The financial trade press has been full of claims recently that the Association of British Insurers (ABI) has shelved plans to publish proposals to change the way insurers pay commission on life and protection products to financial advisers, including mortgage brokers. However, Mortgage Introducer can reveal that when we spoke to the ABI back in May this year, the organisation had already decided to combine the commission review with a wider ranging examination of the life insurance sector, likely to published next year.
The delay adds to the debate surrounding commission payments for protection products, and in particular the practice of paying indemnity commission. In February last year the ABI published its first report into commission, entitled ‘Financial Advice: How Should We Pay For it?’, which included a proposal to abolish indemnity commission (on all financial products including investment products as well as protection), claiming it could cause consumer detriment. The ABI asked for industry comments on the proposals, promising to report back on its progress in early 2006.
The initial report received a robust response from AIFA (the Association of Independent Financial Advisers), sister body to AMI (Association of Mortgage Introducers). The organisation said that any move to abolish indemnity commission needed to be “justified in its own right and not through accusations of consumer detriment”. It is also understood that a number of insurance companies were unhappy about dropping indemnity commission.
Yet many brokers still feel that the practice needs to be overhauled, specifically when it comes to the area of clawback. Advisers that opt for indemnity commission get paid the full amount of commission upfront once the insurance policy is placed. Clawback means that advisers can be forced to pay back a percentage of their commission – which could be the majority of the payment – if their client cancels their life insurance policy within a set period of time, usually two or four years.
Some intermediaries feel the current system leaves them in a Catch 22 because they rely on the upfront commission payment as a major source of income, yet they are at the mercy of clients who may abandon their insurance, trigger the clawback and seriously damage the introducer’s income. Many advisers also feel that the existing commission structure does not take into account the work they do setting up the insurance policy, which they feel they should be compensated for even if the client cancels the cover within the clawback period.
Broker Danny Lovey, who operates as The Mortgage Practitioner, explains: “I don’t think the current system suits anyone – the insurers or the intermediaries. We do all the work for the insurers, chasing up doctors for medical records and so on, but then we can have a huge chunk of our commission clawed back if the client cancels the policy. I suspect the promised review has dropped off simply because the ABI couldn’t find a consensus within the industry.”
Lovey believes that one of the reasons insurers are keen to keep indemnity commission, and in particular the clawback cause, is because they see it as a way of preventing so-called ‘round-tripping’ or churning, whereby advisers switch their customers to a new policy provider every few years to maximise their commission income.
“If there were no clawback then this could obviously result in round-tripping, but a four-year clawback is too long,” Lovey says. However he does not advocate the abolishment of indemnity commission in favour of trail commission, suggesting instead a new structure that combines an initial payment to reflect the work undertaken by the adviser, plus trail commission after a period of nine months, which would last for two years unless the policy were axed, removing the problem of clawback. “Advisers need a degree of payment upfront because they do all the work upfront.”
Lovey believes that a two-year clawback would be sufficient, citing insurers such as BUPA, Prudential and Scottish Equitable who currently offer such terms. He believes that the vast majority of intermediaries would not advise their clients to switch their life or protection insurance to another provider unless there was a compelling reason, such as changes to the client’s circumstances, which would see them benefit from a different policy. Lovey says that insurers could easily weed out advisers who do churn their clients to earn more commission.
He says that most of his clients that cancel their life insurance or protection cover in the early years do so because of major life changes, situations that cannot be anticipated. At a time where the life insurance protection gap is estimated to stand at around £2.3 trillion, according to research by re-insurer Swiss Re, coupled with an income protection shortfall of £160 billion, Lovey believes insurers should be doing more to encourage the sale of life and protection insurance.
“I know of mortgage brokers who just pass the assurance business on as they simply cannot be bothered because of the current clawback and non indemnity system,” Lovey says. He acknowledges that his commission formula could potentially result in a lower income for advisers, but says the security of no clawback would be better all round.
He explains: “It would be far better for advisers to be paid less, but to be paid quicker and have that income guaranteed. It would also be an incentive for more brokers to write protection business, which is so vital for mortgage borrowers these days.”
One of the reasons why the ABI’s initial report on commission structures – ‘Financial Advice: How Should We Pay For it?’ – proposed the abolishment of indemnity commission was the view that the practice could be potentially detrimental to consumers. This was based on research by consultants Charles River Associates (CRA) and it was actually CRA who proposed the scrapping of indemnity commission rather than the ABI directly.
The report stated: “The rationale for CRA’s proposal to abolish indemnity commission is that confidence is damaged because advisers – especially independent advisers – rely for business finance on revenue from product providers related to individual product sales.”
CRA’s argument was that those insurers offering the biggest upfront commissions could potentially sway advisers, creating the possibility that consumers would not be given best advice or the most suitable cover.
