The financial insurance and annuity industries are multi-trillion-dollar industries, and they should be. These products are important components of holistic financial plans for individuals and families.
Life and disability insurance can help protect income during wealth-building years, while annuities provide secure lifetime income during retirement, which mitigates significant risks that can derail a retirement plan (like sequence risk and longevity risk), and that often are created by investments themselves. Frankly, with all the challenges of retirement today, a combination of investments and annuities are necessary to provide the income and security retirees crave.
But the insurance industry needs to be disrupted. Unlike most of the financial services world that has already migrated away from commission-driven sales, insurance products are still largely distributed through commissioned sales agents. And that creates a lot of problems for the end users — consumers — who need the benefits these products provide and the peace of mind that their best interests are being served. The costs of those commissions are built into the price of the products, so the consumer pays year after year for as long as they own the product.
Where to Start
The major reform of insurance has to begin with the removal of commissions to create disruptive pricing. The commissions that are built into the pricing of traditional products drive up costs significantly — anywhere from 25% to 85%. So, consumers get far less for each dollar in the policy because so much of the initial premium and subsequent account growth is siphoned off to pay the agent their sales commission. And in products like annuities, cost is not often discussed, so the consumer rarely knows how much they are paying for the contract.
According to Morningstar, when you include the product costs, the investment costs and the rider fees, the typical variable annuity costs about 3.65%. For a $200,000 policy you are paying about $600 per month. How many other purchases do consumers make where they’re paying $600 per month for life without either making a conscious decision to do so or price shopping first?
Commissions also create a conflict of interest that cuts in two directions. First, for the commissioned salesperson, their interest is in selling a product — they do not get paid otherwise. And, since the commissions are generally quite generous, this compensation model can lead to some unscrupulous (and well-documented) sales practices.
As a consumer, it’s hard to know if the product you’re being pitched is the best fit for your needs and if the amount of coverage recommended is appropriate or is being inflated by the salesperson to make a larger sale, and thus, a larger commission.
And then, for the fee-only advisor who does not accept commissions, insurance products (particularly annuities) create the opposite conflict. An advisor loses money when their client purchases an annuity using a portion of the assets the advisor is getting paid to manage — this can be a strong motivation to not recommend annuities to clients even when the annuity may be in the client’s best interest. And, can lead advisors to dismiss consideration of all annuity products for their clients, thereby shirking their fiduciary obligation.