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The Actuary The magazine of the Institute & Faculty of Actuaries

Regulation of life assurance commissions

nregulated life assurance commission produces a conflict for the intermediary between the self-interest of the intermediary and the duty owed to the client. That duty is to give objective advice but the reward for that advice can vary significantly with the life company selected by the intermediary and the product selected by the intermediary. Disclosure of the commission received for the chosen transaction alone does not enable the client to identify whether self-interest or impartial advice has won the day. This was recognised some 75 years ago when compliance with a maximum commissions agreement became a condition of membership of the Life Offices Association (LOA) and the Association of Scottish Life Offices (ASLO).
For many years all members abided by both the letter and spirit of this agreement, and this kept the market in order until the agreement collapsed dramatically in the early 1980s. Even then industry efforts stabilised the position for some years. Ever since, there has been a commission disclosure regime where protection for the consumer has been illusory. This article attempts to show how this came about.

The maximum commissions agreement
Equity-linked contracts were developed in the 1960s and this facilitated the setting up of offices writing linked life business only. These offices obtained some business from tied agents but they also competed for the business of independent intermediaries. Most of these new offices chose not to subscribe to the agreement. By paying commission higher than established competitors the new offices were able to build up substantial volumes of business. They also paid over-riding commission that encouraged intermediaries to place enough business with the linked life company to trigger the over-rider.
Association members became increasingly frustrated, as commission advantage often was a major competitive factor. The companies outside the agreement were unwilling to give up their marketing advantages for the greater good of the industry. They rightly calculated that, provided most of the market abided by the agreement, the government would not take action.
In 1982, a number of members gave notice of their intention to resign from the associations so that they could compete on commissions. Clearly once this happened most other offices would follow suit. Both the LOA and ASLO had important roles as industry bodies and to avoid their disintegration the Commissions Agreement was abrogated from 1 January 1983. Straight away annual-premium commissions rose by 15% and single-premium commissions by 50%. The financial press forecast a commission war that would lead to government intervention. The timing could not have been worse because Professor Gower was preparing a report on investor protection for the government.

In February 1983 an idea for a new independent body to control commissions called the Registry of Life Assurance Commissions (Rolac) was proposed. The objective of Rolac was to ensure that commission did not create bias in the selection of a life office by an insurance intermediary. For this reason Rolac would not cover tied agents when they placed business with the office to which they were tied. Rolac’s operations would be controlled by an independent registrar but its member life offices would fund it. The Rolac maximum commission scales would be published widely and always be available to the press and to the public. Member offices would declare in policy documentation that commission did not exceed the Rolac scale. A key feature of the new agreement that would give it some teeth would be differential rates of commission. The basic scale would apply to intermediaries who merely introduced business. Professional intermediaries would qualify for the highest scale provided they did not accept commission above the Rolac scale from any office if they did they would be put in the lowest category for all Rolac offices. The task of categorising intermediaries would be in the hands of the registrar.
When Marshall Field, the chairman of the LOA, was consulted, he welcomed the initiative and agreed that Rolac must remain at arm’s length from the associations. Nevertheless he made available to us many of the resources of the LOA, such as the use of their premises.
Then followed confidential meetings with chief executives of a significant number of companies. All of them thought Rolac had a sporting chance of success and were willing to support its development. These meetings had a valuable spin-off in providing the key players who would form the Rolac Steering Committee under my chairmanship. They were Peter Bairstow of Sun Life, Roy Brimblecombe of Eagle Star, Roger Corley of Clerical Medical, Peter Taylor of Sun Alliance, and Ted Tilley of Legal and General.
We held a meeting in London attended by 75 life office chief executives. By the end of the meeting we had a mandate to issue a press release giving details of the Rolac proposals. The meeting agreed to meet the costs of Rolac and made a commitment to try to keep commission levels under control.
The insurance and financial press were generally supportive of the Rolac initiative but doubts were expressed whether we should find a registrar of sufficient stature and independence to be acceptable to all sections of the industry.
During 1983 the offices supporting Rolac met on a number of occasions to thrash out the terms of a new commissions agreement. A drafting committee of 75 chief executives does not sound like an ideal arrangement but it was remarkably effective largely due to the work behind the scenes of the Steering Committee. The earlier commissions agreement was used as a starting point but the opportunity was taken to question everything anew.

A new commissions agreement
To achieve a balance for differing types of contract and for differing premium payment terms we defined a level annual rate of commission throughout the term and the rate of renewal commission. The difference between these two was commuted to give the total initial commission. The total initial commission was then respread over a period of months so that the initial commission earned did not exceed 25% of any premium during this period. Indemnity terms would allow full initial commission to be taken at the outset but with clawback of unearned amounts should the policy terminate early. This spreading of earned initial commission would enable life offices to offer better surrender values in the earliest years of a policy.
By mid-1983 we had published the new commission terms and invited and received comments from a wide spectrum of interested parties. A revised set of detailed proposals was published in September for a further round of consultation. The intention was to publish final terms in January 1984.
In the meantime there were a number of important lines to be cleared. The deputy director-general of the Office of Fair Trading considered that the Rolac proposals would benefit consumers and she did not visualise any competition issues. She pointed out that only insurance companies should join Rolac, otherwise we would fall outside the exemption of the Restrictive Trade Practices (Services) Order 1976.
We sought the views of Professor Gower who welcomed the industry-led solution put forward by Rolac. He regretted that our proposals did not cover tied agents except when they introduced business to a company other than their own but appreciated the reasons for this.
The Consumers Association gave guarded support but welcomed the intention to publicise the Rolac commission scales. They were convinced that complete disclosure of commission would protect the consumer from bias and lead to a reduction in commission levels.
At a meeting, Alex Fletcher, the minister for consumer affairs, indicated his support for Rolac. He was asked if he would be willing to put his views in a letter that could be distributed at a meeting to be held three days later. His officials intervened to say that such a letter could not be given for some months. To their consternation the minister disagreed and a very supportive letter signed by the minister was delivered to us that same afternoon.
The meetings with the various intermediary bodies were always friendly but there were healthy disagreements particularly over the issue of tied agents. The brokers’ organisation BIBA was in favour of differential commission but they wanted bigger differentials in favour of their members.
By the end of 1983 six more life offices including the largest linked life company had joined in support of Rolac. In his annual report to the LOA, Marshall Field was able to confirm that due to the Rolac initiative the industry had exercised considerable restraint on commissions.
The Gower report on investor protection was published in January 1984. Professor Gower argued that it was vital to remove the major cause of conflicts of interest and duty of life assurance salesmen by controlling commissions. His conclusion was that unless the Rolac proposals were successful there would need to be government control of commissions. For the long-term success of Rolac he considered that some statutory backing would be required. He was dismissive of the notion that disclosure alone would control commissions.

Along comes the Financial Services Act
At this point the industry initiative of Rolac had stabilised the market and had introduced a new concept in commission structures that would tackle the longstanding problem of poor surrender values in the early years. A golden opportunity to give permanent consumer protection to purchasers of life assurance products was now waiting to be grasped in the forthcoming Financial Services Act.