Time for a new commission model

Adviser Jon-Paul Hale says it's time to review how commission is paid when clients move to a new adviser.

Monday, May 27th 2024, 9:31AM

by Jon-Paul Hale

I recently talked about the issues of replacement and service commission and the challenges of our approach to the connection of advice. In this article I want to explore our approach and why we have it, as it doesn't seem that people understand this as well as they think they do.

If we go back to earlier times when Whole of Life and Endowment were the only products and the answer to every problem.

These policies were sold in a pretty simple time and process. Rate cards and one-page application forms. The upfront commission for sales and service was collecting premiums.

Many would say this was the best of times and the worst of times.

Like all things, things change. Along came term life; it seemed less complex and cheaper and has become the default base for all of our current covers.

This is where upfront commission morphed into upfront and renewal. Not so much for service as to ensure that retiring advisers had income to live on.

Although the world view of this has changed over the years, when talking purely about life insurance, this trail/renewal commission has remained largely the same.

That basis is an ongoing reflection of the value of the contract introduced to the insurer. It is paid as an asset commission, not a service commission.

It vested with the originating adviser as long as the policy remained in place — aka forever. That is why we have seen retired advisers over the years continue to receive income from renewals.

Which was then used as a proxy for the base value of adviser businesses and, thus, the multiple-value approach to adviser business valuations.

From a value basis, this makes for a reasonable approach to valuing advice businesses in a way that has significant stability and aligns with how other service-based businesses are valued. With the added addition of increased security of business income from the nature of insurance contracts.

But the world has changed. We now believe that the ongoing commission should be used to service clients.

While I agree this is desirable in the overall picture, it ignores the contractual aspects of these commission payments.

When it comes to contract legislation, new legislation applies to a new activity, not an old one. A fundamental principle is that new legislation cannot change the terms of historic contracts at the contract level.

It can change how people and organisations act around the contract but does not change the contract itself. Changing the underlying commercial contract fundamentally changes the rules for many past contracts, which would have significant unintended consequences across society.

Your agency agreements have continued to evolve. As successive agency agreements have been rolled out, the terms and requirements of those agreements have changed.

From experience, most advisers don't review these and sign them as a matter of course because they have to be accepted for them to continue to be an agent for that provider.

What has entered the chat are the requirements to provide service under these agreements. The likes of Southern Cross, Accuro, and, to a lesser degree, nib are calling ongoing service commissions that move with the servicing adviser.

For life insurance, not much has changed regarding the payment of commissions, but servicing has entered the requirements of the contracts we have.

This raises a point about the change of servicing, where the original adviser is paid while the current servicing adviser delivers service. I talked about that in my last article on this subject.

There have been comments in the media recently about fee-for-service in the life space, and this may be where we go. It's similar to how mortgage advisers work. Where the provider isn't paying a commission, the client pays a fee.

However, part of the challenge here is that the insurer is paying the "servicing" commission, which has been accounted for in the client's premium.

Effectively, a client with a policy serviced by a new adviser would pay twice for the advice on that policy if they paid fees for that service.

Now we can wax lyrical on the pros and cons here.

Like ACC, if you choose to go to a physio that charges a co-payment on top of the ACC-funded costs, that's your choice.
You can go back to the adviser who is getting paid for "servicing" your policy.

Take this closer to what we do: You go to a lawyer and pay them a fee for their service. You then seek a second opinion, and that lawyer also charges you a fee. They won't provide a second opinion because you paid the first lawyer.

The point is that the client needs servicing, and someone needs to pay the associated adviser for that service.

Because we work in life insurance, we know two things:

Clients prefer to avoid paying for advice.
Clients need to seek advice more often to maintain their coverage as needed.

Charging fees becomes a barrier to clients accessing advice, this is well documented with overseas studies.
Fee-for-service life insurance results in less market access for the public, who have less insurance.
This is not the intended outcome when we consider New Zealand is significantly underinsured.

Additionally, we need more advisers in the market to cover everyone effectively.

A significant number of people only have access to advice with direct and bank providers, and that's more of a transactional relationship than an advice one.

We also have adviser businesses valued on their renewals rather than EBIT for the most part. To be fair moving to an EBIT approach isn't necessarily a bad thing, but it does introduce complexity we presently don't have.

EBIT would capture the profit of the business where the service provided to non-earning clients is highlighted, sometimes distinctively.
It would also potentially distort the easy multiple approach of individual contracts.

So what's the answer?

I've said it before, and I'll repeat it: the approach nib has introduced to the market. A suitable Change of Servicing Adviser sign-off that transfers both servicing and commission to the new adviser, with the new adviser receiving the "service" commission after three years.

This opens up a few things:

The originating adviser gets paid the value of the client based on today's view
The new adviser doesn't have to find capital for the client purchase, which is helpful in assisting new advisers getting started when they are picking up our "C & D" clients who aren't profitable to service.
It stabilises the value of our businesses with less risk of collapsing values.
The client's moving adviser is less likely to get advice to move to a new provider with poorer terms. I'm not so naive to think this will stop "sales" for the benefit of the commission, but it does provide some release of pressure on the working and earning piece.

Some clients view moving providers specifically so the new adviser gets paid without considering their own cover issues. We need to do better with this aspect as the "new" adviser, but that's an epistle for another time.

My point in raising this discussion is that we need to move coherently on this subject to find a solution that works for all of us before the regulator imposes something we don't like to solve the issues I have raised.

I doubt we will see much pressure on upfront commissions as the FMA has already stated that we need to earn and pay the bills; the focus continues to be inforce contracts and adviser behaviour around replacement, which leaves the servicing commission aspect open for discussion.

My view where the situation of advice is service without new coverage:

Change of servicing with the change of commission model above is appropriate for the situation of taking over a client for the future.
Where the advice is a second opinion or specialist help, like a difficult claim, the adviser should charge a fee or manage a direct method of remuneration that clarifies the incentives for the advice or support provided.

We're no longer agents selling policies on commission; we're professional advice businesses that need to operate as professional advice businesses. This is a significant change of mindset for many.

Tags: Jon-Paul Hale