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How sales incentives can distort the advice of insurance companies

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Life insurance providers are under pressure to disclose sales incentives, which can affect their advice and are banned in some countries. But the industry is resisting.

He was 18, unburdened by the responsibilities of life. He had no dependants, no mortgage, no debts to be a drain on his estate. Indeed, if the unthinkable happened, he would have no estate to speak of. None of that stopped a canny salesperson selling him life insurance, though the policy he signed up for was promptly unsold when his mum stormed into the insurance company’s office demanding an explanation and a cancellation.

Walking into some life insurance sales offices can be bad for your health. Reports released over the past four months suggest that some New Zealanders are being fleeced by insurance advisers, who persuade them to buy life insurance and related products that don’t suit them. And the advisers are rewarded with hefty – but typically undisclosed – commissions. They may persuade customers to unnecessarily switch policies, so they can get another commission. It’s all legal. And customers are none the wiser.

Macro alias: ModuleRenderer

Sometimes the agents’ commissions are financial; sometimes they get so-called “soft” perks such as prize draws or expensive overseas holidays. Sometimes both. Either way, it is tempting for advisers to put their own interests ahead of those of the customer. And the customer won’t even know what’s happened.

Here’s how it works. You walk into a life insurance office. The adviser will probably have several products on offer, some of which will be better suited than others to your needs.

But what if one insurance company offers a 200% commission on the first two years’ premiums (not unusual), but another offers only 100%? The difference could easily be several thousand dollars for the agent involved. One insurer may give an all-expenses-paid overseas trip to an agent who meets certain sales targets, while another one doesn’t. Or perhaps one offers a trip to Europe and another to the Bay of Islands.

The temptation to steer you towards the product of the company offering the best trip, or the biggest commission, is strong. So the adviser ends up convincing you to buy a product that isn’t ideal – or even that you don’t need at all.

Furthermore, insurance companies often pay big commissions to advisers for the first two years of a policy, but then the remuneration drops sharply or stops. This is an incentive for advisers to persuade customers to switch policies regularly, so they keep reaping new commissions, even if the new policy isn’t necessarily in the best interests of the customer. It may be more expensive than the old one, or contain nasty clauses or exclusions that will leave them (or their dependants) worse off if they have to claim on the policy.

The commission cut

In May, the Financial Markets Authority (FMA), the regulatory body for capital markets and financial services, released its review into conflicted soft remuneration from nine of New Zealand’s biggest life and health insurance companies: AIA, Asteron Life, AMP, Fidelity Life, nib, OnePath, Partners Life, Southern Cross and Sovereign. The review, which looked at life, income protection, trauma, total and permanent disability and health insurance, excluded small insurers and those – banks, for example – that sell only their own products.

The report found that, in the two years to March 2017, the nine companies spent a total of $34 million on soft commissions, including $3.8 million on events (dinners, conferences and corporate entertaining), $1.6 million on gifts (vouchers, Christmas presents and prizes), and $18 million on domestic and overseas trips.

Only the top salespeople got to go on the trips, and they always involved advisers meeting targets – selling a certain number of policies or dollar value of cover over a set time, or minimising the number of policies cancelled or moved to another insurer.

These are not day trips to Hamilton. We’re talking the Bay of Islands or Queenstown; Tahiti, China, the US or UK. In most cases, partners got to go, too.

“These trips are intended to both incentivise advisers to sell the insurers’ products and to reward them for their success,” the FMA said. “The focus on sales volumes and targets rather than good customer outcomes increases the potential for conflicted conduct.”

At the lower end of the scale, one insurer took 12 advisers on a four-day trip to Queenstown, paying for all flights, accommodation, meals and activities, including heliskiing, a wine tour and a motorsport driving experience. The total cost of the trip was $103,000, which works out to $8600 per adviser.

At the top end, serious money was spent on 20 advisers who took an all-inclusive trip to London worth $1.9 million ($95,000 per adviser).

It’s hard to imagine how you spend $95,000, even in London. Presumably that includes the cost of taking insurance company staff along too. And maybe their partners.

But soft incentives work. The FMA report notes that when one insurer stopped offering overseas trips to advisers who met the specified targets, its sales dropped by about a third in a year. To its credit, the company didn’t immediately reinstate the trips, deciding instead they were “no longer aligned with their goals of protecting and acting in their customers’ best interests”.

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The hidden cost

The FMA calculates that the $34 million insurers spent on soft incentives is 9% of the amount customers paid in premiums for their new policies over the same period. And that’s not including monetary commissions, which, for the first one or two years of the policy, can be as much as 200% of total premiums.

