By Bryan Tucker posted February 1 2019
In January 2019 the Financial Markets Authority and the Reserve Bank issued a joint report on Life Insurer Conduct and Culture. The report makes some damning assertions about the industry and has given insurance companies until 30 June 2019 to respond with detailed action plans about how they will change.
Vesta Cover staff have worked in the insurance industry for over 30 years and have seen this report coming for much of that time. An industry shake-up is long overdue, and we applaud everything being done by the FMA and Reserve Bank.
The Government followed up within 24 hours announcing that they would be regulating commissions and incentives in the life insurance industry. It is expected that changes will take effect in May 2019.
KEY FINDINGS IN THE FMA/RBNZ REPORT
1. The industry has had a lack of focus on good customer outcomes
2. It has been too complacent about identifying, managing & fixing poor conduct by its staff and advisers
3. Many Life insurers consider 3rd party advisers & brokers to be their customer – not their policyholders
4. There is limited evidence of products being designed and sold with good customer outcomes in mind
5. High commission rates being paid to insurance brokers are accounting for over 20% of premiums paid by customers – making cover far less affordable.
The only highlight is that they found staff dealing with claims generally had a good customer focus and that insurers are usually looking to achieve fair claim outcomes.
UNINTENDED CONSEQUENCES OF THE 'HIGH COMMISSION' BUSINESS MODEL
Having such a drastically generous commission and incentive package creates some unintended, but perfectly predictable consequences:
1. While insurers also pay advisers an ongoing service or renewal commission for the clients they have introduced, a disproportionate amount of adviser income is generated by the sale of new policies. Not surprisingly, this is where many advisers focus their attention. This can mean that regular reviews of a client’s cover are not done. Many a client will complain that their adviser has not been seen since they bought the policy many years ago.
2. Some particularly unscrupulous advisers understand that their ‘claw-back’ liability ends after 2 or 3 years and so they then approach the client with a “new and improved” offering that coincidentally pays the adviser another up-front commission. Too often this creates poor outcomes for clients as they have to reapply for the new cover and risk losing coverage for pre-existing conditions. As an industry this ‘churn’ further accentuates the cost of these high commissions by forcing insurers to raise their premiums even further.
3. To help combat churn by the few unscrupulous advisers out there insurance companies constantly measure the retention rate of each adviser's group of clients. Slight changes in retention rates have an immediate impact on an adviser’s future income from that insurer. More significant changes can result in the adviser’s ‘agency’ with the insurer being canceled. Losing more than 15% of an adviser’s total introduced premium can put him/her at risk of termination. While this is a moderately effective way to limit churn it can also discourage advisers from providing the right advice. Some will leave a client in a poor quality, expensive policy rather than use low impact options to transfer them to more suitable cheaper cover. Some will ‘advise’ the retention of a policy even after a client’s need for that policy has evaporated. All to avoid the impact of a change in their retention rate.
4. For many Insurers, a disproportionate focus on commission and incentive packages as an easy way to lift market share arguably relieves them of their need to constantly innovate. If innovation and pricing were the only major means to lift market share the industry, and clients, would benefit from sustained product improvement and aggressive pricing.
HOW THINGS NEED TO CHANGE
Insurers who want to be successful in the future need to flip their thinking and change their priorities. Rather than allocating their time and resources to supporting adviser to sell their products they need to concentrate on client outcomes and product innovation. Their success in the future needs to hang on the quality of their product offering, price, service and claim paying ability, not on the commission terms they have devised for distributors.
Adviser remuneration models need to move away from large upfront commissions to much smaller service commissions that reward providing ongoing service and meeting the needs of clients. Some of the advisers operating today probably don’t have a place in the industry of the future. The fast and loose ‘hunter’ will be replaced by the careful, methodical and technically savvy ‘farmer’ who will focus on servicing clients to the best of his or her ability. The rewards will come from building a large and well-serviced book of clients. Working out how to create a pathway into the industry for new advisers will be a challenge.
Regulators, as they are doing here, must focus their attention not only on the conduct of the adviser but also the environment created by insurers.
Government needs to focus on law changes that outlaw harmful behaviour and further protect the consumer. An example of this could be a change to the law around transfers of existing policies to another insurer. Right now, this presents significant risk to consumers who can find themselves uninsured for a health issue they were covered for previously. Removing the ‘up-front’ financial incentive to do this would be a first step. Requiring the new Insurer to carry over the previous policy’s terms on like for like cover would also help.
