Commissions — The Beginning of the End?
New Approaches to Compensation
By Jeremy Forty and Keith Walter
Commissions are an established way for insurers to compensate producers
and to build business. But threats to commissions are gaining momentum
in a number of life insurance markets.
In almost all life insurance markets around the
world, commissions are the main way salespeople
and advisors get paid. Commissions are key to
generating sales in an industry that often requires
large amounts of sales effort to find customers and
“Commissions
“ are under
persuade them to buy insurance. For companies
attack because there is a
operating in high-growth and emerging markets, the
growing belief that they direct link between sales volume and commissions
misalign the interests creates a variable cost structure that helps manage
expenses. Commissions in these markets help
of producers and
share risks and rewards between life companies and
consumers in ways that distributors, which, in turn, helps to build distribution
harm the latter.” systems cost effectively. In many ways, they have
been a positive influence.
2 towerswatson.com
Despite the prevalence of commissions, they are
under attack from regulators in several mature life
markets. It is worth examining this pushback by
answering some relevant questions:
•• Why are commissions being targeted?
•• Which markets are affected, and does this
presage a general move toward regulator
intervention worldwide?
•• What alternatives are being considered, and what
are the strategic implications for life insurers?
Why Commissions Are Under Attack
Commissions are under attack because there is a
growing belief that they misalign the interests of
producers and consumers in ways that harm the
latter. Here are some examples:
•• The sale of higher-cost or higher-risk products that
pay higher commissions (e.g., life insurance
savings versus bank deposit products)
•• Advice to buy a product rather than to repay debt
•• Provider bias that can occur when an advisor sells
the products of more than one company,
particularly if volume overrides help drive
remuneration
•• A recommendation to terminate and replace an
existing product, a decision that may have direct
costs or result in the loss of valuable benefits
such as guarantees
Regulators often view the risk of consumer
detriment as high when buying life products
compared with other financial products. While
regulators’ perceptions often reflect previous cases
of mis-selling, the root cause is an asymmetry of
information between the consumer and the financial
services industry: Consumers often lack knowledge,
confidence and interest in the cost of providing for
their financial futures. This information disparity can
mean consumers are at a disadvantage to evaluate
or challenge the advice they receive.
Figure 1. Proposals for market-wide bans on commission payments

Market
(proposed
implementation date) Scope
Australia •• Applies to all retail products, including
(July 2012) superannuation and investment
products
•• Risk products within superannuation
(beginning July 2013)
•• Does not apply to non-superannuation
risk products, mortgages and health
products
Netherlands •• Investment funds •• Details still being developed
(January 2013) •• Bank savings products
•• Connected sales of two products where
the value of at least one depends on
the performance of investment markets
•• All life insurance products
•• Mortgages
United Kingdom •• Applies to all advised sales
(January 2013) (i.e., where there is a personal
recommendation to a customer —
around 90% of new business)
•• Packaged investments: personal
pensions, life insurance savings and
investment products, mutual funds
and certain other collective
investments
•• Applies to all financial advisors,
whether tied or independent and, in
modified form, to vertically integrated
firms
•• Does not apply to protection-only life,
general insurance or mortgages, or to
non-advised, direct or execution-only
sales
Approach Related changes
•• Complete ban on transaction-based •• Fiduciary duty to act
commission payments from product in customers’ best
providers, including volume overrides interests
and rebates from platform providers to
distributors
•• Replaced by 100% fee-for-service
arrangements
•• Asset-based trail commission banned
but asset-based fees for service
allowed — but only by customer
agreement for the continuation of
services by the advisor
•• Requirement for customers to opt in
or renew their agreement for ongoing
services every two years
•• Ban on override
commission in general
insurance
•• Ban on provider influence on distributor •• Clearer disclosure of
remuneration advisor status and
•• Replaced by advisor charging, in which remuneration
advisors agree on charges with •• Higher conduct
customers standards for
•• Advice charges must be related to independent financial
services provided, not products sold, advisors
and ongoing charges only where •• Minimum qualification
ongoing services are provided standards and
•• Customers able to discontinue advice continuing
charges professional
•• Providers able to facilitate payments development for all
but factoring and indemnity advisors
commissions banned
•• In practice, still possible to have initial
and trail advice charges that are similar
to commission

“Consumers
“ often lack knowledge, confidence and interest in the
cost of providing for their financial futures. This information
disparity can mean consumers are at a disadvantage to evaluate or
challenge the advice they receive.”

Emphasis 2011/3 | 3
 Commissions can also be problematic in other
ways. They create ambiguity about whether the
salesperson is acting on behalf of the customer
or insurer. Even when an advisor represents the
customer, if the insurer is paying commission,
Jeremy Forty
there is a conflict of interest. Commissions also
Specializes in strategy
and distribution help advisors position their services as free, which
consulting.