Ironically, it was the life insurers’ own industry body, the Financial Services Council, that first put numbers on the cost to consumers of all those adviser commissions. In 2015, it contracted insurance consulting firm Melville Jessup Weaver to look into advisers’ remuneration. Its report, which appeared in November that year, found that consumers were paying 10-15% more for life insurance than they should, because of the agency commissions that were often ridden with conflicts of interest.

The consultants’ recommendations, included:

  • forcing advisers to disclose their actual remuneration to clients (and tell them what their policies would cost without it);
  • cutting upfront commissions, which could be as high as 200%, to 50%;
  • lifting the ongoing servicing commission to 20% (from about 7.5%);
  • imposing a maximum upfront commission of $3500.

But the big one was a recommendation to ban volume-based commissions, including soft commissions.

All hell broke loose in the insurance industry. Some of the biggest companies, including AMP, Sovereign, Asteron and Partners Life, resigned from the Financial Services Council in protest. In February, the council’s long-standing chief executive, former Labour Cabinet minister Peter Neilson, stepped down after his position was disestablished. The report was filed.

The FMA says paying higher premiums is not the only risk to consumers when conflicted insurance advisers are motivated more by the prospect of a trip to London than by their customers’ interests.

“A customer may be overinsured, or underinsured … may have a policy with less-favourable terms … or with features that do not meet their needs. This may affect the customer’s ability to claim on the policy at a later date.”

Despite all this, even the most conflicted advisers could argue they aren’t breaking the law – and they’d probably be right. One section of the profession, authorised financial advisers (AFAs), must abide by a code of conduct that includes a requirement to place client interests first, but most life insurance policies are sold by RFAs, or registered financial advisers. And RFAs are under no such obligations. The main rule for them is to “exercise care, diligence and skill” when giving advice.

This, one might argue, could mean anything, perhaps even an adviser’s requirement to carefully, diligently and skilfully feather his or her own nest.

Consumer Affairs Minister Kris Faafoi. Photo/Getty Images

When unfair is fine 

In late May, Consumer Affairs Minister Kris Faafoi announced a review of insurance contract law aimed at improving consumer protections. He wants consumers to have confidence in how insurance works and for interactions between parties to be “fair, efficient and transparent”.

As a first step in the review, the Ministry of Business, Innovation and Employment (MBIE) released an issues paper covering, among other things, claims handling, disputes resolution, excessive sales pressure, and the problem of soft and hard commissions, which “may be incentivising behaviours that are negatively impacting consumers”.

The issues paper highlights another area that may shock many consumers. The Fair Trading Act 1986 regulates against unfair contract terms in most sectors, but some extraordinary exceptions for insurance companies allow them virtual carte blanche to put in any unfair clause they feel like.

For example, insurance policy documents can contain potentially unfair terms in relation to:

  • the risk insured against;
  • the sum insured;
  • the exclusions in the contract;
  • the basis on which claims are settled;
  • the requirements for disclosure;
  • “the duty of utmost good faith that applies to both parties”.

It seems astonishing that the legislation appears to be allowing insurance companies not to act in good faith, which has long been regarded as one of the fundamental principles of the contractual relationships between insurers and clients. As the MBIE document mildly puts it: “We have heard concerns from consumers about the exceptions for insurance. We understand these concerns to be that action cannot be taken against some unfair … terms in insurance contracts because of the exceptions.”

The minister’s review isn’t the only spotlight on the insurance industry. MBIE has commissioned a working group to develop a code of conduct for financial advice; its draft code is due in August. At the same time, Australia’s Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry is opening cans of worms across the Tasman, and there are ramifications here, including a “please explain” letter to insurance company chief executives from the FMA demanding assurances that the bad behaviour revealed in Australia isn’t happening in New Zealand.

The FMA has made it clear it isn’t finished with the insurance industry yet. Richard Klipin, chief executive of the Financial Services Council, says if the industry had been new in 2018, practices might look very different. But he argues that life insurance companies struggle against a reluctance from the public to confront mortality, and therefore accept the need to protect themselves.

“Often there is a tension there. The reason people take out insurance is to manage risk in their lives, but most people underinsure. They don’t get up in the morning saying, ‘Something bad is going to happen to me; I need to do something’.

“If all New Zealanders were walking around with adequate savings and insurance and KiwiSaver, I’d be going ‘the job’s done’. But the reality is we are far away from that.”

Still, Klipin accepts that in an industry where products tend to be sold, not bought, some practices need to change.

“A whole load of conduct has grown up around the industry, and if we were going to judge by 2018 standards, you might say maybe we would do it differently.

“It’s in the interests of everyone to work for New Zealanders to see they have the right product, delivered fairly. And we need to step up to the plate and make sure we are acting fairly.”

Financial Services Council chief executive Richard Klipin.

The self-regulation problem

The self-regulating Financial Services Council is working on a code of conduct, which will be announced in September and come into force next January. Details are still under wraps, including whether it will be binding, who it will cover, how it will be enforced and what penalties there will be for companies that break the rules. But Klipin is optimistic it will bring change.

