Insurance, commission, and the separation of church and state

Sonnie Bailey

5 April 2019

If you know anything about me – from meeting me personally, reading this blog, or understanding how my business works – you’ll know that I’m very sensitive to conflicts of interest. I encourage businesses to use remuneration and incentive structures that make sure their interests are aligned with the interests of their clients, and I am leading by example (even though it’s not in my short-term best interests). In light of this, you may be surprised that I am a strong advocate for commission for insurance advisers. Here’s why.


In January the FMA and Reserve Bank published a report on life insurer conduct and culture.

The same day, ministers Grant Robertson and Kris Faafoi published a press release explaining that the Government will “fast-track consumer protection measures in the financial sector” off the back of this report.

My initial impression was that New Zealand would see a ban on commissions relating to financial advice relating to personal insurance* products. I’m glad I didn’t write a knee-jerk article, because I appear to be wrong.

* The FMA/RBNZ report talked about “life insurance”, which I think is misleading. Because to my mind, the way most people think of “life insurance” is as a product that pays a lump sum if you die prematurely. This is not the only type of product that the report discusses. I had to read through the majority of the report to establish that the FMA/RBNZ were in fact talking about what I refer to as “personal insurance” – including not just life insurance, but also income protection insurance, trauma/critical illness insurance, total and permanent disability (TPD) insurance, and the like. 

There are likely to be changes to incentive structures associated with advice relating to personal insurance. Many of these are likely to relate to incentives with “advisers” directly tied to the insurers. (I put “advisers” in speech marks, because really – are they going to recommend products issued by other providers?) The changes are also likely to relate to “soft commissions”, or indirect commissions, such as gifts and overseas trips provided by insurers to their most valued advisers. (You can guess the criteria they use.)

One thing that appears to have been clarified since then, is that insurance advisers that aren’t tied to a single insurer will continue to be able to receive commission.

I’m glad. Because, as much as I dislike commission in principle, and have oriented my own business so I don’t personally receive commission, I think insurance advisers should continue to receive commission.

Let me explain.

The cobra effect – or the law of unintended consequences

If you’re not aware of the cobra effect, I recommend reading about it on Wikipedia or Richard Meadows’ entertaining article titled “Goals gone wild”.

Basically, it relates to a (possibly apocryphal) story that illustrates how decisions made with the best of intentions can have outcomes that are the opposite of what is intended.

Removing commission in the personal insurance industry might seem like a good idea to most, but I’m certain it would ultimately have negative outcomes on regular Kiwis.

It comes down to the importance of the separation of church and state. Or, at least, something equivalent to the separation of church and state in the insurance industry.

The separation of church and state

Without going into too much detail, there are a lot of good reasons for there to be political distance between religious organisations and the nation state.

This is orthogonal to the idea of a “separation of powers” – that good Government requires a separation between the executive, the legislature, and the judiciary.

In the insurance industry, there are a lot of good reasons for there being a decent amount of distance between insurance companies and insurance advisers.

A major reason for this is because…

Insurance is HARD.

I’ve worked in many different roles in the financial services industry. I’ve had the privilege of seeing advice from many different angles, and seeing how many advisers operate. Over the past two years I’ve been providing financial advice directly to clients.

I’d like to think I know more than the average punter about insurance. But despite this, my wife and I use an insurance broker to recommend the products that are the best suited to our needs.

I’ll let you into a little secret, which you might find surprising.

In my opinion, providing high quality insurance advice is harder than providing high quality investment advice.

And frankly, I only deal with the tip of the iceberg. I don’t implement insurance advice, or deal directly with underwriting issues, or help clients make claims.

Being a good insurance adviser requires a number of skills that are difficult to develop. Sure, you need to be something of a salesperson – because most people don’t want to pay a substantial amount of money each month for something intangible, especially when the best and most likely scenario is that they’ll get nothing in return.