However, the report also said that “CRA found some limited commission-related bias towards particular companies and product types, but no evidence that commission was inducing advisers to sell where no sale was appropriate (at least relative to fees). CRA also found room for improvement in the overall quality of advice, quite unrelated to the question of commission.”
CRA concluded that it would be wrong to replace commission with fees, as this could discriminate against clients on lower incomes, but it did recommend a raft of measures to simplify commission structures, making them more transparent for consumers.
On the topic of indemnity commission the ABI obviously sensed that dropping the practice would not be so straightforward. The report’s conclusion said: “Indemnity commission is an important source of finance to (often small) IFA businesses. The ABI is very aware of the implications for those businesses of the proposals to abolish indemnity commission. A reduction in the UK’s overall capacity to deliver independent advice would be bad for product providers, and more importantly bad for consumers, who would face reduced access, and poorer competition and choice.”
The ABI said that it wanted to encourage feedback and debate from across the industry regarding the impact of any changes to commission structures, as well as options for replacing indemnity income, such as bank loans or equity finance.
One of the first to reply was AIFA with a response it said was “hard-hitting and highly critical of the timing and majority of the proposals”. At the time AIFA said: “The costs and impact of the ABI proposals should not be underestimated. We do not see any need for radical reform and do not believe that the proposals, if they were to proceed, would contribute significantly towards restoring confidence.”
AIFA’s statement continued: “Industry reputation, not commission, is the real issue. There needs to be a concerted effort between industry and regulators to weed out the pockets of commission bias but at the same time there needs to be an awareness campaign to help dispel the poor perception of commission.”
Speaking to Mortgage Introducer, Fay Goddard, deputy director-general of AIFA, says that the organisation is also well aware that the promised second report on commission structures by the ABI had been subsumed into the wider review of life insurance.
She says: “I think the decision to include the commission review into the bigger report shows that the ABI has taken onboard our views and our response to the initial report. I think the insurance industry has given some more thought to the issue and has realised that it is not so straightforward to deal with.”
Goddard points out that the original proposal to abolish indemnity commission had not been backed up by any concrete evidence that the practice was actually causing consumer detriment. She explains: “There was nothing in the first report to justify the removal of indemnity commission. This should be treated as a business issue and we need to address concerns by clients rather than using the consumer confidence aspect to abolish the practice.”
There was also a concern from AIFA that if the ABI were to decree that indemnity commission be abolished, which would not be a legally binding requirement, not all insurance providers would be supportive of the decision. “There was a fear that it would only take one or two insurers to break ranks and offer indemnity commission, and then you would find commission bias,” Goddard says.
Goddard says that research among the members of both AIFA and AMI revealed differing opinions on commission structures and the part that indemnity commission played. She says that for some advisers the indemnity option was important because they relied on the income it produced. According to Goddard, AMI’s membership was in general “quite strongly in favour” of indemnity commission.
Goddard says that AIFA is supportive of a considered review of commission structures, saying that not all advisers are in favour of the current clawback system, although she acknowledged that it did prevent churning. She says: “All of the work is done up front by advisers, so it is not unreasonable to expect that they should be paid up front for this work. People should be paid for the job when they do the job.”
AIFA is continuing its dialogue with its members, the ABI and the insurance industry in general on the issue of commission review. “It is an issue we need to face jointly as it is in the interest of advisers, providers and our clients to address this properly and work to get a sensible outcome,” Goddard say. “We are in favour of evolution not revolution.”
Some commentators believe that because indemnity commission has been such an integral part of the financial services industry for a number of years it is down to advisers to build their businesses to be able to cope with this particular income, including the danger of clawback.
Ray Boulger, senior technical manager at brokers Charcol, explains: “Advisers have to factor in to their business that there is a risk of clawback if clients cancel their insurance policies. If the adviser is not comfortable with this, then they should choose trail commission. This is clearly an issue for their own judgement, but I don’t believe what kind of commission advisers choose to take makes any difference to the advice they give to their clients.”
Not everybody is happy with the delay in reviewing the commission structures, with consumer watchdog Which? being reported as saying that the original ABI report had “the whiff of whitewash”. Some insurers, on the other hand, are being proactive in introducing their own solutions with Norwich Union and AXA launching new commission options for investment business, although it is not known whether similar initiatives are being planned for life and protection policies.
The ABI said this week that its work on commission structures and how advisers are remunerated in general would be on-going, but no final date for the publication of its findings had been agreed, or indeed what form those findings would take and whether they would be part of a bigger review of life insurance. A spokesman for the ABI said the organisation would be considering the findings and impact of the FSA distribution review before making any recommendations. He also said that the issue of how advice and sales of financial products were paid for was an issue that needed input from all stakeholders in the industry.