“In the end, a code of conduct binds an industry together to lift standards and build trust in the sector. If people step outside the code, there have to be consequences.

“We will meet what you expect in a code. In the end, the best-functioning market is where you have engaged and knowledgeable consumers, with engaged, informed and disclosing advisers and product providers.”

Faafoi is putting his faith in a bill brought in by the previous National Government – the Financial Services Legislation Amendment Bill (FSLAB), which is before a select committee. It has the worthy aim of ensuring that financial services are provided “in a way that promotes the confident and informed participation of businesses, investors and consumers”.

The bill will bring the rules for registered financial advisers (RFAs) in line with those for authorised financial advisers (AFAs), so everyone is expected to put their clients’ interests first.

But Faafoi wants to bring errant insurance salespeople into line with better disclosure requirements: salespeople will have to tell their clients about commission structures – hard and soft.

“I want to see FSLAB improving the disclosure obligations of those offering financial advice so that consumers can make informed decisions,” Faafoi told the Listener. “Part of the work on improving disclosure will look at addressing soft commissions.”

In fact, the bill is a bit vague on this point. All the industry has to go on so far is that those giving financial advice must “disclose certain information to retail and wholesale clients. The content, timing and manner of disclosure will be prescribed in regulations and may differ from the existing requirements,” the bill says.

Industry players have been quick to push for a light-handed regime.

“To avoid an undue compliance burden, the disclosure regime must be flexible and principles-based,” law firm Chapman Tripp said in its submission to the economic development, science and innovation select committee. “Ideally, it would prescribe the substantive matters that advisers need to disclose and leave the form of delivery to those best placed to make that assessment: the advisers themselves.”

The Insurance Council, the guiding body for the general insurance industry, though not the life insurance companies, goes further, saying it wouldn’t want the Government to limit how companies remunerate advisers.

“While … we fully support remuneration disclosure, we do not support restrictions on the types of remuneration that can be provided by financial advice providers.”

The Financial Services Council agrees.

“Ultimately, the way companies choose to structure their remuneration packages is a commercial decision,” the council said. “However, the FSC strongly supports the request from the FMA to consider the nature and value of the soft commissions they provide to ensure that their use of them is supporting good outcomes for consumers.

“The key issue with remuneration is clients’ right to know the who, what and why of the advice they’re receiving and if it’s linked to remuneration at all. In other words, ensuring that any potential conflicts are properly managed and disclosed, and that the adviser is up front about them.

“This hasn’t always been the case and all of us have had to lift our game.”

Conflict "unavoidable"

Although the Insurance Council acknowledges any payment an adviser receives from any source except their client carries with it an inevitable potential for conflict, it argues that it can be managed.

“The question is simply one of nature and degree as to how likely the financial adviser would be to set aside the client’s interests for his or her own interests or the interests of his or her employer. But in our view, this misses the point.

“Conflicted remuneration is unavoidable in New Zealand’s financial services industry; it should be managed, not banned. Market innovation should not be constrained in terms of the types of remuneration that can be offered. What is critical, in our view, to protect consumers is:

  • first, the disclosure of that remuneration to consumers, so that consumers can make informed choices about the conflict(s) their financial adviser is under;
  • second, for financial advice providers to have clear and effective policies, procedures and controls around conflicted remuneration in place.”

The message to Kris Faafoi: you can trust us. But consumer-protection bodies beg to differ. Both Consumer NZ and Citizens Advice Bureau New Zealand (CAB) have been lobbying for years to have commissions banned. They cite the example of the Netherlands, where commissions on all financial products, including life insurance, were outlawed in 2013.

Photo/Getty Images

In Australia, the Government stopped short of banning commissions, but capped upfront commissions at 80% from this year. That will fall to 60% by 2020.

Andrew Hubbard, deputy chief executive of the CAB, argues that telling advisers to disregard their own interests in favour of those of the clients is a great theory but isn’t going to happen in practice.

“In an ideal world, this might suffice. But that is not the world we live in. Faced with the possibility of a healthy commission or bonus, advisers may not always heed the impulse to do the right thing. Or they may convince themselves that their interests and the client’s align, when this is not the case.

“We are not confident that simply requiring advisers to manage their own conflicts of interest will significantly increase consumer protection.”

Hubbard argues that, in many cases, disclosure just gives people lots of information they don’t know how to interpret. In the worst cases, it can give someone a false sense of trust in the adviser selling the insurance product – a warm fuzzy feeling about that lovely person who’s being so open with me.

Ironically, the Government received the same warning from its own officials in 2015. An MBIE issues paper about the financial services sector highlighted a number of “disturbing” behavioural studies, both local and international, that found disclosure can sometimes be worse for consumers than non-disclosure in terms of resolving conflicts of interest.

