Risk poor policy analysis could affect commission decisions

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NZIER’s recent analysis of the NZ Life Insurance market for Sovereign Insurance purports to show that the life insurance market is shrinking, that new customers are more price sensitive than existing, and that a reduction on commissions could help reverse this, writes Michael Naylor.

Thursday, June 9th 2016, 9:44AM 1 Comment

When added to the MJW report, and the RBNZ FAA submission, there is a trend developing of reports recommending commission reductions, which could impact on official policy. It is vital that these reports use quality analysis otherwise policy changes could be inappropriately based.

The NZIER report has some good aspects but it suffers from major weaknesses.

Changes in Level of Insurance Cover
NZIER use annual increases and decreases in gross premium data, as well as data on numbers of covers in place, to argue that the NZ personal insurance market is flattening out. Unfortunately, it does not break this data down into categories like permanent life, term life, income insurance, trauma, etc. In general, it is difficult to argue from gross figures that NZ is underinsured, because people only need as much personal risk cover as the present value of their future needs indicate.

In a stagnant society, people whose risk needs are increasing will be balanced by people whose risk needs are decreasing, so it is only the factors which cause dynamicism in society which cause changes either in sums or in policy numbers.
The FSC/Massey Exploring Underinsurance report found that NZ had adequate cover levels of life insurance, though the amounts were not correlated with actual need. NZ’s problem was income, trauma and TPD, insurance cover. NZIER did not do this breakdown.

Insurance Price Elasticity
The main variable NZIER tried to estimate is the price elasticity of insurance sales, that is the extent to which polices sold decrease as premiums rise. Note that the correct elasticity is actually the rate elasticity, not premiums; as the rate per amount of insurance rises, how much does both of the sum and the scope of insurance decrease.

Some studies show that rate elasticity is possibly above negative one, so that a 1% increase in rates creates a more than a 1% decrease in demand. Given, however, that other studies show a low figure, little can be concluded which is useful in policy debates.

The NZEIR also makes no distinction between the elasticity response in terms of policies sold and the elasticity response in terms of the sum insured.

The NZIER report was not able to find a conclusive answer to the elasticity question and therefore cannot make any argument as to whether a reduction in distribution costs would increase insurance cover. The dynamics inside the market are far too complex for that kind of simple question.

Commission Policy
The NZIER argues that high commission payments are a significant financial drain on insurers, and that a cut in these commissions would increase the amount of insurance sold. The NZ problem is, however, not a higher level of overall commission but a high upfront and a lower or non-existent trail commission. Thus controls on commission, as per the Australian model, of lower upfronts and higher trail, would not necessarily reduce overall commission costs. No analysis is made of distribution costs.

NZIER also ignores the effect which advisers have on sales. Personal insurance is traditionally seen as a product which has to be sold, and which consumers do not in general have the capacity to wisely purchase the correct amount and the correct quality.

A strong case can be made that fewer advisers could actually lead to fewer policies sold, and lower quality, inappropriate quality policies.

Given the low price elasticity of insurance and a reasonable high adviser elasticity, it could be argued that any regulation which reduces adviser commission income would actually reduce the quantity of insurance sold. It would certainly reduce the quality of insurance sold. There is no evidence of the simple price elasticity effect which the NZIER report assumes as the basis of their argument to support commission reduction.

These adverse factors are particularly important for income, trauma, and TPD insurance, which are drastically under-purchased in NZ, seem rarely purchased without help, and thus seem to respond decisively to adviser education. Our market already has a low level of advisers per population, and any further reduction could have a disastrous impact.

NZIER also do not attempt to analyse the cost of distribution alternatives to advisers. It is, for example, estimated that the costs of web-based direct sales exceed intermediated sales, with lower quality price-focused policies sold, and higher risk customers. Lapse rates tend thus to be correspondingly higher. The combine effect of this is customers with lower risk bearing capacity and insurers with no cost advantage.

Insurance Purchase Triggers
The NZIER report does try to analyse the key market drivers. Because, however, they fail to break down demand into life, income, trauma, TPD, they end up focusing exclusively on demand for life policies. They tie demand for life insurance mainly to mortgage and rental breakdowns rather than the usual household composition. Rental-households do not experience this trigger so need other sources of pressure to buy.

NZIER do make the useful point that using mortgage purchase as a trigger is not growing the market as the number of owner-occupiers is stagnating. They fail to go on to make the obvious point that most mortgage-triggered life policies are sold by banks and are often low quality products, with sums tied to the mortgage level, rather than actual needs, with no policy quality comparison across providers and limited sake of non-life personal risk products. Advisers are not the problem.

Insurance Market Stagnation
The NZIER report does usefully conclude that personal risk insurance products are being purchased by a stagnant, traditional, segment of the NZ population, and that current advertising policies by NZ insurers are not effective at breaking out of that segment. Advisers do not seem to be effectively breaking out of their segment either.

I have to agree that there does not seem to have been strong growth in policy numbers over the last decade, indicating that insurers have not been able to penetrate outside of their traditional market segment into a more diverse society. Given that NZ society is becoming increasingly diverse in multiple dimensions, the industry needs to collectively become more creative and diverse, using omni-channel methods to activate a far wider range of triggers for insurance purchase.

Poor Quality Data
The NZIER attempt does raise the question as to why NZ insurance statistics are so poor. The companies which back the FSC and the ICNZ have not provided the kind of detailed financial information required on policy size, on client type, etc, to allow useful research to be undertaken. A good start would be the creation of an industry wide data base of useful customer characteristics.

Tags: Commission

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