recommended may be the last chance for the industry to shape the future of retail life insurance though a genuinely “co-regulatory” approach. Taking account of the thoroughness and timeliness of this review, now is the time for the life insurance industry and life insurance advisers to act on these recommendations.
So what has Trowbridge recommended?
- A new structure for adviser remuneration. The recommendation is for the removal of up front commissions, to be replaced with level commissions plus a client based initial advice payment (with a maximum dollar amount) to be paid no more than every five years.
ASIC’s report in October 2014 found that high upfront commissions are more strongly correlated with non-compliant advice, including in situations where the recommendation is to switch products. Trowbridge, in his report, talked about three main industry challenges, the most important of which was:
To introduce modified remuneration arrangements for advisers and licensees that minimise conflicts inherent in existing arrangements, especially the perverse incentives or temptations associated with high initial commissions and the replacement policy or “churn” problem, whereby under existing commission arrangements there can be a large financial reward to the adviser for replacing an existing policy with a new one.
So the recommendation deliberately provides a maximum up front payment from manufacturers to advisers which is less than the cost of advice. The intent is that the adviser will make up the rest from a combination of trail commission (to a maximum of 20% of premium) and fee for service to customers.
Trowbridge suggested in his speech at the FSC Life insurance conference that this would encourage efficiency on the part of advisers and manufacturers – which would lower the overall cost of insurance.
Other financial recommendations were about transition – suggesting that the five-year rule be applied immediately, with a two-year transition for the remaining financial changes, and a removal of any volume based incentives for advice firms, to further reduce conflicts between best advice and financial incentives.
- Competitive access and choice for all advisers – each licensee should at least seven products on the approved product list.
- All licensees should improve processes, with administrative support from insurers, to improve customer understanding of Life insurance.
- A Life insurance code of practice should be introduced for insurers, licensees and advisers.
“Each of the AFA representatives has worked tirelessly over the last five months to demonstrate the role financial advisers and their licensees play in supporting Australians to get, and claim on, life insurance. It has been a thorough process,” Mr Fox (AFA CEO) said. “Ideally this final report would have our complete support but unfortunately, in its current form, it does not.”
Mr Fox said the AFA is concerned that the Trowbridge Report recommendations, if adopted, are likely to increase the cost of life insurance advice to Australians. “While acknowledging that there is a growing momentum from advisers towards fee for service, particularly for comprehensive financial advice, we believe Australians will pay more for life insurance advice if these recommendations are implemented. This is because advisers will need to charge their clients an additional fee in order to recover some of the costs of providing advice.”
From Geoff Summerhayes, member of the working group, and CEO of Suncorp Life;
— Suncorp Life (@SuncorpLife) March 26, 2015
From Alexis George, Managing Director Insurance at ANZ Global Wealth,
Alexis George: Trowbridge is a watershed moment for our industry. We do need more debate but also to move forward #fsclife
— riskinfo (@riskinfonews) March 26, 2015
Consequences for the industry
Trowbridge recommends almost immediate implementation, suggesting that the implementation of the five-year rule should start from (say) 30 June 2015. He suggests that his proposals can be implemented without legislation; by ASIC imposing license conditions on the relevant entity (licensee or manufacturer). If that happens, then what are the likely financial consequences?
The retail advised part of the industry has not been very healthy of late – industry statistics don’t disaggregate advised and non advised business, but anecdotally, the overall advised life insurance business is barely growing – many sales to one company in the industry are lapses from another company.
So will the proposals, as suggested, improve coverage, and value for money for customers?
- Will premium rates go up or down? If so by how much?
Currently around $30 of every $100 of life insurance premium in the retail advised business goes to the adviser and/or licensee (over the life of the contract, obviously this amount varies enormously between the first year and subsequent years, and also varies by life insurance company). This amount is likely to go down – probably by $5 to $10, depending on the size of the premium, with the proposals, as advisers will be paid less. It seems likely that insurers would give some, if not most of this, back to customers as a reduction in premium rates. So an up to 10% reduction in premium rates is likely to result.
- Will sales of retail advised business go up or down? If so, by how much?
Many advisers have suggested that they will stop selling new business, if up front commission is no longer allowed. If premium rates go down (as suggested above), then perhaps more life insurance will be sold anyway, as customers potentially take advantage of cheaper prices.
In the end, the answer to this one will depend on how much life insurance is “sold not bought” – in other words, how much of the value of the adviser is in pushing a customer to buy life insurance. Many people don’t like to think about life insurance, it involves acknowledging mortality, which is not much fun. So a good financial adviser will help a customer understand the importance of life insurance. If fewer financial advisers are in that business, will life insurance sales suffer? And how much does that matter?
- Will lapses of retail advised business go up or down?
One of the major reasons for the proposals is to reduce “churn” in life insurance – those customers who move from company to company every few years, earning their advisers a new up front commission every time they do so. The proportion of lapses which are churn is hotly contested in the industry, but the ASIC report (which shadow shopped, and found 37% of the advice life insurance customers received failed to comply with the laws relating to appropriate advice and prioritising the needs of the client, and gave a number of specific examples involving advice leading to lapse and a new up front commission for the adviser), suggests that it is a significant proportion of total lapses.
The Trowbridge recommendations are specifically designed to reduce lapses arising from up front commissions. It would be disappointing if lapses didn’t improve significantly if the recommendations were adopted.
- Overall, what will the impact be?
The life insurance industry – particularly the retail advice part – is a highly interconnected system. It’s difficult to foresee all the consequences of changing one part of something so interconnected. I support Trowbridge’s view that the changes he is proposing will ultimately improve the cost and availability of life insurance to consumers. But I am sure that there will be some surprising outcomes along the way.
In my view the life insurance industry has to change. The incentives are misaligned, and many studies have shown that people are great at convincing themselves they are doing the right thing if their incentives push them in that direction. Fixing behaviour is best done by aligning the incentives, so that everybody’s incentives line up behind providing good value insurance to those who need it.
Given where the structures of the industry are right now, any change will be difficult. John Trowbridge has come up with a pragmatic proposal for change. There are probably details that can be improved, but the broad thrust of it is in the right direction. I agree with many of the people I spoke to at the FSC conference – we do need some more debate on the detail, but it is important to move forward towards implementation.
This particular topic is such a fraught one that I am repeating my normal health warning particularly for this post. I was one of the many people who spent time with John Trowbridge during his consultation process, giving him some detailed data and modelling about some of his ideas, during his process of writing this report.
This post consists of my own personal views, and does not necessarily reflect the views of any of my employers – past, present or future.