Financial Adviser 1 “It would be good to catch up for a coffee.”
Financial Adviser 2 “Yes, we must do that when things slow down a bit.”
This conversation could have occurred, and no doubt one did occur, yesterday, however, originally these words passed between two business associates 20 years ago. Sadly, the chances of the coffee-catch up are no greater today than then.
The juggernaut of change that has rolled relentlessly over the life insurance industry in Australia during these last 20 years is unlikely to slow in the coming 12 months; in fact, odds are, it will accelerate and increase in size.
Hot topics of the past will continue while new ones will be added to the list:
  • how will the industry fare post departure of the banks?
  • will the Code of Practice carry the punch of Donald Trump or simply the dreams of Don Quixote, and, of course; 
  • commission – will the Royal one result in the end of the other one?
Each could well be the topic of an article in its own right, but not on this occasion. 
The chosen topic is something that currently resides in the back room, yet if brought into the light and handled correctly, it might shoot significant holes in one of the great challenges facing the industry:
  • the gun is the debate surrounding adviser remuneration; will traditional commission-based remuneration remain viable or is there an inevitable move to innovative fees for advice models;
  • the trigger is the urgent need for a revolution and evolution of risk insurance product; and 
  • the bullet is, quite simply, the drive, imagination and experience of financial advisers and licensees.
The topic is the theoretical facilitation of risk insurance remuneration change by way of the development of a wholesale rate, advice-based, risk insurance product range with the change being championed, not by the manufacturer, but by distribution.
From the adviser perspective, the sentiment surrounding remuneration has been split between a resolve that commission must remain and a desire to move to fees but, whatever the sentiment, the obstacles remain, and, at times, they appear insurmountable: 
  • clients may not see the value of advice and will thus be unwilling to pay a fee;
  • low net worth clients will not be able to afford to pay a viable fee; 
  • if an adviser charges a fee, clients may switch to a commission-based adviser; 
  • etc, etc, etc ……
The objections are, of course, perfectly reasonable, however, arguably a way forward is achieved by focusing on the crucial issue, is it in fact possible to make fees acceptable to the client, financially viable for the adviser and beneficial to both, bearing in mind there is apparently only one way to fund fees; i.e. by way of a reduction in the risk insurance premium cost? 

Commission dial-down

When the subject of fee-funding by way of a reduction in risk insurance premium is raised, the first, the most basic and often considered the only way to do this is to implement a dial down of commission.
“If you dial down commission to Nil and thus, take the commission load out of the risk insurance premium, you may be able to charge a fee.”
The problem is, of course, that the circa 30 per cent premium reduction arising out of a 100 per cent dial down of commission, is generally considered insufficient to fund a viable fee for advice.
Thus, whilst commission dial-down may be a reasonable starting point, for the sake of brevity, it will be considered no more than that; i.e. other options need to be found.

Wholesale rate, risk insurance product

Contrary to popular perception, dial down commission is to a wholesale rate, what chalk is to cheese.
To appreciate the difference, it is necessary to consider the various components of risk insurance premium, and the direct and indirect impact advisers and licensees can have on them.

(a) Commission 

It has already been acknowledged that when commission is dialed down to Nil, premium reduces by up to 30 per cent; however, in addition to direct commission costs, there are:
  • costs associated with systems to support commission; and
  • adviser and licensee insurer-funded benefits.
If a product is designed in which there is no commission option available, additional savings to the insurer flow on, for example, there is no need to design and maintain a commission system resulting in a premium reduction in the order of one to two per cent.
Similarly, the removal and/or rejection of insurer funded benefits such as lunches, conference funding and the like, might bring about a similar saving.
Adviser and licensee impact on the commission component of premium is all but absolute as it is ultimately their choice whether or not to utilise a commission-based remuneration model.

