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The Actuary The magazine of the Institute & Faculty of Actuaries

Commission and the OFT

ollowing Brian Wright’s articles on the regulation of life assurance commissions, is it time to seek an acknowledgement from the Office of Fair Trading (OFT) that market forces are increasing commission rates to the detriment of consumers? Is it time to obtain an indication from the OFT that, were the financial services industry, or some part of it, to make an arrangement to limit commission rates, the OFT would not regard such an arrangement as anti-competitive?

Why now?
Commission rates on single premium life and unit trust business are still increasing under unrestrained market forces. Such increases are unsustainable. The increases are largely paid for initially by shareholders who either recover them from policyholders’ benefits or suffer losses, or the insurance company closes to new business thus restricting choice. Some increases are paid for from the ‘inherited estate’ of with-profits funds, which may ultimately affect policyholders’ returns. Commissions in excess of charges are not reflected in illustrations of policyholder benefits.
Why is the OFT critical of countering these market forces? It was the OFT that blocked a maximum commission agreement (MCA) of some 20 years ago as Brian Wright explained in his articles. The OFT did so due to its ‘anti-competitive’ aspects and was not allowed at that time to take into account the benefit of the MCA to consumers. In addition, the industry has a belief that an attempt to introduce an MCA or similar arrangement now would be held as anti-competitive by the OFT.
Where is the evidence?
The FSA published a report by Charles River Associates (CRA) on the effect of commission-based remuneration on advice in January 2002. Its main conclusions were:
– There is significant bias in the advice on a small number of single premium products.
– Bias appears to be more serious in the independent than in the tied sector.
– Where there is bias, it is causing consumer detriment.
– The amount of detriment caused is appreciable.
– The advice market is not riddled with bias.
– There is no detectable bias on regular premium products.
The ABI also engaged CRA to report on financial advice ‘How should we pay for it?’ in February 2005. The FSA study is directly comparable to the ABI research. The ABI board unanimously agreed that this research should form the basis for a thorough public discussion of the issues. The ABI has not published its CRA report and the public discussion has not happened.
There is further evidence from IFAs themselves of the increasing commission terms available to them. It is also interesting to note how the opportunities for earning commission on single premium investments have followed a sequence:
– with-profits bonds;
– precipice bonds;
– split capital trusts;
– buy-to-let;
– equity release and residential property in SIPPs.
With the latter recently removed, will fashion revert to with-profits bonds, investment bonds, and unit trust business and lead to further pressure on commission rates for these products?

OFT intervention
What is the basis for intervention by the OFT or, at least, for an intimation from them that an attempt by the industry to get its own house in order would not be blocked this time? The Clementi report on legal services says:
‘The rationale for regulating any market is that there is an element of market failure, ie that leaving the activity unregulated could lead to undesirable consequences, and that the benefits of regulation will outweigh the costs.’
Now, the FSA won’t intervene pricing is not in its remit so regulation is not an avenue open to the consumer. The Treasury, presumably, could intervene, as it did in stakeholder pensions. The ABI could encourage commission restraint, but form to date suggests that it would not take on this role. Some of the major companies might get together to make a difference for the consumer they were prepared to have a go 20 years ago. To do so they would need their belief removed that the OFT would block an agreement.

Current climate
There are indications that the climate is more favourable now for commission restraint than before. The OFT has recently assumed from the EU the power to apply Article 82 (abuse of a dominant position) of the EC Treaty, with its legal exemption regime, within the UK. The OFT may recommend to the secretary of state to make a national block exemption of an arrangement from Article 82 and from Chapter II of the Competition Act (the UK counterpart).
In a radio interview at the end of last year, Phillip Collins, the OFT chairman, clearly linked the objective of competition law to benefiting the consumer a change of stance from 20 years ago. In two recent cases in Germany and South Africa, courts criticised early surrender values as being too low because of commission-based deductions.
So, the OFT needs to make the first move to acknowledge that competition does increase commission and to help to remove the belief on the part of companies that the OFT would block an agreement.
That being said, the way the OFT works, undertakings (a group of life companies wishing to reduce the consumer detriment of excessive commission) may request confidential informal advice on the application of Article 82 on an ad hoc basis. However, the OFT will not consider a request for an opinion relating to hypothetical questions so a more concrete proposal will then be needed from the industry.