But you also need to be a little wonkish – to develop a good understanding of how policy definitions change from one policy to the next. You need to have a decent medical understanding, because you have to understand the intricacies of underwriting. You need to have empathy, and communicate effectively with people who have to share very personal information with you, or are experiencing some of the worst experiences of their lives.

There have been times when I’ve considered going further down this rabbit hole. There are many reasons I haven’t done it.

But one of them is that I’m extremely committed to my fixed-fee, advice-only business model. By offering my services this way, I can recommend strategic, high-level insurance advice, which works quite well – in conjunction with insurance product advisers. I couldn’t do what I do, without good commission-based product advisers being available to refer to.

The truth of the matter is that I can’t work out any other business model that would work for insurance – apart from receiving commission.

I’m the first person to talk about the issues relating to commission, and how it create conflicts of interest. But as it stands, it’s the best model for insurance advisers out there.

Maybe I’ll come across a different model. But for now, a commission-based remuneration structure is the best option I can think of.

The worst-case scenario

Let’s imagine that commission for genuine insurance advisers (who aren’t tied to just one insurer) was banned. They’d need to come up with alternative remuneration models.

It would be impossible to come up with something resembling a “fixed fee” model like I personally use.

Maybe insurance specialists could charge this for the first part of the process, like I do, which relates to whether you need certain types of insurance and what level of cover you might need.

But if you want to proceed with taking out insurance, they will need to recommend a product, informed by various factors including your pre-existing medical issues and family health history. They will need to negotiate with an insurer (or various insurers) to find something suitable for you and get the policy over the line. It’s impossible to know how long that will take. It’s not even certain whether you’ll be able to get the insurance you want.

And then, they’ll need to charge you periodically to undergo reviews to ensure your current insurance arrangements are suitable, including making sure you’re not over-insured.

If you need to make a claim on your policy, that will involve more time from them. Perhaps an enormous amount of time. They’ll need to charge you for their time – even if your claim is unsuccessful.

If insurance advisers charged on the basis of their time, the costs would potentially be very high. There would also be a high degree of uncertainty about how much time it would take them, and whether you’ll even be able to acquire insurance.

Admittedly, it’s an empirical question as to whether some or most Kiwis would pay these costs out of their own pocket. I’m speculating, but my guess is that they won’t.

What you’ll find is that there will be less demand for insurance advisers who are genuinely not tied with any single insurer. The market won’t be there. What you’ll find is that the “advice” industry will evolve so that most insurance advisers are tied with one insurer. They may promote themselves as advisers, but to an extent, it will be more accurate to represent their advice as sales… masquerading as advice.

There will be much fewer “independent” insurance advisers who will help clients compare and contrast between insurers.

As I’ve mentioned, insurance is COMPLICATED. I don’t pretend to be able to pick which insurance policy is most suitable for me and my wife, and I think I’d be in a better position than most people to do this.

Individual Kiwis will be making decisions based on limited knowledge and understanding of how insurance operates. They will probably focus myopically on price, rather than value. (Because unless you work in insurance every day, it’s hard to assess value.)

By gutting the insurance advice industry, the genuine competitive pressures that these insurance advisers pose for insurers, are likely to get a lot weaker.

Insurers won’t be held to account to the same degree. This will result in worse outcomes for Kiwis.

I’m open to different perspectives. I’d love to be proven wrong. I’d love to be pointed to other business models that would work for insurance advisers and maintain a decent separation of “church” and “state”. But without commission, I just can’t see it.



An aside 

One of the things that strikes me about the FMA/Reserve Bank report focusing on “culture” in the insurance industry is that in the report, neither regulator seems to entertain the possibility that they might have some influence on the culture within their industry.

Colour me naive, but I’m pretty convinced that a regulator has an impact on the industries it regulates. The FMA and Reserve Bank have an impact on the culture of the insurance industry. For more on this point, read my article where I explain why I think our financial services laws should be enforced more aggressively. (In short: “show me the consequences and I’ll show you the outcomes”.)

But that’s a different topic for a different day…

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