Towers Watson,
can diminish customer perception of their value. It
may prove hard to shift this perception as advisors
London
move into an environment in which they have to
charge their customers explicit fees and face more
pressure to justify the services they provide. Moving
the industry away from a commission-based model
becomes more difficult.
Commissions Receive Global Scrutiny
Aspects of commissions have long been subject to
regulator intervention:
Keith Walter •• Some markets regulate the maximum level of
Specializes in life
insurance actuarial initial commission that can be paid on life
and risk consulting. contracts.
Towers Watson, •• Countries such as India regulate the maximum
Singapore
level of charges that can be made to support the
payment of commissions.
•• Other countries, such as South Africa, regulate the
payment of commissions on replacement
business.
Many markets already regulate the disclosure of
commissions, and there are moves to introduce —
or strengthen — disclosure in many others.
The scrutiny of commissions is becoming more
widespread, led by Australia and the U.K. (Figure 1,
previous page). Related measures are being discussed
in a growing number of markets, including Germany,
India, the Netherlands, South Africa and Sweden —
and we expect to see the debate extend to other
markets in the future.
“In
“ less-well-developed markets, it is possible
that banning commissions could inhibit the
development of the life insurance business and
customer access to providers.”
4 towerswatson.com
Common Themes for Alternatives to
Commissions
Proposed alternatives to commissions are most
developed in markets in which investment products
dominate the mix of new business and in which
a high proportion of sales are made using a
financial-planning-type model. It is anticipated that
remuneration will move away from initial charges
contingent on product purchase, to ongoing
remuneration linked to services and assets under
management. This is not necessarily mandated by
rule changes. Advisors may be able to retain current
payment structures as long as insurers do not
influence the payment basis.
Beyond this, we identify four common themes:
•• Insurers are banned from influencing how advisors
are paid.
•• Advisors must agree on the basis of remuneration
with their customers.
•• Advisors are to be paid based on the work they
do, rather than the products they sell. So in the
U.K., advisor charges associated with product
sales will have to be the same for products that
are close substitutes. And in Australia and the
U.K., advisors will only be able to charge ongoing
advice fees for ongoing services.
•• Customers will be able to “switch off” ongoing
services and ongoing advisor remuneration — or
even, as proposed in Australia, have to opt in
periodically to ongoing services and the payment
of the related advice charges.
These themes are often supported by other changes,
such as clarification of the role of advisors or
salespeople, clearer obligations to act in the best
interests of customers, higher standards of conduct
and revised disclosure arrangements.
Strategic Implications
These changes will clearly have a direct impact on
advisors. For instance, advice charges may well
be lower than commissions, particularly where
there is a requirement for product-neutral charging
(where commission rates that differ by product type
will be banned). How consumers will react to the
replacement of commissions with advice charges is
unknown, but increased discussion and disclosure
of advice charges is likely to increase consumer
sensitivity to the cost of advice — and perhaps to
overall product charge levels. Many advisor firms are
likely to face downward pressure on incomes and
profitability.
Advisor firms under financial pressure have a
number of options. They may consolidate into
larger firms, seeking to gain advantage through
scale. These large advisory firms will be run on
more rigorous commercial lines and may be more
prescriptive about how individual advisors work.
Advisors will focus even more on tangible factors
such as price, service and features, weakening the
importance of discretionary decisions and local
broker consultant relationships. Investment platform
usage will increase, similar to Australia, where
platforms already dominate the market.
Alternatively, advisors may ultimately adapt their
businesses to focus, or place greater emphasis, on
products where commission payments will continue
to be permitted, such as pure life protection in the
U.K. and non-superannuation risk protection in
Australia.
A third option would be to increase advisory fees by
upgrading the services provided to the customer.
More emphasis may be placed on holistic financial
planning and ongoing services, including asset
choices, tax advice, and product and insurer
selection.
And finally, advisors may ask for a larger share of
the total charges paid by the customer. They might
insist upon better product terms from insurers or
use lower-cost solutions that require insurers to
squeeze out costs through choices such as the use
of low-cost passive funds.
Insurers will need to adjust to distributor-determined
compensation, and the fundamental change in
alignment of provider, distributor and customer
interests that shift will bring. The relationship
changes because the advisor is clearly positioned
as a service provider for the customer, rather than
as a route to market for the insurer. The ambiguity
inherent in commission remuneration is removed,
and insurers lose an important lever to influence
the placement of their products. This is, of course,
exactly what the regulators have in mind. Insurers
will therefore need to ensure they are able to
compete in a post-commission marketplace.
