(Complete Show Notes Below)
In the 61st episode of the Financial Procast:
We’re pulling back the curtain on life insurance commissions. Yep, you read that right…we’re actually going to talk about how much commission is paid on life insurance policies.
Wait a minute!
If people actually know how much commission you’re making, they won’t buy the policy. Or at least that seems to be the prevailing theory amongst many folks in the life insurance industry.
In fact, just a few years ago the state of New York put in place Reg. 194 which requires an agent to disclose commissions to their clients, if they client asks them directly for that information. Now, it’s not really cut and dry.
The regulation actually requires the commission to be disclosed as a range over a period of time, but it’s a start.
Why are some agents diametrically opposed to full disclosure?
We’re not exactly sure but we have a theory:
Perhaps they’re not doing the best they could for their clients and/or prospective clients and feel some guilt about the money they’re being paid as a result?
Think back to a car buying experience as an analogy for this sort of a relationship.
You walk on the lot of a car dealership, find the car you want, talk to a salesperson and thus begins the fun. They give you a number, you ask “is that the best you can do?”. Well actually, no, it’s not the best….so they go off to talk to the “manager” and then come back with a better deal.
This process repeats several times until you actually get to the best number.
Life insurance isn’t exactly the same, however, as we’ve stated many times—there is a right way to design a cash value life insurance policy to optimize cash value performance.
Here’s where the obfuscation comes into play. There are a great many ways an agent can design a policy.
1. He/She can apply your given premium to a policy that is focused on maximizing the death benefit. This is the traditional way of selling life insurance and it also maximizes the commission paid to the agent.
Now, long term policy performance will be okay but the short term (the first 10 years or so) will almost always have a negative internal rate of return on cash surrender value.
2. The way we do it—apply your given premium to the policy that is focused on maximizing your return on cash. Most often, this means we will be squeezing the death benefit to the lowest allowable level (avoiding the creation of a modified endowment contract). This is very non-traditional and it lowers the commission paid on the policy.
Result: A much shorter time to see a positive return on cash, a policy that has lower internal costs (as a result of the lower death benefit and base policy premium).
There are times that people will ask us, “Is this the best you can do??…Can you change this or change that?”
We’re always willing to make the changes as requested but we start by presenting the best design. Which is probably the world’s worst sales tactic?
Then again, we never claimed to be great salespeople—just a competent resource.
We never consider how much we’re getting paid in commissions when presenting options to our prospective clients. Our presentations just offer up the best performing contracts for the situation.
Let’s Get Specific
Most of what exists out in the ether regarding the exact commissions paid on life insurance products is wrong. No way around it.
That’s probably because the people who attempt to write about it or discuss it aren’t actually insiders and have very little understanding of how commissions are actually paid.
Whole Life Insurance
For starters, let’s look at the base premium on whole life insurance. Most base commissions for most life insurance products sit at 50-55% of the premium. Then there is an expense allowance that is paid which brings the total to 70-110%, depending on the product.
Now this is what’s paid to the agent typically.
The actual expense incurred by the life insurance company is between 130-150% of the premium in the first year. That’s the total that’s paid by the company to distribute their product. Please understand that number is not what an agent receives, that is the aggregate amount.
Then it begins to trickle down with pieces and parts being removed by every hand that touches it along the way.
Keep in mind, this is just a top line number. It’s akin to asking a business owner about his gross revenue. Really impressive but it doesn’t mean much.
And it certainly doesn’t tell you how much money he makes. There are a lot of things that drag his net number down. That’s where the magic happens with any business.
In our case, since we minimize the base premium of whole life insurance, most of our clients’ premium dollars are being applied to paid-up additions. And for us paid up additions pay anywhere from 2.5-3% commission. So, the largest portion of your premium pays us the least amount of commission.
What about Universal Life Insurance?
Universal life insurance doesn’t have a required premium, just a set of expenses that must be met every year. If you want a more detailed discussion on this, check out Episode 60, we talked at length about this very fact.
So, universal life insurance has what’s called a target premium. It serves two purposes really:
1. It’s a rough estimate of a premium that should cover expenses for the policy based on the current or assumed values of the policy.
2. It serves as the baseline as to how commissions are paid. Similar to the base premium of a whole life insurance policy, this is where the largest part of the commission is derived in regards to a universal life insurance policy.
Now, in our case there’s not anything we can do to lower target premium. We focus on funding based on the guideline level premium because it allows us to get the target premium to lowest point possible.
Example: Someone wants to commit $10,000/year to a universal life insurance policy. We use software from each company that will allow us to input that number, solve for the guideline level death benefit and it tells us the target premiums is $3,000. That means the additional $7,000 goes toward “excess” or “additional premium” which will greatly accelerate your return on cash value.
Again, target premium will be paid a commission of 55-90% and the additional premium will pay a commission of 2.5-3%. The vast majority of the money going in has a much lower expense component.
What’s more…with universal life insurance, this design is easy to do. Whole life insurance can be a lot more tedious to design but we do it every day.