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The Actuary The magazine of the Institute & Faculty of Actuaries

Regulation of life assurance commissions II

uring the 1980s and perhaps earlier there was an apparent unresolved conflict in government policy between investor protection and the belief in unrestricted competition. The Financial Services Act allowed a maximum commissions agreement that was completely undermined by the competition authorities without any weight being given to the benefit to consumers of undistorted advice. The government failed to balance the two issues. But this was still in the future and for now the Registry of Life Assurance Commissions (Rolac) looked set to succeed.
The appointment of the registrar had become a matter of priority. The press pointed out that Rolac members were proposing to give the registrar extremely wide powers and he or she must be seen as capable of controlling the very people who appointed him or her. Moreover the categorisation of intermediaries would not be credible unless there was confidence in the impartiality and fairness of the registrar. Various individuals had been suggested for the post of registrar but none offered the requisite degree of independence of the insurance industry. Then the name of Malcolm Reid was suggested. He was one of the most senior officials at the DTI and for some years had been responsible for the supervision of insurance companies. Malcolm Reid’s appointment was widely welcomed both within the industry and outside. He and his support staff began setting up the registry. To overcome the problem that only insurance companies were permitted to join Rolac the registrar was empowered to set up a consultative council to include representatives of intermediary bodies and consumers.

Hard or soft?
In January 1985 the long-awaited government white paper on investor protection was published and this largely followed the self-regulatory approach of the Gower report. The white paper stated that the fixing of life assurance commissions to intermediaries was a commercial matter and not one that it would be appropriate for the government to control. The proposed legislation would require either full disclosure of commission (hard disclosure) or a declaration that the commission scales of the company were within the limits prescribed by the voluntary industry agreements of Rolac and the Unit Trust Association (UTA) (soft disclosure). In the latter case details of the limits must be available at the point of sale. Over-riders were to be the subject of ‘rigorous disclosure’.
At this point the whole industry accepted that the Rolac initiative had won the day but there would now be no need of the device penalising the intermediary who accepted higher commission than the Rolac scale. The responsibility for the voluntary commissions agreement would vest in the regulatory organisation covering the life assurance industry. So Rolac was put on hold.
In May 1985 the Securities and Investment Board (SIB) was set up in anticipation of the Financial Services Act 1986. Under its aegis the proposed self-regulatory organisation (SRO) covering life business and unit trusts would be Lautro. SIB was precluded from having a commission agreement whereas Lautro could do so provided that its rules in terms of investor protection were at least as effective as those of SIB. The member offices of Rolac agreed that it made sense to transfer Rolac and its staff to Lautro. Malcolm Reid became chief executive of Lautro and I was appointed as chairman of its commissions committee. By the end of 1985 SIB set out regulations for the SROs including the terms of hard and soft disclosure in Lautro.

MCA in the mix
In May 1986 Lautro was incorporated and announced that it was seeking recognition as an SRO under the Financial Services Act. By then the Lautro Commissions Committee was at work on the maximum commissions agreement (MCA) permitted by the 1986 Financial Services Act. The committee included representatives of unit trusts, intermediaries, and the public interest as well as life assurance and pensions business. Rolac and the UTA had already completed most of the work for the MCA but now everything had to be reviewed by a committee representing wider interests. A new problem was to eliminate product bias between single premium insurance bonds and unit trusts.
In November 1986 Lautro published its commission terms and invited comments. There was widespread support for the 25% limitation that had been developed by Rolac and for the severe restrictions on indirect benefits. Intermediary bodies argued that the proposals would reduce the incomes of their members at a time when they faced costs of investor protection. Consumer bodies considered the rates too high. The Commissions Committee looked again at the overall effect of the proposals to achieve a fair balance between consumers and intermediaries. The following spring it published the definitive MCA and issued technical specifications. As ever the commission on pension schemes and individual arrangements was complex. To help avoid product bias by tied agents Lautro ruled that sales-linked payments to them that followed the pattern of the MCA would be regarded as free from product bias.
In March 1987 Sir Gordon Borrie, the director-general of the Office of Fair Trading (OFT), published a preliminary view attacking SIB for its proposals on polarisation, which aimed to distinguish between tied agents and independent intermediaries. He also criticised SIB for allowing a commissions agreement with soft disclosure in Lautro even though the Financial Services Act made provision for this. SIB made a spirited defence pointing out that the OFT had given too much weight to the opinions of those interested in higher commission levels.

The Treaty of Rome
Under the Treaty of Rome any practices that restricted competition within the European Community were prohibited. The treaty gave the European competition authorities the power to waive this prohibition in the case of an agreement that improved production, distribution, technical or economic progress, and gave benefit to consumers. At an earlier stage Lautro consulted DGIV, the competition directorate in Brussels, and it did not then voice any objections to the MCA. Shortly after Sir Gordon Borrie’s criticism of the MCA, a letter came from DGIV stating that it considered that the MCA was anti-competitive.
We informed the DTI that we intended to visit Brussels to argue the case for the MCA but we were told that the minister wished to discuss the matter with us first. At the meeting the minister, Francis Maude, thought it better if he and his officials went to argue the case with Brussels, as it was a government policy issue. A few days later a DTI official told us that despite their best efforts Brussels insisted that the MCA should be permitted for 12 months only. We refused to ask member offices to adopt the new regime for such a short period and asked for three years instead. The response was that it was to be two years take it or leave it. So we agreed to take it with the hope that after two years’ experience of the MCA we might persuade Brussels to grant the MCA exemption on the grounds that it operated for the substantial benefit of consumers.
In July 1987 Lautro had finalised the MCA and the following February its rule book was approved by the Securities and Investment Board. The MCA was to commence operation in April 1988.
Under the Financial Services Act the director-general of the OFT was required to report to the secretary of state whether the Lautro rules imposed significant restrictions on competition but he was precluded from considering any aspects of investor protection. In March 1988 Sir Gordon Borrie published his report. He was in principle opposed to commission and considered that intermediaries should ideally become fee-earning like accountants and lawyers. He realised that an immediate move to fees would be unwelcome to the public and would reduce availability of independent advice, so he saw it as a long-term aim. He considered that competition on commission was malign and against the public interest. But he thought that the MCA would inhibit the move to fee-paying and concluded that the MCA with soft disclosure was anti-competitive. He did concede that the development of the MCA by the industry had acted as a constraint on commission escalation and he felt that the rates of commission in the MCA were not significantly anti-competitive. His solution was that the commission rates developed by Lautro should be used as a yardstick to facilitate disclosure.
The industry considered that Sir Gordon Borrie’s reasoning in the report was flawed and that, without the restraining effect of the MCA, market levels of commission would inevitably rise. It was difficult to see why he thought the MCA would inhibit any move towards fee-paying. His idea of a yardstick scale did not attract any support. In the light of his opposition to the MCA there appeared to be no point in approaching Brussels for an exemption even though the benefits to the consumer of the MCA would seem to make it just what was contemplated for exemption in the Treaty of Rome. At the end of 1989 Lautro terminated the MCA and brought in full disclosure.

Full disclosure
The immediate result of the regime of full disclosure was a significant increase in commission above the Lautro scales and the position has worsened over the years. Disclosure on its own has not stopped the malign competition on commission that both Professor Gower and Sir Gordon Borrie deplored.
Perhaps the time has come to re-examine the issue of a maximum commission agreement but on this occasion giving full weight to the benefits of such a system to the consumer.