News Article : Reforms at last . . .
|Category:|| Advisers & Brokers : Commission & Fees|
|Posted:||01 Sep 2005|
A bit of history
Following the introduction of FAIS, the industry’s intention to review its life commission structure is well-timed. For far too long the powers that be have ignored the sharp criticism of upfront commissions. As we discussed in a cover story (see Insurance Times & Investments Volume 7.9 September 1994 page 16 — yes, 11 years ago) there was a strong case for introducing so-called ‘levelised commissions.’
There’s no argument these days about the fact that upfront commissions cobble the client’s investment returns, and are a significant reason why policies that lapse the first two years are worthless. Even by year three the surrender value is poor. In 1993 came the abolition of the Sixth Schedule to the Income Tax Act, accompanied with reforms that permitted life assurers to sell products of a short a term as five years.
Clients cottoned onto the idea that buying five-year contracts improved returns, since the commissions were limited in the formula to 16,25% (five x 3,25%) the first year and one third of that in year two. They could then continued the policy after maturity for as long as they liked.
But it didn’t really overcome the fundamental problem. What should have been done we wrote about a few months later (Insurance Times & Investments Volume 8.3 March 1995 page 25): ‘… standard commissions create a barrier to the transference of existing policies to another broker. Since all commission on such business has already been paid out, the tendency is for the intermediary to make new sales to such clients in order to generate income.’
On the other hand we said: ‘level commissions would encourage better service because clients wishing to take their business elsewhere could do so. The new intermediary would enjoy the future commission flows on existing business as reward for having a better client service. This would also discourage switching.
Apart from allowing the policy to acquire value sooner, level commissions would also encourage sales people to spend more time ensuring their clients both wanted the product and were able to afford it.
Greater flexibility would exist because policy loans could be arranged far sooner, reducing still further the chances of an enforced surrender.
There would be greater customer loyalty, while the client would be far less likely to cancel a policy, given that its sale had been more adequately researched.
Level commission would also increase short term investment returns; remove much of the anxiety about disclosure; and ensure more loyalty from the intermediary whose livelihood would begin to rely more on long term relationships with clients than on the ‘quick sell’.’
As for the objections I wrote that it was incorrect to say ‘life assurance is sold, not bought.’ Instead it is a ‘life contract’ that is sold not bought; and this contract runs for the term of the policy. In that sense a sale is not completed until maturity.
As for the objection that the broker could not survive without upfront commissions, why doesn’t he finance his business with capital? I had to. By Nigel Benetton