(b) Claim pool 

This is the pool of funds from which claim benefits and expenses are paid. 
When setting the claim pool contribution, the factors an actuary will consider, over which the adviser and licensee have influence, include:
  • policy terms and conditions, crucially the generosity of definitions and benefits;
  • underwriting practices, with ‘prudence’ being the ideal; and
  • claims experience.
The matter of policy terms and conditions, will be considered later in this article.
In regard to underwriting practices; rather than reducing requirements, an increase in them may have merit as this might serve to both reduce insurer costs by way of improved claims experience and increase adviser safety by way of a reduced chance of misunderstandings and disputes at the time of claim. 
Examples of prudent changes in underwriting practices might include:
  • full, rather than abridged, underwriting;
  • no take-over terms;
  • compulsory proof of income; and
  • reduced non-medical limits.
The great unknown is, of course, the positive impact informed, adviser involvement in claims management might have on the insurer’s claims experience and, flowing on from this, risk insurance pricing.
Rather than simply assisting in the completion and lodgement of the initial claim form, the adviser might duplicate the robust initial advice process at the time of a claim:
  • fact-finding with the claimant to ensure all relevant information is recorded;
  • analysis so that potential issues and opportunities are identified;
  • research so that advice provided is comprehensive and sound; and
  • recommendation as to how best to proceed with the claim.
Then, and only then, is the claim form completed but when it is lodged, it is accompanied by such additional information as might be reasonably necessary for the insurer to undertake a comprehensive initial claim review. 
What should follow is a faster claim assessment, a more appropriate claim outcome and fewer problems going forward. 
Whilst the above underwriting and claims management practices add to the administrative burden of the adviser, if fees are being charged, this will be appropriately reimbursed. More importantly, however, all parties - insurer, adviser/licensee and client, will reap crucial rewards, some financial and others not. 
As for premium reductions, changes such as the above might bring with them reductions of five per cent or more.

(c) Expenses 

Examples of expense impact areas might be:
an increase in the policy minimum premium, say, from $300.00 to $1,000.00 with the logic being, advice-based recommendations are less likely for insurances under the increased minimum amount so why not simply recognize this;
  • setting a minimum average premium at a licensee level which, in part, might overcome any concern about increasing the policy minimum premium; and
  • mandatory use of on-line applications.
Premium reduction, a further one or two per cent.

(d) Profit

An adviser recommending the products of an insurer with known profit problems, would certainly be opening themselves and their licensee up to criticism at best, with litigation likely. 
Unsustainably low insurer profit margins can lead to:
  • premium increases;
  • expense reductions which may reflect in poor client service standards;
  • restrictive claims assessments and management; and, at the extreme end,
  • withdrawal of the insurer from a particular product type or divesting of the risk insurance portfolio.
Whilst the primary focus of a wholesale rate risk insurance product is the bringing about of premium reduction, there should also be an acknowledgement of the merit of improved insurer profitability.
Following on from the above, the development of a wholesale rate risk insurance product should take into account, not just commission dial-down but ALL areas of adviser and licensee impact on premium pricing. 
Whilst the premium reduction associated with each change may not sound like much, the quantum of potential changes is such that the overall impact on premium can be considerable.  
Thus, the wholesale rate will take as its starting point the “up to 30 per cent” dial down commission premium reduction. Adding to this, further reductions flowing on from other changes made as exampled above less that proportion retained by the insurer to ensure reasonable profit and sustainable pricing. Net additional premium reduction associated with a wholesale rate risk insurance product could well be in the order of 10 per cent or more.
To date, the entire premium reduction contribution has been made via non-contractual changes. The third and final piece in the product puzzle is in the contractual area; how to evolve a research-based product into an advice-based one.

Advice-based risk insurance product

Arguably, for too long, product design has been driven by risk insurance research such that it is generosity-based rather than needs-based with resultant contracts being unnecessarily complex, cumbersome and the antithesis of advice-friendly.
Now whilst generosity is certainly to be preferred to the Draconian contracts of the 1970s and 80s, a product infused with an advice philosophy will have the reasonable rights and obligations of the insurer and client delicately balanced such that the Pendulum of Equity is very much in the vertical position.
By way of example, with the examples being in no way representative of the full range of changes that might be considered:

(i) Term insurance

The term insurance need has traditionally and simplistically been portrayed as “a lump sum to reduce/remove debt with the returns from the invested balance replacing the income of the deceased breadwinner.”
The crucial issue is, however, not so much the specific need, because that will vary from one client to another, but rather the fact that the need will likely be made up of two, separate and distinct components; a capital component (debt reduction/removal) and a revenue component (replacing income of breadwinner).
Up til now, the sole solution has been term insurance, which provides for a lump sum payment; ideal to satisfy the capital need, but less than ideal for the revenue component, as it requires capital over-insurance to be put in place so the “balance can be invested to satisfy the revenue need.”
This product design “flaw” unnecessarily increases the total premium because the cost of insuring a lump sum can be up to three times the cost of insuring the equivalent revenue stream
An advice-based term insurance product would provide for both within the recommendation: 
  • a lump sum of $X to reduce/remove debt; and
  • an indexed revenue stream to age 65 of $Y a month.
In an holistic model, the revenue stream would only be required to age 65, after which superannuation savings would take over.
Whilst issues such a tax, etc have been ignored, the point remains, even within term insurance, there are ways in which to bring about significant cost savings and, in the process, potentially enhance the ability of the adviser to make an appropriate recommendation.

