If you’ve ever talked to a life insurance agent, there’s a good chance you were told that taking out a bigger policy – or investing in an annuity – was the key to financial peace of mind. It could be, but before you bite, be aware that the agent has incentives for selling you certain types of policies rather than other ones.
Most professionals who sell insurance are paid largely on a commission basis. In fact, most agents aren’t even employees of the carrier. More often than not, they’re independent contractors who are compensated based on how much they sell, with higher commissions for certain types of products.
This doesn’t necessarily mean they’re giving advice that doesn't fit your financial needs. By law, agents have to offer policies that meet certain “suitability” standards. In other words, a consumer finds who finds out later on that the coverage was inappropriate for his or her financial situation can file a complaint.
Still, agents have a significant motivation to sell as much as they reasonably can. Whenever agents or brokers sell a life insurance policy, they’ll typically bag more than half of the first year’s premium. That can amount to hundreds or even thousands of dollars, depending on the size of the policy. They often also receive so-called “renewal” commissions, which can amount to as much as 7.5% of premiums, for the next nine years that you keep the policy. Beyond that, some policies give the agent a small “persistency” fee annually.
Some insurance carriers are beginning to do away with renewal commissions on term policies, the most basic type of life insurance product. That’s one reason why sales reps may try to push whole life policies, which combine life insurance with a tax-advantaged savings component. Whole life coverage also lasts longer – the entire lifespan of the insured person – and tends to involve bigger dollar amounts, leading to a bigger payday for the agent. The question before buying such a policy is whether it's a better way to provide financial security for yourself than other options, such as securities or an annuity.
When customers balk at the cost of a whole life plan, some agents may suggest a “blended” policy, essentially a hybrid of whole life and term insurance products. They get a smaller commission than when they sell a conventional whole life policy, but more than they would if you bought a term plan.
Typically, customers don’t pay any more or less when they buy directly from a carrier or through a broker. The brokerage will split its commission with the life insurance agent, but the total amount of remuneration remains the same. If you value the personal service of a broker, you won't have to pay more to use one.
Annuities: A Lucrative Business
With more life insurance companies selling a variety of financial products today, agents often earn even more when they sell annuities. The fixed annuity, which pays the owner a set amount each year, is still the bread-and-butter of the industry. But many reps offer products that are more complex and often pay significantly higher commissions.
For example, a variable annuity offers a cash-balance feature where the payout depends in part on the performance of different stocks, bonds and mutual funds selected by the owner. These policies can garner commissions of 7-8% of the invested amount, split roughly equally between the carrier and the selling agent. Meanwhile, the investor gets a product that frequently charges 3% or even 3.5% of the account balance in annual fees – well above most mutual-fund expense ratios – and steep early-withdrawal penalties.
Perhaps even more controversial is the equity-indexed annuity. Here, the return is based on how well a benchmark such as the S&P 500 fares over time. In addition to being relatively complex, these products have also caught flak for paying agents so generously. Sellers typically receive more than 5% commissions each time they sell one.
That doesn’t mean most life insurance reps make massive incomes. According to the Bureau of Labor Statistics, the 2012 median salary for insurance agents was a modest $48,150 (the average salary was $63,400). The first several years of developing a customer base can be particularly challenging, with less than 20% of new agents lasting more than four years. Still, experts say that understanding the industry’s payment model can help consumers appreciate why some agents may have a bias toward certain products over others.
The Bottom Line
When you're comparing different products, ask the agent or broker how much commission they make on each one. If they refuse to tell you, you might want to find someone who will. And, of course, shop around for quotes from several sources before buying any product.