Pros and Cons of a Commission Cap

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In the Government’s recently released options paper on its review of the Conduct of Financial Institutions, (see: Government Considers Capping Commissions…) the pros and cons of capping life insurance commissions for intermediaries are addressed.

Under Section 3.4 Options to improve product distribution, Option 4 (impose parameters around the structure of commissions), it suggests there could be explicit limits on the percentage of upfront and trail commissions that can be earned as well as rules determining when different types of commissions may be paid.

It goes on to outline the pros and cons of capping commissions detailed below, however the Government clearly stated in the paper, “We are not considering a total ban on commissions at this time because there is significant risk that this will reduce access to financial advice for consumers, drive all sales in-house and reduce competition in the market”.

It also noted a complete ban on commissions could likely make financial advice more expensive and difficult to obtain for the average consumer. It could also lead to consumers paying upfront fees to obtain advice.

Pros:

  • If well-designed, this option could reduce the likelihood of behaviour that drives poor customer outcomes while still retaining access to financial advice. 
  • Could encourage advisers to be incentivised for providing ongoing service and advice about product suitability and for maintaining good customer outcomes rather than sales performance. 

Cons:

  • It is challenging to set the ‘right’ levels and structures of commissions that strike a balance between promoting customer interests and enabling adviser businesses to continue to operate. 
  • It is possible this could encourage intermediaries to sell more because they are paid less. 
  • A blanket approach may impact on existing business practices and models more disproportionately than a principle-based approach where businesses are allowed to determine their own mechanisms to reduce churn or improve customer outcomes. 
  • It is possible this may have wider consequences for the industry, such as a reduction in upfront commissions may make it more difficult for new entrants to the industry to operate sustainably, ultimately reducing consumers’ access to financial advice. 

Minister of Commerce and Consumer Affairs, Kris Faafoi, says the financial sector reforms fit well with a broader programme of work underway to improve the regulation of New Zealand’s financial system and to prioritise customer interests.

This includes the Financial Services Legislation Amendment Act to ensure a consumers interests are met by providers of financial advice, changes to the Credit Contracts and Consumer Finance Act to target irresponsible lending, and a review of insurance contract law.