Insurance on a rollercoaster

Life insurance policyholders are shifting so frequently between insurers that the average "life" of a policy has dropped to just five years, a trend that could hurt consumers.

Many in the industry say the cause is "churn", the practice of insurance advisers moving clients' policies from one insurer to another to qualify for "upfront" commissions which can sometimes be more than 200 per cent of the first year's premium the policyholder pays.

Statistics from the Financial Services Council (FSC), the industry body for insurers, show in the two years to the end of March, individual life insurance policies with annual premiums of more than $235 million "lapsed", while "new" policies issued by insurers totalled just under $200m (see chart).

A similar pattern can be seen with trauma and income-protection insurance.

While it is not known how much of the "new" business are policies replacing lapsed ones - some industry players estimate as much as 80 per cent.

The Financial Markets Authority has begun investigating as claims of consumer detriment rise. The regulator has sent letters to several advisers following tipoffs alleging churn, industry sources say, and it admits it is concerned about the risk of "excessive replacement business in the insurance industry".

In a written statement, the FMA said new fair dealing provisions in the Financial Markets Conduct Act include a prohibition against misleading representations about financial products or services, including any representations about the need for products or services. "The FMA will consider whether these prohibitions are being breached when reviewing the issue of churn."

"When someone is buying a new insurance product they need to be fully advised about the level of cover they are purchasing and be informed about any losses of cover or benefits they may suffer by surrendering an old policy and taking a new one. The impact on policyholders, in terms of the fees involved in replacing policies, should be part of that advice."

Maximum civil penalties under this provision are $1 million for individuals or $5m for a corporation.

There are two costs to consumers with churn.

Firstly, the more frequently insurers pay big upfront commissions, the higher premiums must be to fund them.

Secondly, each time a person takes a new policy, they run the risk of pre-existing conditions covered by their old policy not being covered by the new.

Peter Neilson, chief executive of the FSC, said high upfront commissions are a legacy of the past when people bought "whole of life" policies they would have for decades. "When you had those very, very long-terms, 180-200 per cent upfront commission . . . was not excessive," he said.

But policies' lifetimes had fallen in recent years.

"Anecdotally, people have said it used to be seven to eight years, but it has probably come down to about five years, and is still declining."

Last year, insurers tried to reach agreement to lower upfront commissions and raise renewal commissions, which are commissions paid each year the policy is in existence, designed to encourage advisers to leave clients' policies in place.

The attempt failed, Neilson said, but was sparked by Government concern over churn. "That came on pressure from the Government saying we would have to do something."

Veteran insurance adviser Lindsay Forbes said if the industry can't tackle churn, the Government must regulate.

Insurers should be allowed to pay upfront commission only on genuinely "new" business, not replacement business, he said.

That would mean upfront commissions would only incentivise sales of genuinely new policies, not churn.

There was little churn in the fire and general insurance industry because upfront commissions were much lower, Forbes said.

"There is huge churning in the life side. Renewal commissions are small [5-7 per cent] and new business [upfront] is large [150 - 200 per cent]," he said.

Ed Saul, from online life insurer Pinnacle Life, said "You can assume a fair proportion . . . is being lapsed because they are moving from one insurer to another." But he said it's not clear if that is 50 per cent or 80 per cent. Though Pinnacle Life does pay commission, the levels it pays are far below those paid by other insurers and it doesn't do much broker business.

Forbes said advisers' switching clients from insurer to insurer claim they are doing so to get them better policies, but the benefits rarely outweigh the risks. The risk of claims being declined due to people inadvertently failing to disclose information that would be material to their policy coverage was too great, he said.

Jeff Page, the chief executive of Kepa, The Advisors' Institute, which represents over 700 insurance advisers, said upfront commission rates were "phenomenally high". He predicted a consumer outcry similar to the one experienced in Australia, which resulted in upfront commissions falling to around 60 per cent of first year's premium.

"Churn is costing millions and millions and millions of dollars. If there is less churn, would the clients be paying less in premiums? If there is competition, they will," he said.

He said upfront commission levels were likely to reduce, and had already just started to do so.

The insurer taking the lead is Fidelity Life which has lifted the renewal commissions it pays and lowered upfront commissions.

"Our retention is increasing all the time, just slowly, but it is definitely working," said chief executive Milton Jennings.

It's maximum upfront commission is 140 per cent compared to an industry norm of around 200 per cent.

"Ours is a lot less, but we think it creates the right behaviours," he said.

Sunday Star Times