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Payback time for life offices

During the last few years, there has been a gradual dawning that the life insurance industry’s business model is broke in more ways than one.

Perhaps today’s crop of chief executives and/or general managers of our industry do not remember the good old days when they actually used to make a profit in the first year on single-premium contracts. It did not even take long to make a profit on regular-premium contracts. Back then, the whole of the industry was smoke and mirrors while today that only pertains to the with-profits contract.

The single most important event in life insurance has been the requirement to divulge both charges and commission.

At the time, it was thought this would be the death of independent distribution. When you have to tell your clients you are going to take £1,000 commission on a 10-year £50 a month savings plan, you are not going to sell too many. The clients would be smart enough to realise the life company was not paying that commission out of the goodness of its heart.

There was no life company opposition so it was assumed this would reduce commission. This was wide of the mark – the same and more remuneration is being paid out as sales commission. When you look at the contracts, you will be amazed to find there really is no front-end charge on single premium products and on the regular-prem- ium contracts, capital units are nowhere to be found. It was the transparency of charges that proved the poisoned chalice.

Examine a single-premium investment bond where a network or national brokerage has negotiated 7 per cent commission. The poor old life company does not actually recover its commission for seven years. In normal circumstances, that might be a shorter period if investment markets afford capital growth in the product.

However, during the last nine years, the reverse has happened and almost every investment bond since then is worth less than when it was sold. As a result, the payback period is extended even further.

Things are even crazier on regular-premium contracts. There are group pension contracts that I can confidently state will never make the life company a profit. The payback periods are into teens of years and that is assuming every single employee remains in the plan for that length of time, increases their premiums and that the broker does not churn the scheme after a couple of years over to ano- ther pension provider.

You only need to look at how many group pension arrangements have been in force for 15 years. This is exacerbated by the fact that after two years there is no clawback and in most contracts there is no clawback at all on leavers. How many firms today are making people redundant? In other words, the life company does not claw back any of the commission paid out on staff who have lost their jobs.

This then brings into question the profitability of the suppliers. They seem to be showing profits so at least we still have some smoke and mirrors left. The only thing I can assume is that the creative accounting is becoming ever more inventive.

So now let’s go back to these unprofitable institutions’ distribution channels. In most professional fee-based businesses and even commission-based businesses, the rule of thumb is that the fee-earners earn three times their salary.

In other words, this luscious commission paid out of the goodness of the hearts of the life companies (and it really is today) should be split a third to the salesman, a third to run the organisation and a third to pay the salaries of the proprietors, and hopefully make a profit.

If the businesses that represent the distribution for the life companies had that model, it would produce financially sound organisations and put them in a position to service the investing public extremely well.

Sadly, just as the life companies have played commission leapfrog, so have the brokerages who employ the IFA commun-ity. The net result is there is not enough money to service clients properly. More alarmingly, the firms that clients are dealing with are financially unsound.

The product providers are also unable to make a profit and that is before they spend billions on changing their names. Well, I suspect Predator Life is rubbing its hands together.

The only way you can make money out of a life company now is to shut down your new business department, sack your staff processing new business and close your sales and marketing division. They are all overheads for which there is no contribution from the products being sold.

How can you run a business under those circumstances? What are the chief executives of these companies thinking about? Are things going to change? Life companies have been holding their breath for a hell of a long time now and it seems to me it is either death by asphyxia or strangulation. It needs sorting out. At some stage, the shareholders of these companies are going to learn the truth.

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