The real commission problem

But whether high commissions cause lapses due to churning is not the point.

Commissions are unsustainably high. This is so whether or not churning is a problem. The churning argument is a distraction from the real issue facing insurers, AFSLs and advisers. Excessively high commissions.

Commissions offered by life insurers can be up to 130% of the first year premium and 20% of subsequent premiums. The average length of a policy is between seven and eight years, so this means commissions are typically between 30% and 35% of the premiums received over the life of the policy.

An average life of between seven and eight years is a remarkably short period in what is supposed to be a very long term industry. The short policy life works against insurer profitability.

If a policy lapses after just three years, and many do, the commissions equal 50% of the premiums.

It does not matter what is causing the high lapse rate. Churning is not the problem. The real problem is high commission rates are not sustainable. Let’s call the spade a spade.

Something has to change.

This is not a novel observation. For example. The AMP chief executive Craig Mellor has said that commissions are on the way out and fee for service is on the way in.[1] ASIC deputy chairman Peter Kell has expressed similar views: “The conflicts created by that sort of model are too often getting in the way of advice that serves the interests of the client”[2] and ASIC’s 2014 Report 413 Review of Life Insurance Advice identifies a high correlation between technically flawed advice and high commission insurance products, and a high correlation between lapse rates and commission rates[3]

In the retail space insurers are besieged by the “first mover” paradox. Each insurer knows its commission rates are unsustainably high, but if it moves first to lower its commission rate it will lose business and market share to its competitors, and short term performance will fall.

So, in summary, everyone knows commission rates are too high and are not sustainable, but individual insurers, except for the giants like the AMP, are reluctant to lower them unilaterally for fear of losing market share and suffering even lower profits.

So the 12 life insurance companies that make up the Australian life insurance industry need someone else to lower their commission rates for them.

This is where the Trowbridge Report came in.

[1] Source: Article by Ruth Liew in the Sydney Morning Herald on 20 August 2015 AMP boss says financial advice commissions are on the way out. AMP boss says financial advice commissions are on the way out

[2] Source: Article by Andrew Robertson in the Finance Quarter ABC 12 March 2015 Upfront commissions compromise quality of financial advice Upfront commissions compromise quality of financial advice

[3] ASIC Report 413 review of retail life insurance advice October 2014

The Dover Group