Are Life Insurance Commissions on Their Way Out?
The average commission generated by a life insurance policy varies depending on the type of life insurance in question.
For example, the average commission on term insurance is 30 to 70%, while it is 90 to 105% on whole life insurance products. Of course, what we're talking about here are the first year commissions, commissions for subsequent years drop much lower to an average of 4% a year for term insurance and 6% annually for whole life insurance.
Life insurance commissions are generally broken down into three components.
First Year Commission (FYC): This amount is a percentage of the total premium. It ranges from 40% to 60%. The FYC is generally higher among permanent policies, such as Whole Life or Universal Life, when compared to term policies, but many insurers have been lowering the FYC rate on their permanent policies, especially guaranteed permanent policies.
Production Bonus: This is a multiple of the First Year Commission. The bonus rate is generally higher for higher producing brokers, but this does not translate into consumers paying a higher rate. It simply means the Managing General Agent (the go-between between the insurer and the consumer) makes a smaller cut on higher producing brokers. This makes sense because these brokers tend to be more experienced and need less training and hand-holding than newer brokers.
Renewals: This is the amount the broker receives each month starting after 13 months. The percentage ranges from 2% to 8%.
Insurers charge back the brokers commission if the policy cancels in the first two policy years and some insurance carriers have persistent bonus schedules, which penalize chargebacks at any time.
All life insurance distribution channels have associated costs. If the insurance companies are not paying commissions, they will be paying another type of distribution cost, such as salary or online marketing costs.
With that in mind, we asked some of Ontario's foremost insurance industry experts whether they thought commissions were on their way out of the life insurance business, and here's what they had to say in answer to that question.
Insurance broker William Shung points out that banks with a life insurance arm or insurance companies with a banking arm will always attempt to sell life insurance direct because they know their advantage is a big direct marketing data base. As a result, he contends that it becomes more and more difficult for life insurance brokers to earn commissions and the brokers who will suffer most are the new brokers and they already are.
"We are experiencing fewer and fewer young people in the life insurance business," he says.
Ami Maishlish, who has been in the insurance business for almost 40 years and is president and CEO of CompuOffice Software Inc., believes that thanks to the proliferation of Internet, along with the large client databases and marketing capabilities of banks that have merged with insurance companies, selling direct has become much easier and this will eventually lead to the obsolescence of commissions and the need for brokers in the family and single needs life insurance market, which sells term insurance, term 100, and basic whole life policies.
"The interim stage we're currently experiencing of the direct market mixed with the independent broker will likely last for the next five years or so before the traditional independent agent is phased out of these lines of business to be replaced by financial institution owned and operated term-o-matic and call centre combos or through such combos outsourced to licensed MGAs and/or unlicensed operators," Maishlish predicts.
Should his prediction come to pass, Maishlish believes this will eventually cut out the "family" and single-needs part of the business, leaving only the parts that require knowledgeable and trained human intermediaries or advisors like estate, business, and tax planning and overall financial advice to the upper middle class and the wealthy.
He also points out that there's already pressure from financial institutions to do away with commissions and replace them with fees because that makes financial sense to the financial institutions, as it would cut down on their distribution costs and increase their profit lines. It is also more likely that the upper middle class would be prepared to pay fees to advisors for the added value received.
Tamara Humphries, another Ontario broker based in Markham, will tell you that if commissions did fully disappear, as Maishlish hints, you would see a drop in quality when it came to service to the client.
"The products sold without commission tend to be products with claim problems because there is no agent or broker to advocate on behalf of the insured," she says.
Advocis agrees with Humphries. The Financial Advisors' Association of Canada, says that banning commissions, as Australia and the UK had already done, would hurt advisors and clients alike.
"Plans sold to consumers without an agent tend to have more declined claims and product lines sold without commissions paid to agents tend to have lower productivity than those lines sold with commissions paid to advisors," confirms Humphries.
Not only that, but it will also raise the cost of doing business. Need proof? Advocis would have you look at the other countries where commissions are already banned.
In Australia, the Future of Financial Advice (FOFA) reforms responsible for getting rid of commissions there, established a best interests' legal duty and expanded requirements regarding fee disclosure, says Advocis. These changes increased the costs to serve clients above 30%, and compliance costs for advisors have so far totalled AUD $700 million. In the UK, the reforms banning commissions caused the number of advisors to drop by 25% in that country.
What's worse, the clients that have the most difficulty affording fee-for-service arrangements are those in the low- to middle-income range. Plus, it doesn't take a genius to know that those with assets under $100,000 make up 80% of the market in Canada, so doom could be coming if banning commissions makes financial advice more expensive.
“We need a system that serves investors at all income levels,” says Greg Pollock, president and CEO of Advocis. “Given Canadians’ concerns around cost of living and retirement readiness, it’s critical that more people are able to seek professional financial advice.”
“If we can get to a disclosure model that’s appropriate, then consumers could make the choice,” says Pollock. “If my embedded commission is $1,000, or whatever that number is, then you have a choice, as long as they disclose that.”
Even Maishlish will tell you that though commission as it is traditionally thought of will disappear in ten or twenty years, it will still be around in the form of back-door incentives like trips, referral bonuses, and discounts.
William Shung remains slightly more optimistic. "Commissions are here to stay because they will never achieve 100% of the market by selling direct so there will always be business for the individual brokers to pick up," he affirms.