(ii) Total and Permanent Disability (“TPD”)

The position with TPD is similar to that of term insurance, in so far that there is a capital need, debt reduction/elimination, medical expenses, etc and a revenue need, current recurring expenses that will be ongoing and new recurring expenses that will arise. 
The widespread availability of revenue options under TPD, would lead to a similar proportional cost reduction as that under term insurance.
Additional savings flow on if the definition of TPD is split between Own and Any occupation, recognizing that an inability to perform one’s Own occupation will result in a financial loss, with that loss increasing if the inability extends to Any occupation. 

(iii) Trauma insurance

The trauma insurance need has been characterized as:
  • provide funds for the best possible medical care and rehabilitation services; and
  • fund appropriate lifestyle changes.
Currently, a 100 per cent trauma insurance buy-back facility is available but if an insured suffers two distinct trauma insured events on separate occasions, whilst medical and rehabilitation costs will be incurred for each, arguably, there will only be one lifestyle change cost.
A relatively simple trauma insurance product change would recognize the above via the buy-back facility, bringing with it, an appropriate cost reduction on the initial product.

(iv) Income protection insurance 

It is within the income protection insurance product that the main changes and premium reductions (estimates stated or shown in brackets) might manifest.
Removal of ancillary benefits, leaving the core risk benefits as the base product, up to a 20 per cent cost reduction. This would enable those ancillary benefits (blocked by type) appropriate to a particular client, to be added on an optional basis at the time of application and then removed when no longer required or as a means of cost control, later in the policy duration. 
Duplicated ancillary benefits such as crisis and death cover, might be permanently removed; enabling a more streamlined recommendation to be made within the trauma and term insurance product.
Other possible changes:
  • agreed value might give way to a 12-month average over a five-year period, indemnity product; enabling lifestyle protection rather than, arguably, windfall protection. (five per cent);
  • indexation, cancelled after three refusals (two per cent), limited to 75 per cent of earnings (two per cent) and ending at age 55 (four per cent); 
  • standard offsets (five per cent); 
  • partial disability requiring seven days total disability (three per cent) or 14 days total disability (five per cent) might be considered; and last, but by no means least,
  • a more “prudent” approach to the current total disability benefit (up to 10 per cent).
“Heresy” might be the call, with fears of a return the days of Draconian Life. The restraints of space do not allow a comprehensive response; suffice to say, concerns can be allayed both within the product design and the advice process; for example:
“I am suggesting that you do not require indexation of your benefit after age 55 with the reason being that, the substantial premium savings made with this product between now and age 55 will be diverted into your superannuation savings. Projections show that, by taking this action, your need for income protection insurance after age 55 will actually and considerably reduce rather than increase.”
It is not difficult to see that product changes of the kind suggested above, would result in premium reductions of anything between 10 and 30 per cent.
When this is added to the dial down and wholesale rate reductions, the total price break could be something north of 50 per cent; potentially sufficient to fund a viable move to fees for advice. 
Over time, however, as premiums increase due to age and/or CPI additions, dollars saved will grow to many thousands of dollars each year and many tens of thousands of dollars over the life of the policy.
As represented above, the diversion of these savings, even net of an adviser fee, into retirement savings will enable further risk premium cost reduction as the risk insurance need diminishes. 

How do we get there?

There has been much debate about risk insurance remuneration, product design and the merit or otherwise of the role played by the insurers over the last 20 years in each of these.
That role might be portrayed as constantly seeking to improve policy definitions and benefits, leading to frequent, innovative product upgrades or it might be perceived as the veritable hi-jacking of product development to satisfy a voracious appetite for new business production at the expense of making available risk insurance solutions that facilitate sound and appropriate advice. 
Those favouring the portrayal are likely to support a continuation of the status quo.
Those believing that perception is reality, may see the merit in a changing of the guard, manifesting as distribution taking the initiative and playing a far more dominant role. 
Col Fullagar is the Principal of Integrity Resolutions Pty Ltd

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This is an interesting article. The points made seem valid to me.

How do we get these onto the product manufacturers agenda?

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