Insurance agents told to prepare for disclosure

(May 20, 2005) Like it or not, regulations requiring full disclosure of compensation is coming to the insurance industry, according to a leading consultant.

“If you look at the direction things are going in the U.S., what we really are entering is an environment where very likely commission disclosure is coming,” says Byren Innes, senior vice president and director of NewLink Group. “In fact some people would argue that it’s here.”

Speaking at the Peel Institute’s annual symposium this week in Toronto, Innes says most agents apparently either do not know about current disclosure regulations, or simply choose to ignore them.

Ontario’s Regulation 347/04 already requires the disclosure of potential conflicts of interest, including sales contests and travel incentives. While there are no specific penalties for non-compliance, omission of such disclosure will be noted in regulatory audits and could lead to customers filing complaints.

“My bet is that most advisors don’t even know this regulation changed. If they do know, they probably haven’t really read it through,” says Innes. “Basically what it says is you need to disclose the names of all insurers that you can do business with. Obviously there’s a pressure here for everybody to have a full list.”

Fuelled by New York Attorney General Eliot Spitzer’s investigation into the U.S insurance industry, compensation practices are under scrutiny around the world, as regulators seek to quash perceived conflict of interest.

But Innes says the evidence does not support such a perception. Citing a study from Britain’s Financial Services Authority (FSA), he says there is little to suggest that independent financial advisors take advantage of their positions to put their own interests before their clients.

In Britain, advisors were required to disclose their commissions on each sale as well as non-cash compensation. Despite similar compensation, captive advisors found this requirement to be far more onerous than independent advisors.

An advisor who can offer three different policies can more easily demonstrate that their compensation varies little from firm to firm. If there is a significant discrepancy between compensation offered, the advisor should be able to demonstrate the quality of whichever product they recommend.

But since captive agents have no choice in what firm they deal with, clients have no frame of reference. A first year commission of 190% on the premium might spook a client who cannot be shown this is standard. Innes argues there really is no conflict of interest for captive agents, since they cannot choose to place the client with another firm, making disclosure unnecessary.

Innes suggests a negative correlation exists between point-of-sale disclosure and closure of sales. The more information the client is bombarded with — especially if framed as “conflict of interest” disclosure — the harder it is to make the sale.

As a remedy, Innes says compensation disclosure should be shifted from the sales staff to the policy itself. Clients may balk at an agent collecting an upfront commission in excess of the first year’s premium. A simple statement that 16% of premiums, to life expectancy, will pay for marketing and distribution sounds far more reasonable to the client.

While other sectors of the financial services industry have moved away from non-cash incentives in recent years — most notably the mutual fund industry — insurance has managed to slip under the radar until now.

“The insurance industry has had the luxury of carrying right on, offering incentives in the form of contests, trips, what ever they want to do,” says Innes. “Some of these companies have moved much more down the path of educational conferences.”

Such conferences are usually held in attractive locations, more closely associated with vacations. Most insurance companies admit they would like to do away with these conferences altogether, since there is little evidence they improve sales, but none want to be the first to do so.

With the insurance firms covering the cost of the producers, often their spouses and their own staff for the event, million dollar price tags are common. But Innes says the cost is insignificant when compared to the business they represent.

Sixty qualifiers might represent $60 million in premiums and with conventions often held bi-annually, the million dollar price tag represents less than 1% of the premiums these qualifiers have brought to the firm.

Innes says these incentives do not really work anyway, since those who can meet the sales requirements generally do so because they are top performers in the first place. Those who are not top performers generally see the hurdle as too high and feel it would be a waste of energy to even try to meet the requirement.

NewLink research shows that advisors want incentives to be based on overall performance and not product specific. An incentive may require them to sell five CI policies, for example, when the product may not be suitable for their clients.

Innes says that if conventions were scrapped, the $1 million savings would hardly be noticed anywhere else, whether it was used to reduce premiums, improve products or simply devoted to the manufacturer’s bottom line.

One use for the additional funding that would bring benefits is enhanced advisor support, but Innes says this too can bring the agent into conflict. If an advisor uses the services of a firm’s support staff, they may feel morally (though not contractually) obligated to sell that firm’s product.

Should the advisor disclose to the client the support they receive from the manufacturer? Innes says yes. But he suggests a way around such conflicts might be to shift the support function — as well as the convention incentives for that matter — from the manufacturers to the distributors, giving advisors free access to multiple product suppliers with neutral support.

While incentives and compensation may attract the most public attention, not all conflicts of interest are so obvious. Innes points to one independent advisory firm, which is owned by a fund company, which is in turn partially owned by an insurance manufacturer. If an advisor at this firm recommends a product from this insurance firm to his client, Innes says they should disclose the ownership relationship.