A look at the history of commission shows that every 12 years there is a fundamental change to the basis for calculating the amount payable.
In 1976, the change was from the sum assured basis to the premium basis known as the LOA (Life Offices Association) basis. In 1988, to comply with the Financial Services Act, we moved from the LOA to the Lautro maximum commission agreement basis.
Change is therefore overdue and again it is the dynamics of the business environment that is driving the change.
The key drivers for the change from Lautro commission are the demand for a more flexible approach to payment of pension contributions from customers and the stakeholder regulations and the need to reduce costs to achieve the 1 per cent a year single-charge benchmark.
So, how come the Lautro basis cannot survive?
The first reason is that, fundamentally, the calculation is based on the two cornerstones of expected premium and term. In a world where there is a trend towards varying premiums and various potential retirement dates, it becomes impossible to make the calculation.
Second, the maintenance of a Lautro commission system is extremely costly to administer. The main reason is because each policy increment requires a new calculation and separate record to be set up with a different clawback date from the original policy or any other increment.
It is generally accepted that administering the inflexible and complicated Lautro commission system within the 1 per cent charge is not possible.
Having rejected the Lautro basis on the grounds of cost, complexity and inflexibility, there remained three options:
1: Level commission/ indemnified level commission. This option faces the same difficulties as Lautro because it is premium-based.
2: Factored loans to IFAs.
IFAs were not keen on this option as it would involve third parties, not to mention potential regulatory issues with solvency/capital adequacy.
3: Fund-based/advanced fund-based. This is the only realistic solution and it addresses the issues of contribution flexibility and is cost-effective to administer.
Fund-based commission is the future but, with many IFAs reliant on up-front commission, the final hurdle was to develop a system which could advance future fund-based commission and pay it up-front. To this end, last December, we set up the Commission Accelerator.
How is it calculated?
If we assume that the IFA normal fund-based entitlement is 0.3 per cent a year, the calculation is made at individual scheme member level.
Assume that the premium grows at 4 per cent a year and the fund grows at 7 per cent a year (mid PIA rates).
Based on the initial premium, calculate the fund-based commission at year 10.
Multiply this figure by five to calculate the up-front commission payable.
Assumptions: Based on fund-based renewal commission of 0.2 per cent plus uplift (0.3 per cent). Assumes 7 per cent a year investment return and 4 per cent a year premium escalation. Premium at commencement of £100 a month.
Provided the premium grows at 4 per cent a year and the fund grows at 7 per cent, normal fund-based commission would recommence after year 10. If the growth rates are better, then the repayment of the advanced fund-based commission will be earlier than 10 years and the normal fundbased commission will therefore recommence earlier.
If the growth rates are less, then the fund-based commission will not recommence until later than 10 years.
Reviews and clawback rules
On each policy anniversary, a reprojection to the original year 10 is carried out and if the projection is higher, then an additional amount of accelerated fund-based commission can be paid. If it is less, then no clawback arises.
The clawback rules apply only when the fund is transferred away from Standard Life. Where the policy is paid up, there is no clawback. The amount of clawback depends on which year the money has been transferred away.
100 per cent in year one.
75 per cent in year two.
50 per cent in year three.
We believe this system allows IFAs the flexibility to choose to accelerate all or some of the fund-based commission, to take some as level commission and to do so for individual members.
The commission payable under Commission Accelerator is comparable with the amounts payable under the Lautro basis. However, under the Lautro basis, clawback will apply to transfers and paid-up policies whereas it applies only to transfers with Commission Accelerator.
Standard Life's Commission Accelerator option meets the challenges in the current market faced by customers, IFAs and product providers.
Customers can have the flexibility to pay variable pension contributions when it is convenient for them.
IFAs get up-front commission to cover their advice and set-up costs as well as building embedded value into their businesses. It is more cost-effective to administer and maintain than the Lautro system for the product provider.
If history repeats itself, there will be another change due in 2012. Any ideas?