Running the risk

The risk insurance sector has been walking the tightrope between against-all-odds survival and crisis point for almost a decade now.

While some stakeholders have written off the issues affecting the industry - like high claim rates, challenged remuneration structures, lapse, churn and underinsurance - as a passing storm, others have been vocal for years about the need for rebirth.

From a regulatory point of view though, it has become clear that 2015 is the year all cards are laid out on the table and the industry is given an ultimatum — reform or die.

"We have run out of time and options," TAL outgoing CEO, Jim Minto said on the state of the industry.

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"We either do it together and work out a solution together, or we'll have it imposed on us one way or another."

At the centre of the restructure are two reports - the Australian Securities and Investments Commission's (ASIC's) Review of retail life insurance and the Trowbridge Report, commissioned by a working group comprised of the Association of Financial Advisers (AFA) and the Financial Services Council (FSC).

ASIC left no uncertainty about its view that the quality of advice around life insurance has been adversely affected by remuneration-related conflicts of interest — something it said was rampant.

"Our findings in this review indicate that the impact of adviser conflicts of interest on the quality of advice is an industry-wide problem. Addressing this problem will require an industry-wide response," it said.

But such a response could lead to "significant detrimental consequences" for both planners who recommend retail life insurance to the early accumulator client segment and to consumers, according to IOOF's business development manager, Risk, Peter Stathis.

"The potential outcome could be clients not receiving cover and advisers not providing advice to clients unable or unwilling to pay the required fee," he said.

Trowbridge acknowledged that the material cost of underwriting policies warrants some commission structure, but its proposed alternatives have still attracted the scepticism from the adviser side.

With such varying opinions about the ideal solution to the question of remuneration, it will be near impossible to find a compromise that satiates, or even appeases, all stakeholders.

The commission conflict

If regulators were to step in tomorrow and ban upfront commissions, all but the very mature or vertically integrated businesses would be squeezed out of the advice framework, according to Synchron director Don Trapnell.

New entrants to the market would have little capacity to sustain themselves, he said, while independent advice channels would collapse thanks to dwindling cash-flow.

"There is a potential in our industry today to reduce that advice channel drastically because of the different remuneration models being promoted and that is a serious concern to us," he said.

John Trowbridge's interim report put forward several alternatives, such as a level or hybrid commission structure, and rejected the idea of a "nil commission model".

But Trapnell said none of the alternatives are adequate unless the advisory is very well capitalised.

"We looked at our numbers of our own business, in the event of a level commission being the only remuneration model available, that turned out a 32 per cent drop in gross revenue for Synchron without a commensurate drop in expenses. That's a $1.6 million drop in revenue," Trapnell said.

"Under a hybrid model there is a substantial reduction in the level of upfront commissions from an average of 100-110 per cent, down to around 30 per cent. A mature licensee could fund that, anyone trying to start a licensee wouldn't have the revenue."

Specialist risk adviser and director of Mr Insurance, PJ Byrne, switched to a hybrid commission structure in the last 24 months and he said it was a good choice for his business, but only because it had a strong cash flow.

"We're a very well established business… There's no way in the last 12 years we could have done that," he said.

"If it gets harder, advisers are going to have to make decisions to look to other industries.

"One thing that's been missed a bit is, since I started, there's been more regulatory requirements, more training, our professional indemnity has gone up, but our remuneration models haven't increased."

TAL's Minto said the question of commissions is a vexed one, with changing expectations making upfront commissions difficult to rationalise from a consumer perspective.

However, he said the cost of delivering advice has several fixed elements to it and stressed any solution conceived by the working group must be careful not to price out the smaller customer from the advice market.

"We must design a solution for the wider customer market… Australians need advice. We know when a person gets advice they have a far better prospect of having an appropriate sum insured than when they don't get advice; advice is enormously valuable," he said.

IOOF's Stathis agreed and said those who will miss out will likely be working families, who are most at need of guaranteed-renewal insurance cover.

Zurich's general manager of retail, life and investments, Phillip Kewin, added: "quality life insurance advice can be expensive to prepare, deliver and implement."

"Regardless of whether an adviser is paid by fee or commission, it is vital that they are remunerated appropriately for the cost to serve."

An industry under pressure

From the insurance side, the industry has been facing similar headwinds, in the form of high claims, lapse and questions around the sustainability of income protection products.

"There have been billions of dollars wiped off life insurance," Minto said.

The industry's performance expectations have now been reset at a much lower level and insurers are seeing some evidence of positive performance — but only at that very low base, he said.

"Lapses went up and stayed up. They've gone from around 13 to 17 per cent and they've stabilised, (but) that four per cent change has become ‘the new normal'.

"And then claims have gone up and pretty much stayed there," he said.

Both Kewin and Minto singled out income protection as a major problem area in the life space, with insurers largely unable to keep up with growing claim levels.

"There's been no money made in the income protection market in the last five years," Minto said.

The short-term solution has been for insurers bundle income protection with death cover, but Minto said that's grossly unsustainable and a better solution must be created.

"In this market, if we keep designing products and having to reprice them years later, then we are going to annoy and burn off consumers."

Mr Insurance's Byrne agreed solutions must find a balance between competing interests.

"The manufacturers commercially have to compete, they change products, they change premiums… (But) we have make sure our clients are getting the best arrangements," he said.

A direct challenger

Along with remuneration structures, advisers have also had to grapple with the emerging threat of direct life insurance channel, a platform that has provoked varying responses from the industry.

A frequent question Byrne receives is "why would I purchase life insurance with you, when I could just call up Real (Insurance)?"

It's not an easy one to answer, according to Synchron's independent chair, Michael Harrison, who said consumers had to choose whether they wanted to pay commissions or for direct's advertising spend.

"The cost of doing direct business is all about advertising upfront. (They) don't pay commission, (they) pay for advertising," he said.

IOOF's Stathis said the adviser's value proposition was his or her knowledge of appropriate cover levels and ability to find the right cost savings.

"While these direct options may attract interest from the consumer initially, investigation of the premiums, and terms and conditions of some direct products shows that clients who take advised (retail) insurance cover will finish up with better, less expensive cover," he said.

"The challenge for the advice profession is to persuade the average consumer that seeking advice from a professional risk adviser beforehand will lead to a better outcome in the long run."

Finding middle ground

Despite divergence from stakeholders on the answer to the life insurance dilemma, most agree that any solution must ensure the longevity of the industry and maintain an advice market.

"I don't know how the industry will grow to solve the underinsurance (problem) if advisers can't grow their business," Byrne said.

Synchron's, Don Trapnell, said without life insurance, the cost of social security would skyrocket.

"There is a good argument for supporting our industry and that equates to a good argument to make sure the industry is properly managed and properly regulated," he said.

However, if the industry were to lose, or diminish, the advice channel, research shows insurance cover would decrease substantially, he added.

"We know from studies undertaken by KPMG, on behalf of the FSC, that where a client gets advised correctly, as opposed to going direct, generally it's round about three times the level of cover is obtained by that family and at least some degree of understanding about what they've got, what they've purchased."

TAL's Minto said the remedy to the life market's issues will be in maintaining that integrity of advice, while responding to evolving consumer and capital markets.

"It's very disappointing for the life sector that it's been unable to come up with an agreed position earlier and now we've been given an ultimatum, in effect, by the regulator.

"I am optimistic because if we don't do something here, we won't be operating. We have to do it or the model will break."