Who is responsible for life/risk insurance churn?

Churn in the life/risk space remains a contentious issue, but as Col Fullagar explains, responsibility not only resides with financial advisers but also with the insurers and how they monitor activity levels in the sector.

Arguably, over the past few years the risk insurance No. 1 “most clicked” has been “underinsurance”. Calls to rid us of this ‘vile spot’ have come from all quarters, and in the process it has been linked to almost as many social woes as the carbon tax.

In recent times, however, its reign of supremacy has come under threat by a perennial Top 10 performer – upfront commission.

More precisely, the rumoured link between it and its namesake, the 1960s dance craze “The Twist”.

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For the sake of clarity, the following terms will be defined in this article to mean …

Upfront commission - a form of adviser remuneration where, upon completion of the application, a proportionately large amount of commission is paid, followed on subsequent policy anniversaries by much smaller amounts of commission – for example, 110 per cent, 10 per cent, 10 per cent, and so on.

Twisting, or churning, as it is more recently called – is the act of an insured (under the influence of a financial adviser) cancelling, or allowing to lapse, an in-force insurance policy with a view to then immediately or soon after replacing it with another policy that provides equivalent or similar coverage.

“Similar or equivalent” might be by virtue of the benefit amount, the type of benefits insured or the purpose of the cover being put in place.

The new policy can either be with the same or a different insurer. 

The perceived link between upfront commission and churning is that churning, as defined, is not client-focussed, it is financial adviser-focused – designed to give the adviser access to further upfront commission resulting from the cancellation of the policy occurring outside the commission responsibility period.

Insurers, industry bodies and even politicians all seem to be clicking onto the topic of churning, with opinions varying between those denying a material link through to those calling for a McCarthy style purging of upfront commission and all those associated with it.

Churning versus replacement business

It is acknowledged by most that not all insurance that is cancelled and subsequently reissued falls within the definition of churning.

Walking a fine but important line of differentiation to churning is what will be termed replacement business.

Replacement business is the same in all respects as churning, except that cancellation and reissue is resultant on the findings of an appropriate advice process and the focus of the process is the client, rather than the financial adviser.

Relevantly, therefore, if an action is to be categorised as either churning or replacement business, the only way to do this is to look at the areas of difference – ie, the advice process.

The reasons for the valid replacement of business are many and varied, for example:

• Client’s circumstances change, making current insurance inappropriate – either in its own right or in comparison to other insurance available elsewhere;
• The client’s circumstances remain the same, but new types of products become available or access to existing products becomes broader;
• Alternative cover at a lower cost, improved underwriting and/or improved benefits become available;
• The service standard or claims management of the current insurer materially deteriorates or those of another insurer significantly improve;
• Policy features and/or administrative facilities change – for example, in regards to ownership, splitting of cover, etc.

In these situations, if an adviser does not take some action the insurance would likely be cancelled and not replaced or it might remain in place on an inappropriate basis, which would not only leave the insured and adviser financially exposed but also lead to underinsurance being more ‘clicked.’ 

It is important that the integrity of the advice process is maintained by making a clear distinction in terminology between churning and replacement business.

Notwithstanding the above, it is also the case that an element of churning exists. The challenge, of course, is to identify, measure and correct it. 

Particularly in regards to the latter element of correction, a number of suggestions have been made.

Churning timeframes

One idea being mooted to combat churning is to link it to an apparently arbitrary time frame – ie, policies replaced with similar policies within five years are automatically deemed to be the subject of churning.

To do this is to potentially cast aspersions on an adviser who is simply doing the right thing or who is caught up in one of the countless scenarios, for example:

• Mrs Jones inadvertently allows her insurances to lapse; her adviser finds out and rewrites them with another insurer on slightly more favourable terms; or
• Mr Smith’s insurance had been medically loaded. He changes advisers and his new adviser has ‘preferred status’ with a particular insurer. The insurance is replaced at a 7 per cent premium reduction.

If the original policies had been in force for less than five years, the financial adviser is inequitably labelled a “churner”.

On the other hand, an adviser who buys a mature book of business might get away with the wholesale churning of that book to new insurances.

In today’s dynamic times, a client’s circumstances can change overnight and it would therefore seem illogical to penalise an adviser simply because five years seemed like a good idea.

It hardly seems that a sound solution will derive from elements that might appear to be arbitrary, inequitable and illogical.

Responsibility periods

Another idea being mooted is to address churning by way of extending the commission responsibility period.

Currently, the generally accepted norm is that commission – upfront or otherwise – is subject to a 12-month responsibility period, with various clawbacks applying.

This has not always been the case.

During the 1980s and early 1990s, responsibility periods were two years with 100 per cent clawback in the first year and a proportional clawback in the last 12 months.

In the mid 1990s, the position changed when an insurer introduced a 12-month responsibility period and the others simply followed.

No doubt, the others followed as a result of financial adviser pressure, but that does not mitigate the insurer’s right of free choice – it simply explains why it was not exercised.

Historical lapse rates from these periods would make an interesting study.

Those promoting an extended responsibility period generally suggest that this period should be standard across the industry.