In addition to the fundamental change in the
relationship between insurer and distributor, the
advisor firms’ responses described above have other
potential implications for insurers. A commission
ban could lead to restructuring of the advisor
sector in ways that would restrict some insurers’
market access. Other likely changes include shifts
in product volume and mix, lower margins and
increased commoditization. A reduction in new
business strain and its transfer to advisors or
customers could offset the adverse effect of some
of these changes.
For insurers that are able to compete using low-
cost, innovative products and effective distribution
strategies, the prospect could be attractive:
fewer competitors, higher market shares, lower
new-business strain and the prospect of better
persistency. There may be advantages in owning
distribution, to secure market access and direct
customer relationships. For insurers not able to
adapt, or to do so quickly enough, the converse
would be true: loss of competitiveness and market
share, with a bleak long-term outlook. Figure 2
illustrates how, depending on its strategy, the
possible combined effect of access, volume
and product mix for an individual company could
be substantial. In a post-commission market,
depending on insurers’ current positioning and
future competitive agility, we would expect to see
greater polarization of winners and losers. Further
consolidation in the provider sector would be very
likely.
Figure 2. Illustrative change in U.K. market volume following commission ban
and other planned changes arising from the Retail Distribution Review
Projected three-year change in
Strategy addressable market for new business
Life bond manufacturer — broker –66%
distribution
Pension manufacturer — broker –13%
distribution
Pension manufacturer — multichannel +23%
distribution
Source: Towers Watson
Emphasis 2011/3 | 5
“Regulators
“ seeking market change need to keep
smaller savers enfranchised.”
It is also worth noting that, in addition to the
strategic challenges, providers will also face
significant operational challenges in reengineering
products, systems and processes to administer
advice charges compliantly. For example, in the
U.K., it will be possible for insurers to administer
the payment of advice charges from customers to
advisors, but sufficient flexibility in payment options
will be needed to ensure they are not deemed to
be influencing how advisors are paid. It will also not
be permissible for products to have allocation rates
of more than 100%. Where changes like these are
required, companies will find themselves operating
multiple processes and systems for pre- and post-
commission-ban products. While it is not an unusual
scenario for the life sector, it is an additional layer of
complexity not to be ignored.
Conclusions
So is this the beginning of the end for commissions?
Not necessarily, or at least not yet. Decision making
is often slow, starts well ahead of implementation
and may need to be incremental for such changes.
Although increased regulation of remuneration is
likely, general market-wide bans seem most likely
where three conditions apply:
•• The transformation of the distribution sector from
insurance sellers to financial advisors is well
under way, reflected in increased advisor
capability, reasonably robust advisory firm
business models and at least some appetite on
the part of customers to pay fees for advice.
•• Broking, or at least multi-ties, is reasonably well
developed.
•• The life insurance market is mature, with relatively
high penetration rates and, in combination with
government-sponsored social security programs
and employer-based plans, a broad base of
consumer protections is already in place.
6 towerswatson.com
In less-well-developed markets, it is possible that
banning commissions could inhibit the development
of the life insurance business and customer access
for providers. In such markets, high levels of sales
activity and customer education are particularly
important to the development of the life insurance
industry. A premature move to a fee-based model
seems incompatible with these developmental
requirements and the associated industry economic
model.
Although commission-based remuneration models
can expect to be under increasing scrutiny, we do
not believe there is a historical inevitability about
the demise of commissions. While we believe there
is likely to be a long-run evolution from transactional
sales toward financial advice, we are not convinced
that this necessarily requires the growth of broker
distribution, nor that it will occur quickly. This will
inhibit the speed of the challenge.
Our greatest concern where commission bans
are implemented is the risk of unintended
consequences. The risk that customers will be sold
products with adverse or poor performance needs
to be weighed against the risk of other adverse
outcomes. In particular, advisors are more likely to
focus on affluent customers, where the economics
and feasibility of fee-based remuneration are more
favorable. Many advisors that are unable to do
so may exit the industry. Less-affluent consumers
will find it harder to access advice. Regulators
seeking market change need to keep smaller savers
enfranchised. That danger has been overlooked in
the U.K., where it is very likely that the combined
effect of the commission ban and other elements
of the Retail Distribution Review will significantly
reduce the number of advisors prepared to serve
the mass market. More generally, regulators need
to bring about change that reflects the pace of
industry development. In an era of globalization
and regulatory convergence, we should all study
the experience of other markets, both as possible
indicators of the future and as models for what
works well and what does not.
For comments or questions, call or e-mail
Jeremy Forty at +44 20 7170 2953,
jeremy.forty@towerswatson.com; or
Keith Walter at +65 6880 5655,
keith.walter@towerswatson.com.