To grow the protection market we need an effective remuneration model to build meaningful distributor enterprise value. While the existing Lautro commission structure is recognised as flawed, we seem resigned to live with it. Necessary change should not require regulatory intervention and should be possible through effective self-regulation. If we were to change what structure should we adopt?
An ideal model should:
Cover reasonable sales costs on day one
Remove financial penalties that are hard for the adviser to quantify, or control
c: Renerate long-term revenue
Align distributor and insurer actions
This provides an excellent source of working capital. However, once selected, clawback can make it is almost impossible to move. As a minimum, distributors should reserve 20 to 25 per cent of indemnity commission released over four years, but the adequacy is still dependent on actual lapses.
For insurers, indemnity commission requires them to accept distributor credit risk, which, for specialist protection firms, can become material and limit insurer appetite for new business. This risk could be better managed where the insurer holds the clawback reserve. However, the model does not build long-term revenue.
For the same percentage Lautro indemnity terms, the sum of commission payments is 25 per cent more. However, this ignores the time value of money. For distributors the choice between indemnity and non-indemnity would depend on their ability to access working capital and the interest rate charged. Where a distributor can borrow all it needs at less than 12 per cent a year interest non-indemnity is worth more, but otherwise indemnity wins.
Mix of Lautro indemnity and non-indemnity
Distributor day-one capital requirements and insurer credit risk could be managed with a mix of indemnity and non-indemnity commission. With 30 per cent of new business on non-indemnity terms, the clawback risk should be effectively covered. The challenge for insurers is having systems that can administer both within one agency.
This provides no day-one capital, but generates valuable long-term revenue. Distributors would have to meet their sales and marketing costs from other sources of working capital. Because of the long-tail payments, its present value is more sensitive to lapses than Lautro.
Having weighed up the alternatives, my new model would be:
Day-one commission of around 100 per cent of one annual premium
Clawback run-off over 12 months
Renewal commission of 15 per cent a month from month 13 for
10 years .
This model balances the need for day-one capital with long-term revenue. It also significantly reduces clawback risk. The 10-year commission cut-off increases distributor shorter-term earnings and helps insurers with higher-risk costs from loyal customers.
Martin Werth is chief executive of UnderwriteMe