Written by Ng E-Jay
29 March 2012
The Monetary Authority of Singapore (MAS) announced on Monday that it would launch a Financial Advisory Industry Review (FAIR) aimed at lowering the cost of financial products sold by commission-based insurance agents, and raise the quality of advice provided. I welcomes these moves, but feel more should be done.
A key MAS proposal involves re-examining the current structure of life insurance policies in which the buyer pays commission to the agent as well as the agent’s supervisor. This fee structure is widely used around the world, so MAS might encounter resistance when trying to reign in insurance companies who operate not just in Singapore but globally.
Mr Ravi Menon, a managing director of MAS, said that the total commissions and overrides earned by a financial representative and his supervisors is as much as 160 per cent of the insurance policy’s annual premium.
Supposedly, the FAIR panel will examine whether this commission structure adversely induces representatives to sell products that pay them higher commissions, and pay less attention to the long-term interest of consumers.
Britain and Australia have already banned commission payments and are moving to a fee-based model.
MAS has also noticed a worrying trend of representatives going into other activities, including money-lending and selling real estate. It will reportedly look at banning them from these other activities deemed “in clear conflict” with financial advisory activities.
The new MAS initiative is to be applauded. But what is really needed in Singapore’s context is more financial education, which ideally should start in Secondary Schools and Junior Colleges.
Financial literacy begins in school
A specialized school curriculum should be set up jointly by MOE and MAS to teach school-goers the basics of personal finance, including personal budgeting, inculcation of prudent financial habits, the effect of compounding, and inflation.
Older students should also be introduced to various financial market instruments, life and health insurance, and the benefits as well as risks associated with all of these products. When students graduate and start working, they will then be more discerning when making investments or purchasing insurance products, many of which can be quite complex to the uninitiated.
Perhaps if Singapore students are made financially literate at a young age, they will grow up to understand and appreciate the benefits of fee-based financial advice. A fee-based model typically saves the consumer money, because the consumer often pays less in advisory fees than he or she would pay in commissions under a full commission model.
Singaporeans however do not comprehend this. They feel averse to paying for financial advice because the thinking that financial advice should be given free of charge has been so ingrained in our culture (and in many societies around the world too). They fail to realize they pay more in non-transparent commission structures as well as obscure and excessive administrative charges.
Fee-based model is the right way to go
A fee-based model is clearly the right way to go because it provides the correct incentive for agents to give advice based on the clients’ interest and not on product commission.
However, if the MAS only wants to reduce agent commissions, but does not take adequate steps to bring about an overhaul of the entire industry, then the move will backfire.
Insurance companies who employ tied agents will have to find a way to compensate their agents through other means (say, by a basic salary) in order to retain them, or many agents will find it unprofitable to continue in the insurance line. The insurance company will then make up for this by lowering the bonuses paid out to participating policies. In the end, it is still the consumer who suffers.
Similarly, independent financial advisory firms (who employ agents free to sell products from a variety of product manufacturers) will find it harder to survive, and they will also demand greater compensation through other means from the insurance product manufacturers, who will then respond by lowering bonus payouts on participating policies.
Hence, if the MAS only seeks to reduce agent commissions but does nothing to move Singapore towards a fee-based model or make other changes to the way the insurance industry operates, it will not achieve its aims.
Certain exempt financial advisers not subject to sufficient oversight
In my opinion, the current MAS regulatory framework does not subject certain exempt financial advisers like banks or brokerage firms to sufficient oversight.
Since 2002 when MAS introduced a new Financial Adviser’s Act, insurance firms as well as independent financial advisers have moved ahead and adapted to the new legislation by tightening advisory processes and improving on quality and competency, in line with the new FA Act. Banks and brokerage firms, however, failed to catch up.
This failure to catch up showed up very glaringly in the credit crisis of 2008 when Lehman Brothers collapsed, and left thousands of Mini-Bond holders with very substantial and unrecoverable losses. Subsequent MAS investigation revealed that banks and brokerage firms had failed to provide proper advice to clients, or failed to ensure that clients understood the full nature of the risks embedded in these complex products.
Since the Lehman Mini-Bond incident, MAS has clamped down on the shoddy practices and tightened regulation surrounding complex financial products, but more needs to be done. In this case MAS has shown itself to be reactive rather than proactive, as far as the Big Boys like the banks were concerned. For example, how could MAS even allow a product that could be subject to 100% capital loss to be sold to the retail public?