29 – Pricing life insurance services
Insurances have traditionally been almost universally funded by commissions. Until 2016.
From 1 July 2016, the amount of commission that can be received has been capped, and capped at levels well below where they have traditionally been. By 2018, the maximum upfront commission will have been halved to 60%. While the limit on trailing commissions will be 20% – higher than is currently being used across the industry, this increase will not fully compensate for the loss of upfront commission. Dover estimates a total reduction of around 20% of revenue for a commission-only practice across the life of a policy. Looked at another way, this means that risk-based advisers need to generate 25% more work if they are to maintain pre July 2016 levels of commission-based revenue.
Working 25% harder does not really appeal to anyone. So, the option of recouping some of the lost revenue via client fees for life insurance advice must be considered. The question becomes: how to price something that has never needed to price before?
Before we discuss the pricing models, bear in mind that advisers can still receive some commissions post-LIF. Therefore, when we talk about direct fees for life insurance work, we are really talking about direct fees as an adjunct to the commission receivable.
Of the three pricing models, FUM-based fees obviously do not suit. Either time-based or project fees make more sense. Time-based fees are simple to understand. The adviser simply states the time-based fee, and then estimates the number of hours to complete the advice and application process. Given that there is still a 60% upfront commission available, the time-based fee will typically be a lower per-hour amount than would be the case with advice on things other than life insurance.
But not necessarily. There is no law to stop advisers receiving a 60% commission and also imposing a full fee on the client. The fees need simply to be disclosed and agreed to.
In terms of a project fee, there are various ways for an adviser to decide how much they will require to provide advice. One way, which is conceptually similar to FUM-based fees, is to set a fee in relation to the premium being charged. Dover estimates that the lifetime reduction in commissions from a life insurance policy is around 20%. Therefore, an adviser wishing to maintain pre-July 2016 revenues might simply charge a fee equal to 20% of the premium.
If the insurance premium is $1,000, then the adviser might initially charge the client 20%, or $200. The adviser could then also receive the 60% commission from the insurer, or $600, plus a trailing commission of 20% for the life of the policy.
The figure of 20% is the one chosen to merely compensate for the revenue lost through the LIF reforms. The adviser can choose any percentage he or she wants. However, the client obviously has to agree to the amount chosen, so there is a common sense limit.
The adviser might use the percentage model to set the amount they want to ask for, but they then put an actual figure to the client, who can agree or otherwise.
Of course, an adviser is free to use any basis they want to select the project fee that they wish to charge.
Regardless of which basis is used to calculate a proposed fee, advisers need to remember that figures quoted to clients must always be expressed in whole dollar amounts. That is, a financial adviser cannot simply tell a client that the fee for advice will be x% of their premium. The adviser must go on to calculate a precise dollar figure by multiplying that percentage by the actual premium being quoted.