MJW Review of Retail Life Insurance Advice released

Actuarial consulting firm, Melville Jessup Weaver (MJW), has today released its Review of Retail Life Insurance Advice – a report commissioned by the Financial Services Council (FSC) and its insurance members to respond to issues raised by the Ministry of Business, Innovation and Employment (MBIE) as part of its review of the Financial Advisers Act 2008, and to specifically consider and find solutions to the conflicts of interest inherent in the adviser commission model prevalent in the sale of life insurance in New Zealand.

The Report expressly notes that:

  • The views expressed in the Report are MJW’s own and do not necessarily reflect the views of FSC or its members.
  • FSC members consider that some of the matters covered in the Report are outside the agreed scope of the report as commissioned and funded by them.

The Report should be read bearing that in mind.

A link to the FSC's media release concerning the Report is available here and a link to the Report is available here.

Who needs to read it? Why?

The Report will be of particular interest to life insurance companies, and financial advisers who specialise in life insurance products. It will also be of interest to the broader financial services industry as it considers aspects of the Financial Advisers Act 2008 (FAA) currently under review by MBIE.

The Report also provides a useful additional perspective to the regulation of marketing and sales of financial products in general, adding to the views of the Financial Markets Authority (FMA) in its first monitoring report on practices in sales and advice within New Zealand’s financial services sector released on 17 November. (Our Financial Services News Alert on the FMA’s monitoring report is available here, and the report is available here).

Despite the sweeping breadth of some of the recommendations made in the Report, and the resulting controversy over its scope, it will no doubt generate much needed discussion and debate on the topics covered and recommendations made, and may provide the catalyst for change in the way life insurance products are marketed and sold in New Zealand in the future, in line with changes that are being introduced to the regulation of life insurance sales practices across other jurisdictions, and in particular, Australia.

What does it cover?

The FSC’s terms of reference for the Report were that it should address:

  • The inherent conflicts of interest that exist between insurers, advisers (and adviser groups) and customers;
  • The need for commissions and other remuneration for advisers if under-insurance is to be addressed;
  • The impact of high initial commissions to insurers and customers including solvency and premium level impacts;
  • The role of advisers and their requirement for remuneration;
  • The impact of churning (sale of replacement policies) to insurers and customers including Bank sales practices;
  • Potential solutions to these problems including possible regulatory responses and market solutions and any transitional requirements.

FSC also required the report to be peer reviewed by John Trowbridge, chair of the Australian Life Insurance Advice Working Group which produced the “Trowbridge Report” in March this year in response to concerns raised by the Australian Securities and Investments Commission (ASIC) in 2014 in relation to life insurance sales remuneration structures, product design issues and quality of advice. The MJW Report makes similar and in some areas more extensive recommendations for changes to the New Zealand life insurance industry to those contained in the Trowbridge report.

What is the problem the Report seeks to address?

The Report points out that life insurance (personal risk insurance) is a financial product that is sold, not bought, and therefore those that are engaged in the advice and sales process need to be appropriately remunerated for their services.

Historically, life insurance companies maintained a sales force tasked with the role identifying individual customer need and placing their risk insurance products to meet that need. This in-house sales model shifted to a largely outsourced model during the 1980s, and most life insurers in New Zealand now rely on financial advisers or adviser groups for a large portion of their personal risk insurance sales. The commission based remuneration structure inherent in these outsourced arrangements has become entrenched in the life insurance industry to the point that no single insurer can introduce changes (reductions) in the current commission based model without risking loss of sales to other insurers. This is referred to in the Report as first mover disadvantage, and underpins the authors’ recommendation for legislated regulatory change.

The Report suggests that the range of upfront or initial commission paid to advisers for sales of new and replacement policies is commonly between 180% and 200% of the annual premium and can be up to 230%. This is about twice the average upfront commission paid in other jurisdictions, whereas renewal commission is paid at around 7.5%-10%. The Report finds that the combination of very high upfront commission, with lower renewal commission provides a real incentive for advisers to churn policies after the initial 2 -3 year commission clawback period and leads to an inevitable conflict of interest for advisers. The Report draws the conclusion that this incentive to churn policies leads to poor outcomes for customers (whose interests may not be met by the replacement policy sold to them) and unnecessarily high costs for insurers, which are passed on to customers in higher premium costs.

The authors consider that, although the FAA imposes statutory duties on advisers to consider the financial goals and circumstances of their customer when providing financial and product advice, and to disclose remuneration structures including relevant commission payments, these statutory provisions are not sufficient on their own to ensure conflicts of interest are appropriately managed by the adviser for the benefit of the customer.

The Report therefore makes a number of recommendations for regulatory change in the industry and in particular the reduction in reliance on use of commission based remuneration structures. Such changes would be introduced progressively over a three year period to provide the industry time to make necessary adjustments to their current adviser and sales models.

The Report is not solely focussed on adviser behaviour in the risk insurance sales process. It also identifies areas where insurers themselves can do better in the area of product design and replacement insurance application processes, to reduce the risk of inappropriate policy churn, and also increase the uptake of personal risk insurance in New Zealand. The Report also makes a number or observations in relation to the direct sale of insurance by Banks alongside their banking products, which has been an area of growth.

What are the recommendations?

