People who insure their lives and incomes may be being moved between insurers unnecessarily because of the high commissions financial advisers are paid when they sell a new policy, a report by actuarial firm Melville Jessup Weaver claims.
Research by the firm, paid for by insurance industry group the Financial Services Council, found up to half of new policies sold by financial advisers were to people who already had life insurance.
That compared with just 10 per cent of new policies sold through banks.
Mark Weaver and David Chamberlain, the report's authors, said the high up-front commissions insurance firms paid the advisers created a "material conflict of interest". They believed it was a "significant contributing factor" to the high levels of replacement business being done.
They found the going rate of commission for a life insurance policy was up to double the value of the first year's premium at the point of sale.
On an average annual premium of about $1500 an adviser could get up to $3000 for convincing a person to switch to a new insurer.
The initial payout was much higher than the commission paid to advisers to maintain the relationship with the person insured. Advisers were typically paid an ongoing annual commission of 7.5 to 10 per cent of the premium.
While it was not uncommon for advisers in other countries to be paid the equivalent of the first year's premium, NZ's commission rate of 200 per cent or more was "extreme".
How much advisers get paid to sell you life insurance:
• 180 to 200 per cent of the first year's premium up front
• 7.5 to 10 per cent of the premium amount a year
• Volume bonus of up to a further 30 per cent if they meet sales targets
• Soft incentives such as international holidays if they sell a high level of insurance.
"[It] is not only out of line internationally but it also generates inappropriate incentives for advisers and has profound implications for the structure and operation of the life insurance industry in New Zealand," the researchers said.
Those implications included people being mis-sold insurance because of the pressure to sell a policy and being sold too much insurance.
Switching people between insurance providers also risked their not being covered for pre-existing conditions.
Weaver and Chamberlain calculated undue policy replacement added $100 million every year in excess cost to clients and the economy in an industry worth $1 billion.
About 60 per cent of Kiwi households have some form of life insurance and about 26 per cent have income protection, according to the FSC.
Weaver and Chamberlain's seven recommendations to fix the problems included:
Scrapping the up-front commissions for advisers switching a consumer to a different insurer within a seven-year period;
Reducing the up-front commission for new customers from up to 200 per cent of the first year's premium to 50 per cent and lifting the ongoing commission from up to 10 per cent to 20 per cent to encourage advisers to give an ongoing service to the policy-holder;
Banning volume-based incentives given as cash or soft rewards such as overseas trips;
Capping the dollar amount of commission payable.
The pair admit the proposed changes would likely have a detrimental effect on the adviser industry, with some choosing to leave it.
To help ease the industry into the changes they recommended phasing it in over three years starting from 2017, with a progress review in 2020.
They also said the conduct of the life insurance industry should come under the Financial Markets Authority and an agreed code of practice set up.
As a final recommendation the report authors said KiwiSaver members should be able to use a portion of their annual contributions to pay for group life insurance.
Companies leave Financial Services Council
The report has created controversy for the Financial Services Council itself, with media reporting that two companies have left the body ahead of the report's release.
The report notes that its views are that of Melville Jessup Weaver not the FSC and the accompanying press release says "some members believe there are matters covered in the report that are outside the scope approved by the funders".
FSC chief executive Peter Neilson said he could not comment on the departures.
"That's an internal matter. They are free to have their own views on this paper."
The FSC commissioned the report as part of an information request from the Financial Markets Authority and to help it form a view on the review of the Financial Advisers Act which is underway.