Do compensation models in insurance need a reboot?

Over the past year, consumers have developed a greater appreciation for the role life insurance, disability insurance, and annuities can play as they build their wealth and transition to retirement. In the face of that growing demand, insurers have profoundly transformed themselves, improving access to their products by opening digital distribution channels and creating more accommodative application processes.

But David Lau, founder and CEO of DPL Financial Partners, argues that insurers need to provide even more benefits to consumers by disrupting one long-held part of their business models.

“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,” Lau wrote in a piece for ThinkAdvisor. “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.”

Citing research from Morningstar, Lau said that the typical variable annuity costs around 3.65% once all the product costs, investment costs, and rider fees are accounted for, translating into a nominal cost of about $600 monthly for a $200,000 policy. Commissions that are built into the pricing of traditional products, he added, can drive up costs by anywhere from 25% to 85%, which saps away value that consumers could have derived from the initial premium and subsequent account growth.

“And in products like annuities, cost is not often discussed, so the consumer rarely knows how much they are paying for the contract,” he said.

Commissions also lead to a double-sided conflict of interest. Under the traditional model, commissioned salespersons are compelled both by the stick of not being paid unless they make a sale, and the carrot of generous commissions that come with larger sales volumes. For the consumer, that makes it difficult to determine whether they’re being pitched a product with a certain amount of coverage because it truly fits their needs.

Fee-only advisors who do not accept commissions face the opposite conflict, particularly with respect to annuities. As Lau argued, those advisors lose money when their clients purchase an annuity with a portion of the assets they’re getting paid to manage. That means even if getting an annuity would be in the best interest of their clients, the advisors are confronted with a strong motivation to not recommend them.

The reliance on commission-based products, Lau added, creates a stronger desire for insurance product providers to make their products more complex. Since product differentiation can be crucial in a sales-driven market, he maintained, there’s a greater incentive to make insurance products seem special with complex features that can add hundreds of pages of prospectus documentation for a given offering.

“It’s no wonder annuities are derided as complex, expensive and opaque products, Lau said. “Given these facts, it becomes obvious that insurance needs an overhaul that starts with the elimination of the commissions from the products.”