Commission-dodge structures to go

The Financial Services Board (FSB) has finally moved to shut down the structures introduced by Discovery Life that were designed to side-step the commission regulations on the sale of short-term insurance and life assurance products.

It is now some years since Personal Finance raised the issue of these structures, which Discovery Life’s competitors copied as they sought to fight the unfair advantage Discovery had over them.

On our front page today, we report on the growing concern by the financial services industry about the ability of the FSB to take “rapid and ruthless” action against players who try to side-step regulations and legislation, to the disadvantage of consumers.

Discovery Life signed up product floggers and independent financial advisers to push its products by creating various structures that paid them more than the regulated commissions. These perverse incentives resulted in consumers being switched, often at a high cost, from acceptable products into Discovery Life products.

As other product providers in the life assurance and the short-term insurance industries joined the incentives fray, the only loser was the consumer, who had to cover the additional costs.

The FSB has now sent a firm letter to the financial services industry – aimed at short-term and long-term insurance companies – warning them that these structures may be unacceptable and that they must be dismantled.

The various structures introduced by Discovery Life were aimed at getting product floggers on board as Discovery sales staff and at inducing independent advisers to favour Discovery Life’s products.

* Independent advisers. Structures, generally referred to as Netcos, were established where the shareholders were directly or indirectly linked to a financial services provider. Insurance companies then paid amounts in addition to commission to these Netcos. The amounts were directly linked to a percentage of the premiums paid by policyholders.

Discovery Life claimed these amounts were for the advisers taking on additional work.

Some companies introduced a variation on this structure, whereby money is paid to the staff who work for an independent financial adviser.

However, the FSB debunks the reasons for the additional payments, saying in its letter that these amounts may be for services that advisers should already be providing in terms of the commissions they are paid.

Both long-term and short-term insurance companies have been using Netcos, which have numerous variations that may also include profit-sharing arrangements.

The FSB warns that some of these practices “may be in contravention” of the law.

Jonathan Dixon, FSB deputy executive in charge of insurance, says the FSB has not necessarily prohibited Netcos, but has set out the conditions under which they would be allowed.

Any remuneration to a Netco “must be remuneration for functions not already covered by the definition of ‘intermediary services’, and, if such functions exist, the remuneration must be reasonable in relation to the services actually rendered.

“The current definition of intermediary services in the Long Term Insurance Act is so broad that I would struggle to think what additional functions a Netco arrangement is actually paying for,” Dixon says.

At least one company, Momentum, voluntary closed down its Netco structures last year.

The FSB letter also warns about the misuse of binder (agency) agreements to make unacceptable payments.

* Company representatives. Discovery Life offered financial advisers who worked for other companies generous sign-on bonuses and participation in share incentive schemes in order to get them to join Discovery.

However, the FSB letter does not deal with either of these practices. They fall under the Financial Advisory and Intermediary Services Act, which does not appear specifically to ban sign-on bonuses and share incentive schemes unless they are linked to performance targets. If they are, it amounts to an outlawed conflict of interest.

Hopefully, they will be banned outright following the FSB’s current review of remuneration structures for intermediaries.