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Will FSA pull plug on the commission merry-go-round?

James Phillipps considers the repercussions of the clash on commission.

The recent news that both Norwich Union and Prudential have started terminating the agencies of adviser firms with what they deem unacceptably low levels of persistency has met with a mixed reaction in the marketplace.

Advisers may be able to understand why the giant life companies do not want to take business that is unprofitable for them but the fact that the firms are still paying high up-front commission on investment bond business means they are also at the root of the problem themselves.

Admittedly, both Pru and NU have only cancelled a handful of agencies so far but the timing of the announcements, less than a month before the FSA is due to issue its consultation on the retail distribution review, is unlikely to be a coincidence.

Much of the talk ahead of the review has been focused on the adviser model being broken but the truth is that the life company distribution model could arguably be said to be in the same position.

Speaking at the Future of Life Assurance conference last week, industry analyst Ned Cazalet called the sector “fundamentally rotten” and pointed out that last year life companies paid out 74.6bn in claims while taking in 74.2bn in premiums.

He said that sector is storing up serious problems for the future and that high commission is fuelling the merry-go-round of old money washing round the market.

Commission is undoubt-edly an influence in the industry. For proof of this, one only needs to see how sharply NU’s stakeholder pension sales fell after it cut commission ahead of its rivals two years ago.

After only a few months, NU was forced to raise its commission rates to where they were, presumably not because it was eager to start winning back this business, much of which was unprofitable, but because of shareholder pressure to keep bringing in new business volumes, apparently at whatever cost.

Neither Pru nor NU appears keen on cutting commission on their investment bonds because they know advisers will vote with their feet and take their business elsewhere. Instead, they are apparently trying to change market behaviour by warning advisers that the quality of their business is being monitored and ultimately the threat of their agencies being revoked can and will be used against the worst offenders.

The insurers could be seen to be on shaky ground here. As long as the adviser is reb-ating some of the commission, they can be said to be acting in the best interests of their clients.

Seven per cent up front split between the client and his adviser is not a bad earner for half an hour’s work. So, it effectively boils down to a question of treating insurers fairly. Several adviser firms brazenly told both Pru and NU that if they continued to pay such high up-front commission with clawback periods of just 18 months, they will continue to take it. And why not, you could argue.

Where the investment bond money was held in with-profits, both insurers pointed out that there is a potential reattribution on the horizon and, in NU’s case, MVR-free anniversaries, which the client is giving up. But are these likely to be more valuable than a split of the up-front commission for switching? In many cases, particularly for clients with big pots of money in their bond, probably not.

The insurers undeniably face an uphill struggle to wean advisers off high up-front commission, which they have been all too willing to pay them for so long. This is doubly the case for the likes of NU and Pru because they have to try and reduce how much commission they pay out while keeping the tills ringing to please their shareholders.

It is no coincidence that Standard Life took the opportunity and short to medium-term pain to change its business model before it demutualised. Likewise, one could argue that Scottish Life was only able to switch to its financial adviser fee model because it is a mutual.

If insurers cannot themselves effect a change to the current commission model and advisers remain willing to take this commission, then insurers may look to the FSA to take regulatory action to enforce a change.

When that happens, adv-isers may be left to rue not working with insurers more closely on the commission issue because they may find the regulator much less sympathetic to their needs.

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