Clients need to become more savvy about the advice they receive from their advisers and be far more demanding in their expectation of service. They also need to change their expectation about paying insurance advisers for quality advice. It won’t be possible to receive comprehensive advice from a suitably qualified expert at no charge if that adviser is not being remunerated by way of a commission from the insurers.
HOW VESTA HAS PLANNED FOR THESE CHANGES
It has been Vesta’s stated goal for many years now to reduce the cost of quality insurance for all New Zealanders. Our business model has been to strip away most of the large up-front commissions when we arrange new policies for our clients.
The benefits of this approach have seen some saving as much as 40% on the premiums they would normally pay for the same product. Despite these savings, our clients still benefit from independent market research and quality advice from experienced advisers. You can learn more about the Vesta Cover offer here.
Unlike many in the industry, we should be well placed to survive and thrive when the new environment starts to take effect.
SPECIFIC EXAMPLES OF POOR CONDUCT CITED
• Selling products that can’t be claimed - insurance policies being sold to foreign customers who were ineligible for the insurance cover and could never claim.
• Some insurers sent out promotional material to clients promoting policy enhancements the insurer knew those clients weren’t eligible for.
• Creating products that represent poor value for money – policies that have such low levels of claims that their cost, or even the product itself, is hard to justify.
• Overcharging groups of clients because of a system error and still not fixing the problem for many of the clients more than 3 years after the error was discovered.
The report named the 16 New Zealand insurers it reviewed but didn’t individually identify where the problems were found. However, the broad issues seemed to be almost universal.
Most people who work in any industry for a long time quickly see the flaws and unfair practices that go largely unnoticed or unreported by customers. Banks that camouflage their fees by scattering them throughout the monthly statement or charge dishonour fees if you miss an automatic payment – even though this costs the bank nothing.
VESTA COVER'S PERSPECTIVE
Most people who work in any industry for a long time quickly see the flaws and unfair practices that go largely unnoticed or unreported by customers. Banks that camouflage their fees by scattering them throughout the monthly statement or charge dishonour fees if you miss an automatic payment – even though this costs the bank nothing. The accountancy or legal firm that charges what it thinks it can get away with, rather than strictly based on time spent. The traffic officer who sits at the bottom of a steep hill waiting for ‘prey’.
When pressed, all will provide perfectly logical and sensible answers for why they do what they do. However, those working on the inside know that achieving profitability targets are essential and there are always tricks and tips that will help you do this.
As this report is going to show, sunlight is the best disinfectant.
Insurers trade on their reputation and this kind of publicity is the last thing they want. They now have both a reputational and legislative reason to make sweeping changes to how the industry operates.
THE LIFE INSURANCE INDUSTRY TODAY
New Zealand life insurers consider market share to be a key performance indicator. For most industries, this is achieved by creating a great product and service offering and getting it out there. The more innovative and cost-effective the product the better chance it has of success.
The New Zealand life insurance industry has always operated a little differently. While there are some particularly innovative companies out there most would quietly admit they offer a generic product that differs little from their competitors. Being the first adopter of a new feature or benefit is to be on the ‘bleeding edge’ – a risky proposition for a risk-averse industry. Most life insurers are quite comfortable sitting back from the bleeding edge and will implement new product enhancements only once they have observed how the early adopter fared.
Instead, the insurer chooses to trade on their reputation and financial strength. Their advertising rarely focuses on the features or benefits of their offering but rather brand awareness. Almost all rely largely on their network of 3rd party distributors – financial advisers.
To encourage 3rd party advisers to sell the company’s products there has been an incremental increase in the commission and incentive packages offered. If you go back 30 years, there was a time when an adviser would have received as little as 45% of the first years’ premium for the sale of a life insurance policy. This has now grown to as much as 230%, with other add-on benefits bringing the remuneration even higher. Ironically, the average cost of insurance back then was higher than it is now.
Insurers are able to offer such large up-front commissions because they know that, on average, a client will hold a policy for around 5 to 7 years. After deducting commissions, the cost of acquisition, fixed expenses and claims they can reasonably expect to ‘book’ a profit of between 1- to 1½-years premium. If a new policy is canceled within 2 to 3 years some or all of the commission paid to the adviser is ‘clawed back’.