The Report makes a large number of recommendations for change. Of particular note are the following:

  • Role of financial advice, and advisers under the FAA:

– A clear distinction should be made between ‘product placement’ (sales) and independent financial advice that should precede product placement. – The designation of Registered Financial Adviser (RFA) be dispensed with, and all independent financial advisers be designated Authorised Financial Advisers (AFAs). Employed or contracted representatives of insurance companies should be categorised a QFE advisers (responsible for product placement only). – AFAs must operate as truly independent advisers, and be required to access and advise on the products of multiple insurers, so that they can fully comply with the Code of Professional Conduct to act in the best interests of customers. – A new governance process for monitoring and compliance should be established involving both FMA and professional associations. – The role of QFE advisers should remain unchanged but disclosure obligations to customers must make clear that they act in a purely representative role for the QFE, and that remuneration structures are also clearly disclosed. – The adviser should disclose the premium for the recommended product, any commission payable by the insurer to the adviser or QFE and the corresponding premium if no commission was payable. – Advisers and insurers should work with MBIE to simplify the form, content and method of providing adviser disclosure under the FAA.

  • Remuneration:

– A new model for adviser remuneration should be introduced over a three year progressive transition period during which the maximum permitted initial commission and servicing commission will reduce, culminating in the following final model to be in place three years from the commencement date:

Initial commissions on new policies: a maximum of 70% of annual premium (comprising 50% initial payment and 20% servicing commission (obliging the adviser to provide follow up advice) with a cap based on a $5,000 premium). This represents a significant reduction from the current common level of initial commission of between 180% and 200% of annual premium.Initial commissions on replacement policies, written within 7 years of inception of any existing policy: initial commission payable only on any increase in premium over existing policy, and not exceeding 50% of the premium increase.Servicing (renewal) commission: a maximum of 20% of annual premium (instead of current common level of 7.5%-10%) should be payable to the adviser nominated by the customer as providing current adviser services (who may be different from the adviser who sold the policy originally).No volume based incentives in cash or kind.Customer paid fees for service.

  • An industry wide replacement policy process:

– The process should be one that provides assurances to the new insurer and protection to the customer, particularly given the risk of inadvertent non-disclosure when a claim occurs. – Insurers should maintain legacy products and update existing policies with policy benefit upgrades to reduce the incentive to replace with a new policy offering additional benefits. – In line with health insurance premium practices, premium rate structures should be maintained for annually renewable policies to reduce the incentive to replace a policy with a new policy with a cheaper premium rate structure. – Customers applying for a replacement policy should be required to complete an application form answering questions to identify whether the customer has been recommended the policy by an AFA or QFE adviser, and if so, that adviser will need to provide a range of undertakings to the insurer and customer including with regard to the customer’s needs analysis, reviewing the benefits under the replacement policy in comparison with those of the existing policy, and explaining the benefits under both policies to the customer.

  • FMA should become market conduct regulator for life insurance industry and the life insurance industry should adopt a Code of Practice to be supervised by FMA

– The Report’s authors note that the life insurance industry was left out of the scope of the Financial Markets Conduct Act 2013, and it does not have a professional code of conduct in force. – The Report’s authors therefore consider that life insurers would benefit from being bound by a code of conduct similar to the Fair Insurance Code adopted by general insurance members of the Insurance Council of New Zealand, or the Authorised Financial Advisers Code of Professional Conduct, regulated under the FAA. The authors also consider that the life insurance industry should be supervised by dual regulators (similar to the Australia regulatory model where APRA undertakes prudential supervision of regulated entities and ASIC regulates market conduct). In New Zealandthe Reserve Bank of New Zealand would continue its current supervision of licensed insurers under the Insurance (Prudential Supervision) Act 2010, and the FMA would be the market conduct regulator.

  • A progress review of the life insurance industry transformation in 2020

– The Report’s authors acknowledge that, aside from the fact that a number of financial advisers are likely to leave the market, the full consequences of such changes cannot be foreseen in advance. They therefore recommend a full review on 2020 to assess the effects of the changes once implemented.

  • KiwiSaver investors to be able to purchase life insurance cover

– To address the low level of life insurance cover in New Zealand by comparison to other developed countries, the Report’s authors recommend that KiwiSaver members be permitted to apply a portion of their annual contributions to pay for group life insurance cover made available through their KiwiSaver fund once their contribution levels have reached a minimum required level.

Our view

We consider that the Report makes an important contribution to stimulate vital debate that needs to occur in New Zealand, despite the Report’s limitations and the degree of controversy that has attended its development and publication.

Due to time constraints in the preparation of the Report the authors note that, although they were able to collect a range of data from insurers and talk to a number of industry groups and stakeholders, they have not conducted detailed independent research or analysis on the issues, nor have they been able to seek extensive input and feedback from industry participants before finalising their report. They did, however, have the benefit of numerous as well as drawing on overseas reports and developments in this area to inform their recommendations.

It may not be surprising therefore that the recommendations in the Report largely follow those made in the Trowbridge Report, and align with similar changes proposed by the financial services industry in Australia for the reduction in commission based payments in the life insurance industry. However, it does mean that the opportunity has not been taken to canvas more broadly the models followed in other jurisdictions around the world, or to critically evaluate whether the Australian model will be successful in achieving its objectives. But it is hoped that the MJW Report may be a catalyst for others to make contributions to the debate.

In light of the limitations noted in the Report, it is important that the views expressed and the recommendations made should be regarded as personal to MJW and not indicative of an industry-wide view of the issues discussed. There is no doubt however, that the Report’s sweeping and ambitious recommendations are worthy of consideration as part of a wider industry review of commission based sales and policy placement processes.

What next?

If you have any questions in relation to this news alert or the Report, please contact one of our experts.