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Life Health > Life Insurance

Sometimes Transparency Can Be Illusory

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I believe it was Germanys Otto von Bismarck who first put forth the notion that the public at large should not be exposed to the making of laws or sausage. It is a concept that held sway for more than 100 years, but today is giving way to the zeal for “transparency” in all matters of commerce. I have no particular problem with that so long as it is true transparency, rather than an incomplete picture pursuant to someones agenda.

The pricing structure of virtually all products today is a result of competitive pressure in the marketplace and not by government fiat except in the case of monopolies. As a general rule, the stiffer the competition, the tighter the margin of profit. It is a system that by and large has worked well for both the consumer and business. Competition keeps prices and costs, including wages, in line, and as such, is a means of self-policing the marketplace. In some lines of business, developing a reasonable relationship between costs and selling prices is relatively simple whereas others are very complicated and subject to variables and unknowns.

The insurance business falls in the latter category, as its pricing structure must endure over many decades. It is also a highly competitive market where no company can afford to pay more for a cost factor than competition will allow. Further complicating the pricing and cost relationship is the great variety of markets to be served. Some markets are very difficult to serve and require totally different cost factors than those required in the so-called “affluent market.” Comparing costs between two such distribution systems can easily create an illusion that does not reflect reality. But over the years the business has sorted out these problems to bring a vital product to the marketplace at reasonable prices.

The call for transparency today does not always reflect the foregoing issues and can, if one is not careful, produce an illusion that is more a distraction than a benefit.

A significant cost factor in life insurance company costs are agents commissions which, with some regularity, come under assault by regulators or lawmakers. This, despite the fact that studies have shown that other forms of distribution are no less expensive. But they are seldom, if ever, questioned. The problem as I see it is largely centered around the fact that an agents commission in the first year appears to some to be too large. I must admit that when I first entered the business, I was a bit overwhelmed by the size of my first commissions. In my former business if I made a $1,000 sale, my commission was 20% of the gross profit, which usually meant $60 to $100 for me. On the other hand, when I made a life insurance sale of $1,000 annual premium, the commission in that year was $500. It took me a while to realize the two sales were not comparable. In my former business, the sale was for $1,000, period; the life insurance sale was for an annual stream of $1,000 premiums, hopefully to continue for many years.

Disclosing early commissions on life insurance sales is not transparency but an illusion that can be very distracting in a sales situation. This can be easily demonstrated by looking at the commission paid on the sale of a single premium life policy or annuity, which is typically 2% to 5%.

We are sometimes compared to the compensation of real estate salespeople. However, that is also an illusion. Real estate sales commissions are typically 6%-7% of the sales price of the property, and there is no continuing service as that required of an insurance agent. The 2%-5% commissions on our single-premium products (comparable to the purchase of property) are well below that of the real estate people.

By and large, I believe the life insurance business has done a credible job of maintaining a fair and reasonable system of agent compensation with a minimal amount of outside interference. There are variations in commissions among companies, but I know of none who will pay more than they have to in order to bring in the business. Most agents are ever mindful of competitive pressure, which is always there, and they do not have the luxury of seeking a non-competitive product that may pay a higher commission.

But I return to the notion that the higher first-year commission remains the target of most critics. Is such commission justified? Absolutely! Our business is not a transactional business. People do not call up and order it. One of the reasons I have always emphasized that agents sell plans rather than policies has been to highlight the work we do before a sale is consummated. Ours is a problem-solving enterprise and that often takes a lot of work before anything happens. We have to uncover the problem, understand it, communicate it and devise a solution. This often means consultation with attorneys, CPAs and trust officers and research into tax provisions. The current compensation structure enables us to get paid when we do the worknot years later.

One final point, in my many years in the field, I can recall only one instance where my commission came up in the sales process.

Reproduced from National Underwriter Edition, January 27, 2005. Copyright 2005 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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