Study on remuneration structures of financial services intermediaries and conflicts of interest (MARKT/2012/026/H) Final Report by Prof. Dr. jur. Udo Reifner, Prof. Dr. Doris Neuberger, Dr. Roger Rissi, Dr. Christine Riefa, Michael Knobloch, Sebastien Clerc-Renaud and Christian Finger Institut für Finanzdienstleistungen e.V.(iff) Rödingsmarkt 31/33 20459 Hamburg Tel.: + 49 40 30 96 91 0 Fax: + 49 40 30 96 91 22 Email: [email protected] Hamburg, 15 October 2013 Study on remuneration (MARKT/2012/026/H) ii Executive Summary The study has been conducted at a time where according to national discussions, despite the lessons from the financial crisis and a dented consumer confidence in the financial sector, unfair practices of the financial industry as well as the sale of inadequate products like payment protection insurance (PPI) have persisted. It especially considers the effects of certain remuneration systems on the willingness and ability of intermediaries to provide the best advice and to sell the most suitable products to consumers in the retail insurance markets. It covers ten EU Member States and examines the legal, economic and sociological information available through official statistics and publicly available materials, together with the results of the consultation of national experts and a variety of stakeholder groups in the member states covered by this study. The research was done in association with the Financial Services User Group of DG Internal Market and it aims to support the work of this Group in making recommendations to the Commission. The study spans a number of areas, including existing remuneration models, the variety of financial and non-financial incentives available to intermediaries, problematic areas such as the mis-selling of insurance products and the professions involved in intermediation. The study also catalogues some of the existing legislation and efforts made to address problems caused by remuneration structures through regulatory and educational measures. It provides some comparison with similar problems in investment services and in the brokerage of credit to consumers. Special attention is paid to the alternatives of commission and fee-based remuneration systems. The study also investigates the potential effect of any ban on contingent commissions in certain areas of intermediation. The research was based on a study of the vast theoretical economic and legal discussion, which itself is often underpinned by empirical data and information from different countries. An important element of the study was the clarification of the various concepts in order to develop a coherent basis for the questionnaire sent to stakeholders, the results of which formed the main source of information. This study and its results seek to offer an insight into current issues facing the insurance industry with regard to the way remuneration structures may influence wrongdoing. The views expressed by stakeholders or gathered through other research have therefore been reported as objectively as possible. Both isolated positions and mainstream views have been reported. Interestingly, despite the potential variables (as a result of the number of member states or categories of stakeholders consulted), the picture emerging is much more homogenous than was first anticipated. By and large, respondents agreed that the current remuneration structure in operation in the industry creates problems and that something needs to be done in order to address this. Differences between respondents tended to emerge when it came to assessing the exact scale of the problem, as well as the action needed and potential solutions. Those are in effect points that the report does not deal with, because solutions are beyond the scope of this study. However, the report makes a number of recommendations based on the data gathered and the observations our project team was able to make. Conflicts of interest in insurance intermediation (Chapter 1 and 3) There is a general consensus among the European Supervisory Authority for Insurance, EIOPA, the FSUG and national governments and financial supervisors that certain remuneration models in insurance intermediation are prone to creating a conflict of interest which can lead to forms of mis-selling and consumer detriment. These include Study on remuneration (MARKT/2012/026/H) iii churning, twisting, overcharging, inflated products, forced bundling, the sale of unsuitable products or the confusion of products, and lack of transparency. Nearly all respondents expressed their view, that the logic of commissions leads to mis-selling. This potential for conflicts of interest is attributed to insurance intermediation, which combines objective and subjective access to insurance products. The intermediary opens the door to a particular product which is available through him (broker function) while his advice may allow consumers to identify their own needs and relate them to the range of affordable offers available. It is in both areas that, according to our survey, there is growing concern about insurance intermediation in all 12 Member States. This is firstly due to the variety of products offered. This is artificially reduced when intermediaries are dependent on the supplier. Secondly, it stems from the fact that inappropriate advice may identify consumer needs which do not exist at all or at least not to the extent proposed. Thirdly, concerns arise because other products are available on the market but are not offered through this intermediated advice, although they may be more suitable or cheaper. After-sales services offered by some insurers may be more responsive to difficult situations than the ones offered by intermediaries. The short-term perspective generated by first-year commissions, and the conflicts faced by an intermediary who has to serve two masters and integrate brokerage and advice services were both seen by a majority of respondents as having an important role in generating conflicts of interest. Problems appeared to be concentrated in life insurance, especially when bundled with investment (capital life) or with credit (payment protection insurance, endowment credit). Bancassurance was named as a major source of mis-selling. Remuneration (Chapter 2) There is a large range of supplier-led incentives for promoting the sale of financial services. Direct incentives include commissions linked to specific products and/or the amount of sales (either by unit or, most frequently, by value). Indirect incentives comprise score systems, rankings and job promotion in multi-level marketing systems. These incentives are typically linked to the gains the supplier expects from the sale of its goods or services. By contrast, the fees paid directly by the customer usually represent the time invested by the independent advisor in consulting the customer about his or her circumstances and providing advice accordingly. Volume-based sales commissions remain the most widespread form of remuneration for advice in insurance, credit and investment markets, except in countries that introduced a ban on commissions (such as Finland, Denmark, the UK and the Netherlands). Within the commission-based remuneration system, many different schemes are used. Those schemes are not published by providers. Similarly, in most countries, intermediaries do not disclose the form and level of remuneration they receive. This is a key problem for consumers as also suggested by the findings of a parallel internet based exercise that requested offers from various intermediaries. For insurance markets, we find that volume-based sales commissions prevail in product distribution by tied and linked agents, brokers, bancassurance and retailers. The model for and amount of commission payments vary according to insurance intermediary and product type. Brokers tend to receive higher commissions compared with tied and linked agents. Sales commissions in life insurance are based either on the insurance sum or on the annual premium, or in non-life insurance simply on the annual premium. In addition, intermediaries usually receive portfolio commissions based on the annual premium of both life and non-life insurance. Commission rates are usually higher in life than in non-life insurance. Our own calculations for Germany show that 93-94% of total life insurance commissions are sales Study on remuneration (MARKT/2012/026/H) iv commissions, while this percentage declines to 72-80% in the health insurance market. On the basis of OECD statistics, of the total commissions paid by insurance companies, we find that commissions in the life insurance market reach on average 4.3% of total gross premiums per year in the selected Member States. This ratio is highest in Ireland (14.7%), which can be explained by brokers’ large market share and the tight oligopoly of three large insurance companies that compete intensively for market share by paying higher commissions. The major advantage of fee-based advice is its greater transparency. However, hourly fees may often be more expensive than the commissions included in the insurance premium (e.g. 400-500 euro for 1.5-2 hours financial advice without additional fees for advice services by email, or by mail in Germany). The experience of countries that introduced a ban on commissions shows that consumers are unwilling to pay the high fees of intermediaries (Finland). It also shows that customers have to pay more for financial advice than they did before the ban (UK). Finally, following the ban, the number of brokers