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Home > Blogs > Ian Fraser > Life insurers to be saved from the consequences of their own short-termism

Life insurers to be saved from the consequences of their own short-termism

Finance Blogger: Ian Fraser Ian Fraser

It looks like the UK life insurance sector is to be saved from the consequences of its own short-termism thanks to timely re-regulation by the Financial Services Authority.

Five years ago I quoted the leading insurance analyst Ned Cazalet as saying that the practice of churning was “economically defunct, crazy, hugely loss-making, and unsustainable.” Basically, churning customers using generous commission to independent financial advisers permits life companies to dazzle the City with impressive new business figures, even when net new savings remain low. But it is ultimately self-defeating and, like other forms of intermediation in the savings market, is more likely to impoverish consumers than to enrich them.

This is one of the reasons why, as part of its retail distribution review (RDR), the FSA has banned the payment of commission to retail intermediaries, such as IFAs, from end-2012. The UK will become a fee-based market. Consumers will hopefully also become more discriminating and less prone to becoming commission-fodder for IFAs who are adding very little of value.

In a recent Financial Times article about Edinburgh-based life company Standard Life, the FT's insurance correspondent Paul J. Davies explained how the RDR will impact the market. He wrote:

"The upcoming retail distribution review has been designed to stamp out the old practice of paying advisers to keep churning the same pots of savings around the market – allowing all companies to report new sales while the market barely grew."

So there's going to be a lot more honesty. Presumably life insurers' reported new business figures will fall sharply from 2013. However in the run up to the ban, there are fears that irresponsible commission-driven churn and related abuses will have a "last hurrah," in a probable orgy of malpractice at consumers' expense.

The FSA recently issued an 'emerging risk' warning about such a scenario. In its Retail Conduct Risk Outlook 2011 [PDF, 4.26 MB], the regulator wrote:

"Firms may seek to maximise their recurring revenue stream before the RDR is implemented to facilitate their transition to the RDR. In some cases firms may do this in ways that produce poor outcomes for consumers. For example, some providers may seek to use the period before the RDR is implemented to acquire market share by offering large commissions to adviser firms, which could result in unnecessary churn in the retail investment market and excessive costs for consumers.

"Where owners of [intermediary] firms are planning to leave the market and are looking to sell their businesses, there is a risk that, in an attempt to build up their book to increase the attractiveness of the firm, they increase income through selling significant amounts of commission-based products. Other firms may look to increase the amount of trail commission on their books, as a way of cushioning the removal of commission on new business carried out post-implementation at the end of 2012."

So, to cut a long story short, consumers are probably going to have to be very wary of IFAs and insurers bearing gifts between now and December 2012. Thankfully, the FSA has said it will be working with the life insurance industry to ensure that such risks are minimized. If it handles this one appropriately, it will have begun its rehabilitation. But the rehabilitation for the deeply flawed regulator comes a little late. Soon afterwards it is to be dismantled by the UK government.

Further reading on future challenges for the life insurance sector

Tags: commission-based payment , Financial Services Authority (FSA) , insurance , life insurance , regulation , UK
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