It found that:

  • following disclosure, advisers feel comfortable giving more biased advice than they otherwise did;
  • people receiving advice do not properly adjust for adviser bias and generally fail to sufficiently discount biased advice;
  • following adviser disclosure, clients can feel uncomfortable turning down the advice they receive, as it may indicate a lack of trust in their adviser. In fact, upon receiving information disclosure, clients tend to trust their adviser more, on the basis that they perceive an adviser’s declaration of a conflict as a sign they are acting ethically.

The MBIE paper said that if advisers were required to provide a written statement about their conflicts, clients would have time to study and absorb them. But who reads those long and often impenetrable disclosure documents? And even if people read them, MBIE argues it can be difficult to understand the impact of a conflict of interest on the advice being offered.

“In most cases, by the time a consumer is given an adviser’s secondary disclosure statement, they have already decided that their adviser is trustworthy and is acting in their best interests, effectively making the disclosure redundant.”

The industry argues that many consumers are unwilling to pay for financial advice, particularly in relation to insurance, and that commissions are a cost-effective way for people to access advice. Banning commissions will limit the availability of advice, leaving consumers worse off, it argues.

That’s rubbish, says Hubbard. Just as there’s no such thing as a free lunch, there’s definitely no such thing as free financial advice. And bad advice is potentially worse than no advice at all.

Consumer NZ chief executive Sue Chetwin.

“We acknowledge that moving to a fee-for-advice model may deter some consumers from seeking advice. The fact is, however, as the UK Financial Services Authority makes clear, financial advice is never free to the consumer.

“We believe it is better to have a system where fees are transparent and advice is neutral than one where remuneration is conflicted and advice compromised as a result.”

Consumer NZ chief executive Sue Chetwin is also a fan of banning all commissions. At the very least, she says, New Zealand needs more education for financial advisers and tougher penalties for playing fast and loose.

“Direct civil liability would provide a strong incentive for advisers to meet their obligations to consumers and is essential to improve industry standards,” Chetwin says.

Watch this space, says Faafoi. Written submissions to the Financial Services Legislation Amendment Bill have closed and the select committee is due to report back at the end of this month. But cynical commentators say the only thing that’s certain is that the insurance sector will fight tooth and nail – as it has done in the past – against any changes it sees as detrimental to its own interests. It will battle subtly and unsubtly, in open submissions and behind the scenes.

Andrew Hooker of Shine Lawyers.

Don't hold your breath

Andrew Hooker from Australian-based Shine Lawyers, which specialises in compensation law, has been working in the insurance sector for most of his career, starting in the industry itself and then spending two decades taking lawsuits against insurance companies.

He points to a Law Commission report in 2003 and a set of recommendations in 2004 covering pretty much the same stuff the FMA and Kris Faafoi are dealing with now.

He says he won’t be putting much money on Faafoi achieving the change the sector desperately needs.

“Best of luck to him against the insurance industry. It’s pretty powerful.”

When the figures don’t add up

In a country with state-funded care, health insurance may be an expensive luxury.

The day he hit 60, Auckland man Jasper Reeves* became very expensive to insure. His Southern Cross health insurance cover virtually doubled in price overnight.

“It had been creeping up each year for a while,” he says, “though some years the jump was smaller than others, if I hadn’t made a claim in the previous 12 months.

“But this was almost double and I started to think it was not a very good investment.”

Reeves recognised that the passage of the years was making him a higher risk, but the abrupt massive rise in his monthly premium just because 60 years had elapsed since his birth came as a bit of a shock.

His cover was for private hospital and specialist care only – he had been wearing the cost of an occasional GP visit and prescription charges himself – and it didn’t take long with a calculator to work out that he would have to be extraordinarily unlucky to get anything like value for money from his premiums.

“The thing about health insurance,” he says, “is that it can result in your having treatment, or levels of treatment, that you don’t need just because you can. There have been occasions when I’ve gone to see a specialist who confirmed – for $900 that Southern Cross paid – what my GP had already told me for $40. And I was paying $2000 a year for the privilege of having that cover.”

Reeves reckons that health insurance plays to a fear of ending up on a waiting list for elective surgery, such as hip replacement or a cataract operation. But it is far from a certainty that he would need such treatment and if he does, and doesn’t want to wait for it, he can pay to go private with the $12,000 he’s saved in premiums so far.

“The news is full of stories about the failings of the public health system, but most people get excellent treatment and don’t even wait an unreasonably long time for it. In cases of accident and trauma, there’s probably nowhere better to be than here. As for the rest, I’m insured against it; I’ve insured myself.”

This article was first published in the July 14, 2018 issue of the New Zealand Listener.