The dangers of a 'cost to serve' analysis

With the news that the government has accepted the Life Insurance Framework with an implementation date of 1 July 2016, I thought I would provide some insights into the process for advisers to determine their pricing structure.

With the changes to commissions, every adviser who writes insurance, be they risk-only or full financial advice businesses, will have to reconsider how they run their business. This is more than simply working out how you’re going to get paid in future and, in fact, is a evolutionary process that will have a powerful effect on the results and sustainability of your business.

Part of the process we take advisers through when determining their pricing model, is to understand the cost of delivering their advice. The ‘back of the envelope’ calculation I shared in my presentation at the AFA Life Insurance Roadshow, revealed that after considering the work involved in implementing insurance for a client, many advisers will discover their minimum recoverable amount per client will be at least $3,400 plus GST. That’s a surprising figure for many, and it is really important that no adviser takes this estimate as a given. Rather they need to do the calculation in their own business to arrive at the correct minimum recoverable amount for their unique cost base.

In a nutshell, what this looks like is you:

• Run a calculation using your own business overheads and the chargeable staff time you have in the business, to arrive at a charge-out rate (and our advice is to ensure this rate includes your desired profit margin), we suggest determining a different rate for the varied level of service providers in your business;
• List the process you use to engage clients and get them covered;
• Consider a 'typical' client and estimate the average time it takes to service them and get your advice implemented, again, broken down into the different service providers involved in the process;
• Multiply the time by the charge out rate(s) to arrive at the minimum recoverable amount you need to make a profit on your services.

Note I use the term minimum recoverable amount (MRA). The MRA refers to the minimum amount of remuneration that an adviser will aim to obtain for each client engagement – whether they choose to obtain that amount by commission, a hybrid of fees plus commission, or via fees alone.

Clawbacks – whether they are one, two or three years in the final approved LIF – must be accounted for in the MRA, as should time spent to handle claims on behalf of clients, if they choose not to charge each individual client at time of claim.

Advisers will need to know their MRA to service a new client, as well as an annual MRA for their ongoing services, and an MRA to implement new advice for an existing client. They’ll also need to know how to price their services when they have a client with more complex needs than their ‘typical’ client.

I titled this article The dangers of a cost to serve analysis because IF an adviser considers that the answer to determining a pricing structure and sustainable business model begins and ends with this analysis, then the doomsayers who are convinced that the IF will mean the end of the risk adviser, may indeed be correct. It is delusional to assume that an adviser can simply do this 'cost to serve analysis' and then put that number in front of their clients as a fee – or simply refuse to do business with clients unless their commission meets this minimum amount. Those who do so will very likely find their new business levels drop and will potentially lose existing clients.

Now, there are a lot of shortcomings in this 'cost to serve' analysis process, which is why it is only the first step in the process we take advisers through.

So why do we espouse this process? Because in my years of experience helping advice businesses all around Australia determine their pricing model, I have learnt that this step to determine the MRA plays a critical function on both a technical level as well as a psychological level.

Before an adviser can effectively restructure their business model and have the conviction to position a fee (or hybrid model) to their clients, they need to be totally convinced that it is the right thing to do for their business and for their client. If they are approaching their business restructure from the right mindset, the act of crunching the numbers to arrive at their MRA boosts their confidence to quote a fee – they ‘own’ it, because they have seen for themselves, what it will cost them if they undercharge. If they’re still mourning the loss of high upfront commissions and resisting the need to evolve their model, the psychological effect of calculating their MRA actually leads them towards the right mindset – reaching the understanding that if they do not switch their mind to evolving, they will struggle to earn enough to cover their costs. On a technical level, the MRA defines the minimum level at which an adviser will structure their targeted clientele and value proposition. Without this 'science' at the start of the evolution process, many advisers will underestimate the cost of their business and undervalue their services.

The amount the adviser needs to make to cover their costs and make a profit is actually quite distinct from the value they’re providing to their clients. If the adviser finds their MRA exceeds the value the client will receive, then they will either improve their efficiencies to reduce their MRA, or refer the client onto a different service provider who can satisfy their needs with a process and cost that will deliver them value. They will recognise that it’s OK to refer clients with relatively simple insurance needs to a provider that can service them with a simple process and product, and they will seek to reserve their valuable advice process and knowledge for those higher up on the ‘complexity scale’. Herein lies the art of pricing – to quantify the value to a client, when often what they value most are the intangible factors of convenience, experience, accountability and peace of mind.

Determining the MRA is actually the easy part. There are a series of more complex elements of evolving a business that require further thought – and I would strongly recommend that advisers reach out for support to help them in the process. It makes sense that if you’ve run your business a certain way for any length of time, you won’t automatically know how to change it – it won’t come naturally or quickly to you. Reach out to your insurers, your licensees, or independent specialists like Elixir Consulting, and get help from a business coach, PDM or BDM. Just be sure to reach out to someone who has in the very least been trained in how to help you, and ideally, has helped other advisers through this, and has the experience, conviction and skills to help you avoid the mistakes of others and gain the confidence you need to move your business forward.

You’ll want to find someone who can help you answer questions such as:

• What is the client value proposition of your firm?
• How will you position your fees and service proposition – do you need to review the engagement process that you take a client through when they enquire with you so that you can provide the very best advice, position your payment structure at the right time to receive buy-in from the client, and not only win the clients you want to win, but also receive referrals for future clients?
• What type of clientele best suit your offer and where will you find them?
• How will you educate them on their need for your services so that they come to you actively seeking your advice, rather than you having to sell them both the need for your relationship as well as the need for an insurance policy?
• What is your ongoing service proposition?
• How will you handle cases that don’t complete?
• How will you manage the clawback provisions, whether they end up being three years or less?

At Elixir Consulting, we’re on a mission to ensure that Australia keeps a vibrant advice community that continues to build a successful business delivering risk advice to clients.

I’m in the final throes of completing my next book that will be released next month, titled Worth Paying For – Unlocking the value of your risk advice service to ensure the successful future of your business and your clients.

Sue Viskovic is the managing director of Elixir Consulting.