This article is a follow-up to a previously published piece about insurance commissions being paid to financial advisers. If you have not already read this, you can read it here.
The article in question attracted some criticism from industry participants and happy clients of commission-based advisers.
This new piece will attempt to address these criticisms and further shine a light on the practice of accepting insurance commissions and its adverse impacts on end clients.
It is in no way a critique of insurance advice itself, rather it is a challenge to the established practice of accepting commission-based payment that is indirectly funded by clients.
The critiques
The main criticism of the first article can be summarised into three points:
- Insurance commissions make receiving insurance advice more affordable. Sure, it increases the premiums, but the adviser gets a higher amount of commissions initially (60%) to pay for the upfront cost of providing the advice. Without this they would need to charge the client a higher upfront fee that might not be affordable.
- Without insurance commissions, advisers would need to charge fees to help a client through the claims process if were to become necessary.
- The ongoing commission that an adviser receives pays for ongoing reviews of the policy and an update to the cover if it becomes necessary. Without commissions, the client would need to be charged a fee for this service.
While these points are worth considering, the last two critiques are fundamentally flawed. However, for the sake of argument, we’ll address them directly.
The numbers
Over a 20-year period, how much more premiums would you pay with a commission-based policy compared to one without commissions?
Let’s examine how premiums compare over a 20-year period between commission-based and commission-free policies. The data provided comes directly from a popular insurer used by financial advisers and brokers, based on $1 million of Death & TPD cover and Income Protection for a 30-year-old male with a $100,000 income:
Over 20 years, adjusted for 3% annual inflation, you would pay $20,000 more in premiums for a policy with commissions. The higher the initial premium or the longer the policy lasts, the greater the difference.
Counterarguments
“But you need to pay a high fee to get commission free insurance”
Many advisers now charge a fee even for commission-based advice. Assuming a $2,000 upfront fee for commission-free insurance, the savings from avoiding commissions can be realised within about four years of holding the policy.
“What if I need to claim, the client needs to be charged a fee for that”
The argument that clients need to be charged for claim assistance falls apart when you consider that claims are not anywhere near guaranteed. So, you could go an entire policy lifetime without cashing in on this so-called benefit of commissions.
Even if a claim does occur and costs say $4,000 in adviser support, this cost is still more than offset by the savings from commission-free policies.
“What about ongoing reviews? What if the policy is no longer competitive”
The notion that ongoing commissions cover regular reviews and policy updates can lead to concerns about insurance churning—replacing cover merely to secure another upfront commission.
Even if regular reviews and new insurance are in the client’s best interest, assuming three such reviews over 20 years would cost $6,000, which is less than the $20,067 saved by going commission-free.
Comparison
Even using very liberal assumptions of zero financial advice fees from the commission-based adviser, alongside a guaranteed claim, choosing commission-free still ends up well in front.
The higher the premium and the longer the policy is held, the greater the difference benefit of nil commission.
Invalid justifications for commissions
One common justification for commission-based insurance is the idea that clients receive some form of “ongoing service” funded by these commissions. However, it’s important to note that there is no obligation for such services to be provided. In some cases, an adviser could theoretically collect commissions annually without offering any additional support.
Commissions lead to higher premiums. This raises the question: if clients are essentially paying extra for ongoing advice, why not streamline the process and have them pay directly for the advice when it’s actually needed?
In reality, the level of service is likely to be limited, if provided at all. While the idea that commissions automatically translate into value for money is appealing, it doesn’t always hold true in practice. Instead, greater transparency could benefit clients, ensuring they only pay for services when they genuinely need them.
Additionally, the argument that commissions cover the cost of claims assistance can be misleading. It’s worth considering whether it’s fair for someone to pay commissions for years without ever needing to make a claim. This structure can leave clients paying more without necessarily receiving a corresponding benefit.
The claims argument is convenient as it allows a particularly unscrupulous adviser to play on the emotions that would occur at claim time, in order to justify their way of doing business.
Large subsidising small
The fundamental issue with insurance commissions is that they are volume-based, meaning the higher the premium, the more commission the adviser receives.
The idea that a certain level of commission directly equates to a corresponding level of service is flawed. The amount of money earned from an insurance policy does not necessarily correlate with the service a client receives.
For instance, managing a $2,000 p.a. policy does not take half the time or effort of managing a $4,000 p.a. policy. This exposes a significant contradiction in the rationale of advisers who justify commissions as compensation for the service provided.
Most importantly, the commissions from a smaller insurance premium, such as one for a young person, are unlikely to cover the cost of any substantial service from an adviser.
In the example provided, the commission in year 5 is $456. If the adviser realistically spends more than an hour working with that client, they are operating at a loss.
How is this sustainable? Well, maybe it could be funded by someone 15 years into the policy, where the commission would be $1,217.
It’s commendable that commission-based advisers have embraced a progressive, socially funded approach to advice. The early years of advice are effectively subsidised by other clients paying higher premiums. A bastion of socialism within an otherwise entirely capitalistic industry. The clients actually paying these higher premiums might not be as pleased with this arrangement though.
On the other hand, the notion that insurance commissions cover the cost of claims could be viewed as a form of insurance itself. You pay extra in premiums for something that may never happen, but if you do need to make a claim, the associated costs are covered by all policyholders. While this might seem reasonable, it would also be one of the most expensive types of insurance available.
Over 20 years, you could end up paying an additional $20,000 in premiums to safeguard against potential claim costs, which might only amount to $5,000. It’s like paying $200,000 for car insurance over 20 years for a car worth $50,000. Quite the deal, right?
Summary
This article was deliberately written to challenge and critique conventional industry practice. It will evoke strong reactions from advisers who have built their careers on a commission-based model.
Many of these advisers have undoubtedly provided their clients with essential insurance, helping to ensure financial stability during some of life’s most difficult moments.
This article is not intended to undermine the crucial role advisers play in recommending insurance. Rather, it aims to elevate the value of professional advice above that of the policy itself.
The question arises: why should an adviser’s payment be directly tied to the client’s premium? In many cases, this linkage can undervalue the advice, especially when initial commissions are minimal.
In a truly professional advice industry, volume-based commissions have no place. The more separate the product and the advice, the greater the confidence a client can have in acting on their adviser’s recommendation.
