Regulating insurance commission has failed dismally since 1977

The fallacy that insurance commission is the root of all evil has led to numerous failed attempts to regulate it.

Dr Brian Benfield, a retired professor from Wits’ Department of Economics, holds nothing back in a hard-hitting article in Biznews titled Insurance commission price-fixing: An ignominious and damaging failure.

The initial Retail Distribution Review (RDR) discussion document in South Africa was published in November 2014, with several updates over the years that eventually morphed into other pieces of legislation and conduct standards. Many regarded its only purpose as replacing commission with fees. But the regulation of commission started long before then.

“In 1977, the industry as a whole was not able to agree with the regulator, Registrar Willem Swanepoel of the Financial Institutions Office, on any basis for commission regulation… As a result, Mr Swanepoel unilaterally introduced his version of commission regulation without industry consensus. Perversely, the only material beneficiaries may have been the insurers themselves.”

This was by no means the last attempt to regulate commission. Dr Benfield states:

“In the nearly half-century since it was first introduced in 1977, insurance commission regulation has failed to serve its stated purpose of reducing premiums for consumers. On the contrary, it has:

• driven prices up appreciably;
• seemingly made criminals of otherwise respectable business people;
• is readily skirted by the well-established;
• is largely impervious to equitable enforcement;
• has led to the ballooning of the size of the controlling bureaucracy;
• has necessitated new industry taxes (levies) growing far faster than inflation;
• is being passed on to consumers, entirely nullifying its stated purpose of inhibiting premium cost growth;
• has led to additional forms of price control over other outsourced services listed in the FSCA’s so-called ‘RDR’ regulations (now called standards); and
• has severely prejudiced emergent intermediaries.”

Benfield argues that “…the natural workings of a vigorous market could readily be harnessed to do the job for them and to protect consumers, the industry and the regulators alike.

“The correct price can be determined only by the free interplay of manifold suppliers, intermediaries and consumers acting independently at widely differing times and in many disparate locations. Price-fixing by individuals in bureaucratic agencies is gravely deleterious to the progress of any economy. This fact is inarguable and no longer open to informed debate. A one-size-fits-all price could never be appropriate for any goods or services in every circumstance.”

Benfield then sets out the various roles in the industry.

“Insurers provide cover against risks based on elaborate assessments of myriad factors that could affect future events. Insurance intermediaries (agents and brokers) are the interface between insurers and their customers. Traditionally, these intermediaries share in the risk analysis and placement process and their income is restricted to a limited part of the premium paid. Traditional practice is that the intermediary who introduces no business receives no income; those who introduce sound risks are well remunerated; and innumerable positions exist in-between. A freely operating compensatory or ‘commission’ system holds distinct advantages for the consumer and the economy at large. It explains why this system originated centuries ago and why it still pertains in most jurisdictions today.”

Benfield points out that, in the March 2006 Discussion Paper, Contractual Savings in the Life Insurance Industry, National Treasury noted:

“The modern global trend concerning commission is one of deregulation combined with increased disclosure… Austria, Canada, Denmark, Japan, Singapore, Uganda and the United Kingdom, for example, do not limit commission (or insurer charges) in any way.”

“This trend, more latterly also recorded in World Bank surveys, is in line with a worldwide desire to shift towards increasing ease of doing business. This translates into greater competition and greater consumer choice, in turn, resulting in greater consumer protection.

“Government planners do not have, nor can they possibly obtain, the essential day-by-day, minute-by-minute, detailed information necessary to emulate the functioning of an efficient market. To believe they can is what economists refer to as the fatal conceit. Manifold consumer choices determine the prices that guide all production and the delivery of all goods and services – including insurance – except when politicised non-economic forces intervene to disrupt the economy.”

Price control stifles growth

“To make matters worse in South Africa’s complex society, commission price control has meant insurers may no longer support new and emerging intermediaries in ways they could 45 years ago. Emerging intermediaries may now not be paid anything other than the strictly regulated commission, even when they are starting out and volumes are low. This puts almost all of them out of business even before they begin.” (Exceptions are allowed at the lower end of the market – author’s note.)

In conclusion, Benfield notes: “As was predicted all those years ago, it has driven prices up, had innumerable undesirable collateral effects, been harshly prejudicial to emergent intermediaries, and is largely impossible to enforce equitably.”

His suggested solution, in addition to allowing natural market forces to determine the cost of the various services, is to scrap administered prices “…in favour of the simple expedient of comprehensive cost disclosures (and therefore customer-, supplier- and intermediary-based regulation), along with a statement of any possible conflicts of interest.

“Such an arrangement would considerably relieve the burden on regulators, free up the market for greater efficiency, reduce compliance costs, protect consumers, allow insurers to support emerging intermediaries, and very likely have the ultimate effect of actually reducing insurance premiums.”