The code of ethics of an advisor provides that honesty, integrity and duty towards the client are the first obligation of the financial advisor. However the insurance companies and other financial institutions are free to influence the objectivity of advisors though irresponsible commission structures and an enormous variety of sales incentives.
The objectivity of the advisor is put to the test. In front of this constant temptation, it is unfortunately only a matter of time before an advisor decides that his interests are more important than the needs of his customers. This is how the fraud circle starts.
When I was a Sales manager, I had a golden rule. As an intermediary, I was the conduit between the manufacturer and the customer who was represented by the advisor. I had to conduct all of my operations in such a way to create a transferable value to the customer. After all, I asked the representatives to concentrate their sales with one company and thus to put their objectivity at risk. The more they concentrated their sales, the more they were getting in commission and special incentives and the more their objectivity was at risk.
To justify this risk, my philosophy was simple. If you sell a Porsche to a person who cannot drive a car with a clutch, it is the guy with the automatic Hyundai who will first cross the finishing line. Same thing in the insurance industry. Objectivity at the point of sale ensures the customer requirements are defined but it is the management of the solution which is recommended and the service provided over the life of the contract which will decide if the goals of clients will be reached and met. Specializing and increasing your knowledge of a company products improve your ability to manage and service the recommended solution. It’s a pity there are no regulations as to the level service needed in the insurance industry. This means all kinds of solutions can be presented without the advisor being responsible for the management of this solution.
Unfortunately my golden rule is not shared by most insurance companies. The insurance companies prefer to cut all the support and to offer only sale incentives. With sales bonus going up to 205% and more, where the advisor can receive 2 to 3 times the premium in commission, it becomes difficult for the advisor to choose between his interests and the interests of the client. When one adds other sale incentives (all based on production) like trips, purchase of shares, marketing dollars… can the advisor remain objective?
If the advisor places his business with another manufacturer his bonus can drop substantially for example from 180% to 120%. Faced with losing 60% of his bonus in addition to other sales incentives, will he recommend the right solution to his customer?
The advisor also has the option to use an intermediary (MGA) for all the companies. The commission bonus will be the same one for all the companies with the sale incentives remaining different for each insurance company. Will the customers lose without this concentration of knowledge with one company? Before I would have answered by the positive but now with manufacturers offering less and less support when dealing directly with them, there are no advantages in doing business directly with an insurer.
The wrong influence
An advisor approached me lately and told me a banker met his client to speak about leveraging. The client called his advisor to ask him whether he could set up this strategy for him. The advisor answered by the positive because he had access to a leveraging program called 3 for 1. If the customer invested 100,000$ he could borrow 400,000$. He was not at ease with this strategy and he asked my opinion. I convinced him not to do it. He called the customer and explained why he was against this form of speculation. The customer thanked him for his honesty. But the customer did not know that the advisor just had said goodbye to a commission of more than 20,000$. They are not many advisors who would have made this decision not to multiply their commission by 4 just by convincing a customer to enter into a leveraging arrangement.
Looking at the type of frauds in the industry, the problem of leveraged investments is recurring. Sanctions are taken against advisors but there are no sanctions taken against the companies which offer and benefit from this strategy. This is an example of what I call the fraud circle.
The fraud circle starts with a company offering a strategy or product and inciting advisors to offer it through the use of different incentives. We will call this putting the hook into the water. Now it is only a question of statistics. For 10 advisors who will be shown this strategy, 1 advisor will take the hook. Quickly the hooked advisor will be convinced to sell this strategy or product at all costs and to put his interests before the interest of his clients. His sales will increase suddenly. The company makes profit. The wholesalers meet their sales goals and receive large bonus. This salesman will be transformed into a hero. He will win trophies. He will be offered gifts and trips… Soon he will lose his objectivity and everyone at the company knows it. The first clients will have been good and honest sales. But now the advisor is running out of clients. But the incentives are like a drug. Suddenly he lowers the standards to qualify new clients. He sells more and the more he sells the less the strategy is suited to the new clients. It is only a matter of time before a customer loses his money who could not afford the risk. The advisor does not know that he will then be sacrificed by the insurer.
A customer then makes a complaint. The regulator reacts and bring charges against the advisor. The charges are published in the newspapers to show how the regulators fights abuses in the financial industry. By doing this, the regulator justifies its raison d’être.
All this opera would be funny if one could forget that in this circle of fraud real customers lose money. The companies, the wholesalers, the intermediaries who benefitted from these sales do not face any accusations. They are free to find the next advisor. Once again the hook is put into the water. Who will be the next advisor to be bite?