Govt soft on insurers in regulatory revamp

Although the Government considered banning all insurance sales commissions and implementing a fiduciary duty requirement for banks and insurers, it ultimately backed off on the proposals, Marc Daalder reports.

Commerce and Consumer Affairs Minister Kris Faafoi hailed yesterday's announcement of a new financial conduct regime as "putting the consumer at the centre and helping banks and insurers to restore confidence in their industry".

But a closer look at the proposed policies shows that insurers - and those who sell life insurance in particular - dodged a major bullet.

The Government had considered banning cash commissions on insurance sales and making banks and insurers pledge to act in the best interest of their customers, but backed away in the end.

Instead, the Government's measures only ban volume-based or value-based sales targets and create a licensing scheme to force better behaviour on the part of banks and other financial institutions.

The question of commissions

Sam Stubbs, the managing director of the non-profit Kiwisaver fund Simplicity and former CEO of Tower Insurance, says that high commissions provide financial advisers with perverse incentives.

"They encourage the sale of policies which are in many ways providing too much insurance at too high a price for people who either don't need it or struggle to afford it," he said.

Richard Klipin, CEO of the Financial Services Council, stressed there are two different kinds of commissions.

"There are hard commissions - that is, real dollars - but there are also these things called soft commissions, like a trip to the football, all those kinds of things," he said.

The Government will now ban such soft commissions, but didn't address hard commissions at all. These hard commissions are very significant incentives.

Commission rates highest in the world

According to a recent RBNZ-FMA report, the NZ Institute of Economic Research found life insurers in 2016 were spending around $430 million annually on commissions. That's a significant chunk of the $2.57 billion in life insurance premiums paid every year.

If commissions were halved, premiums could drop by 12 percent across the board, NZIER reported. That would mean more people would have access to the product, Stubbs said.

"Commissions make insurance so expensive, that means a huge proportion of New Zealand never gets sold insurance and don't have access to it because it's too expensive. You have a massive under-insurance problem in this country."

New Zealand also tops the global charts when it comes to life insurance commissions as a percent of total premiums.

This chart from the joint RBNZ and FMA January report shows New Zealand's outsized commissions.

Churn of insurance policies

Commissions don't only drive prices up, they also incentivise financial advisors to help their clients sign up for or switch insurance providers, in order to earn the commission.

In their January review of the insurance sector, the Reserve Bank and the Financial Markets Authority found "evidence of sales incentive structures (internal and external) creating risks of sales being prioritised over customer outcomes, and of policies being ‘churned’, ie, customers being sold new policies that are not in their best interests so the salesperson can earn a commission".

Such churning appears to be incredibly common. A previous FMA study found only 2 percent of sales of life insurance policies were genuinely new - the remainder were people churning from one policy or insurer to another.

Klipin defended this, saying that insurance is just like any other product. "In the electricity sector, in the cable and broadband sector, in the mortgage sector, as consumers, there are always new products coming on. There's fierce commercial competition. Leave Spark and come to TV 3, leave Bank A and come to Bank B, or whatever."

It's the same with insurance, he said. As insurers offer new and better products, people switch.

Tougher regulations considered, rejected

While financial advisers, under the Financial Services Legislation Amendment Act passed this year, will now be required to make decisions in their customers' best interests, that requirement is not in place for banks, insurers and other financial institutions.

The Government considered implementing such a fiduciary duty requirement but backed away. It also floated banning or capping commissions on all sales and on those of life and medical insurance in particular, according to a regulatory impact statement proactively released by the Ministry of Business, Innovation and Employment.

It decided against implementing such a policy because of the economic impact it would have on the financial advice industry. "We have endeavoured to give priority to options which would not unduly disrupt the financial advice industry, especially given that it is already going through a period of significant regulatory change with a stronger regulatory regime taking effect from June 2020," the document stated.

"Therefore we have ruled out a total ban on commissions to intermediaries, which would have had significant negative effects on the financial advice industry."

Government action lacking

However, on the same page of the document, MBIE stated that "in the life insurance sector, the first mover disadvantage in relation to the payment of commissions and other incentives makes it extremely unlikely for comprehensive and sustained industry changes without regulation".

Faafoi, in a statement issued last week, said insurers have not "been putting customer interests top of mind. Sales incentives are a big part of the problem. Incentives play a useful role in some cases and we don’t want to remove them entirely. But when insurers sell financial products and services, the focus needs to be on the customer and not just on profit."

While the Government believes that the ban on soft commissions will do enough to force "comprehensive and sustained industry changes", Stubbs disagrees.

"Conceptually, I would ban hard commissions," he said.

"I have been a long-time advocate of banning commissions. I've helped run an insurance company, I've seen first-hand the perverse decision-making that it leads to and my conclusion is that hard commissions just don't work."

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