However, doing this would result in cross-subsidising of commission rates both at an financial adviser and licensee level.

An adviser or licensee that actively promoted business retention such that the lapse rate of their book was lower than the industry/insurer average would be subsidising those with a higher than average lapse rate.

Those with a low lapse rate may want to extend responsibility periods for longer than any mandated timeframe, notwithstanding the main objection to doing this is the contingent commission debt beyond year one.

If, however, the lapse rate of a book of business was and remained sufficiently low, it may well be possible to design a remuneration system such that there would be no clawback after 12 months.

Rather than dictating the same responsibility period for all advisers, it would seem a better outcome might be achieved by enabling advisers to choose the responsibility period appropriate for their business, with certain commercial minimums applying.

Perhaps, too, a better outcome could result if the focus was on what the remuneration system should look like – ie, rewarding client-focussed activity such as:

• The retention of business;
• The rapid completion of business; and
• A high completion rate of business.

(See also, Money Management 21 May 2009 – “Unlocking profit-based commissions”.)

If this was the focus, advisers would be financially rewarded for building into their systems client-focussed activities such as those above.

Those who did not implement this focus would be less rewarded.

If the development of sufficiently flexible remuneration systems came down to availability of insurer resources, advisers might be convinced to forgo the biannual policy tweaks so that resources could be reutilised.

Takeover terms

A third suggestion being mooted is the eradication of so-called takeover terms.

Money Management 9 December 2010 “Terms of trade” considered the subject of takeover terms in some detail.

Issues associated with the practice were listed as:

• Deterioration of portfolio experience;
• Lack of client research;
• Poor public perception;
• Problems associated with time-based exclusions;
• Claims complications;
• Misunderstanding of and problems associated with abridge underwriting; 
• Not assisting underinsurance and growth issues; and
• Impact on insurer expenses.

The conclusion drawn was:

“The challenge for advisers, licensees and insurers is to achieve the desired goals of safety, simplicity and profitability in the advice process as well as growth in the risk insurance market – but to do so in a way as to avoid more serious problems.

“Takeover terms may not be the answer.”

Irrespective of the issue of churning, the eradication of takeover terms may have merit in its own right.

Industry research

If the mooted changes to upfront commission and responsibility periods are implemented, it is likely to impact on the financial position of a significant proportion of advisers; the actual proportion and extent of the impact, of course, being unknown – which is indicative of a problem, as this is not the only aspect that is unknown.

It seems that solutions are being floated, with the risk of minds being made up prior to the appropriate and necessary research being undertaken – or maybe the research has been undertaken but just not made available.

Traditional wisdom dictates that decisions should be based as much as possible on facts, for example:

• Is churning undertaken by a small number of advisers or is it more widespread;
• Is it more prevalent with particular licensees;
• Is it driven by the practices of particular insurers; and
• Are there reasons for it other than commission? 

Research is also important because it feeds both perception and reality, and is a most robust way to silence criticism and scepticism.

Without research, the first two elements of identify and measure are, at best, difficult to satisfy. It may in fact be the case, however, that identification and measuring are unnecessary – ironically, because the means of correction already exist.

Insurer action

A proportion of all insurance cancelled is due to natural attrition for appropriate reasons – for example, the need has ended or a claim has been paid – and this proportion would be, on average, the same for all advisers.

The availability of insurance data is vast and the ability to analyse it is considerable.

It would seem reasonable to assume that insurers have the ability to identify those advisers for whom – and/or those licensees for which – the rate of insurance cancellation is materially higher than that which is assessed to arise from natural attrition.

The presence of a high rate could signal the presence of churning.

If there was reasonable evidence to suggest the presence of churning, the insurer could implement remedial actions involving discussions with the licensee and the adviser, and the setting (if necessary) of targets and timeframes for correction.

Corrective actions might include only accepting further new insurance business on a level commission basis or accepting upfront commission business with an extended responsibility period.

Advice documentation

As part of the advice process, if current insurance is to be cancelled, a reason for this must be given and details of benefits lost must be provided.

Whilst cursory reasons do little to inform the client or to protect the adviser to the extent that the reasons are robust and compelling, a clear distinction between churning and replacement business would exist.

In this way, churning could be identified at a subsequent audit by the licensee.

Measurement would be at the licensee level and simply require the setting up of a register system or the establishment of mandatory reporting in regards to this aspect of advice by the licensee.

To correct the problem would also be a licensee responsibility, bearing in mind that churning per se is not in the client’s interest and thus the prevention of it lies with the licensee.

If this type of approach was taken, there would be no apparent need for insurer intervention nor would there be a need for advisers involved in the genuine replacement of business to be financially penalised or unfairly treated.

Summary

No doubt the ‘clicking’ will continue around the subject of churning and the various proposed solutions to it.

It is hoped, however, that the focus is not simply on the perceived problem with a view to finding a possible solution, instead, the focus should also be on what the relevant components of the risk insurance advice process should look like – get that right, and we might bury the problem of churning and do a merry dance on its grave.

Col Fullagar is the principal of Integrity Resolutions Pty Ltd.