With the Trowbridge report due to be tabled on Thursday, there has been a lot of discussion in the industry on the impact on changes in adviser commission. Without pre-empting the findings of the report, by all accounts it will be nasty for advisers and will represent significant change if implemented. The draft report released in December, mentions that any changes will need to be authorised by the Australian Competition and Consumer Commission (ACCC). In recent weeks, it has been rumoured that moves are on foot to bypass the ACCC and move straight to legislation. This was confirmed by a press release from the Association of Financial Advisers who dropped a bombshell on Friday by stating:
“The Assistant Treasurer and other members of parliament could have strong views around these options. The FSI recommended a legislated solution. This may take some time to resolve”.
The ACCC should not sit on the bench during this process for the simple reason that the Murray, ASIC and Trowbridge reports are all silent on the long term competition implications to the industry from the proposed changes. To prove this point, do a document search in each of these reports on the word “competition” you will draw a blank, and that’s not surprising given that none of the aforementioned organisations have the specialised expertise or the mandate to look at industry competition. That is the job of the ACCC!
So why are the FSI looking to bypass the ACCC? One reason could be that the ACCC might not authorise the conduct of colluding to set commission on competition grounds. Their concern could be that the benefits from authorising the conduct may not outweigh the costs to consumers from reduced competition in the industry. If this is the reason, this article attempts to address what the ACCC might look at by doing a back of the envelope competition analysis, similar to what the ACCC might do, to dispel some of our industry myths around what is good and bad for consumers in our industry.
Myth 1: Churn is bad
The ASIC and Trowbridge reports both expressed concern at the level of customer churn in the industry siting the current lapse rate, at 16% and growing, as problematic to the industry. ASIC have linked high up front commission rates and customer churn with poor advice. Whilst I don’t have the data to argue either way on that issue the part of the conversation that is missing from the discussion is economic theory suggests a high churn rate is a healthy sign that the contestable market is strong and competition is fierce. Industry reports show that a significant proportion of the churn has been customers switching from banks to independent insurance providers, who in my experience offer cheaper pricing, more competitive products and better customer service. From an end-user perspective, I am not convinced that competition regulators would automatically see a high churn rate as bad for the industry. If ASIC are correct and customer churn and poor advice go hand-in-hand the correct way to look at the problem is whether the benefits from improved advice outweigh any reduction in competition that might be brought about by increased regulation. The second part of the argument policy makers have been totally silent on so far.
Myth 2: Insurance companies doing poorly is bad for the industry
It’s common knowledge that insurance companies are doing poorly from a profitability perspective when it comes to income protection and doing ok when it comes to lump sum. The wash-up is that the industry has not been particularly profitable in recent times and certainly profits has been diminishing from the highs of a decade ago. It has been suggested that the industry is not sustainable if the insurance companies are not making profits. I would like to flip this around and look at it from the consumer’s perspective. The fact that insurance companies have not been able to increase prices to restore margins would be an indication that competition is sufficiently high that product providers feel constrained from increasing prices for fear of losing market share. Keep in mind that insurance companies benefit from not only providing the cover but from the investment proportion of having premiums on their books as well. The decreeing margins for insurance companies would indicate that clients are getting a pretty good deal price wise in the market right now. Any reduction in competition might lead to margins being returned for insurance companies.
Myth 3: A level commission structure will reduce insurance costs
This is perhaps the biggest myth of all and as a switch to level commission may cause consumers to pay considerably more for their insurance in the long run. The long tail nature of insurance could mean that more commission is paid to advisers on level commission compared to the current structure. Most actuaries that I have spoken to have unambiguously stated that a move towards level commission will cause prices to go up. Of course it will depend partly on the final commission structures proposed.
Myth 4: A longer responsibility period will be good for the industry
Having a longer responsibly period for commissions in general is a bad outcome for consumers and is one of the more anti-competitive proposals floating around. A longer responsibility period will most certainly decrease churn in the industry, but as pointed out earlier this might be detrimental to competition in the industry. Consider a case where responsibility periods are 3 years and after year one the price for a particular provider rises significantly (as they often do). There is a disincentive for the adviser to act in the best interest of their client by switching policies because a switch in policy will further increase the responsibility period adding more clawback risk to an adviser’s book. This could see consumers paying more for longer periods than would otherwise be the case.
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