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Life Insurance Commission: A Great Evil According to the Internet

Few subjects related to life insurance cause more hot-tempered debate than life insurance commission.  Some believe it's an evil incentive that encourages agents to push “expensive” products like whole life insurance to land a huge payday.

Others look at it simply as the payment mechanism rewarded to agents for the hard work involved with marketing and managing the life insurance policies they put in place for their clients.

Today we'll discuss what life insurance commissions are, what they are not, and attempt to give a little more depth to the discussion.

The Secret to Life Insurance Commissions

Life insurance commissions do in fact operate under a veil of secrecy.  While other financial transactions that pay a commission are more clearly disclosed (i.e. real estate agent commissions and to some degree investment product commissions) life insurance commissions remain obtuse and unknown to the buying public.

What people don't know, scares them and causes them to reach their own conclusions.

The more paranoid among us use this fact to argue that the lack of disclosure stems from high payouts that ultimately hurt the person buying the policy.  The claim is that if you knew exactly what the commissions paid on each life insurance product were, you'd see that the products agents push hardest have the highest payouts and result in the poorest benefit to the policyowner.

This is a very broad generalization, but it does have a degree of credibility insofar as some products do absolutely have higher commission rates with lower performance in some category related to how we might evaluate a life insurance contract.

There could always be a reason for this, so perhaps the application is more misuse of a product simply for the gain of a higher commission instead of the outright blanket statement that one entire product category exists solely for the purpose of generating higher commissions for insurance agents.

An example will help explain this point.

Term Instead of Whole Life Because...COMMISSIONS!

It doesn't take a lot of poking around the internet or financial media to find someone recommending that you only ever buy term life insurance.

The often emphasized reason for this has to do with term insurance's “low cost.”  The argument often juxtaposes the low premium “cost” of term insurance against the idea that the much higher premium associated with whole life insurance creates massively higher commissions paid to the life insurance agents who so aggressively sell whole life insurance.

Exact commissions figures are always speculative, but often we see figures suggesting that agents who sell you whole life insurance will receive 80-100% of the premium you pay as a commission, so it's no wonder they want so badly to sell you such a policy.

This argument often comes in the context of someone who is looking at whole life insurance not only for its ability to provide death benefit but also for its ability to build cash value for some future use.

There are also times that one might be attracted to whole life insurance for its ability to maintain a level constant death benefit for the entire payment period of the policy instead of for only a certain period of time then renewing with an ever-increasing premium.

The “term insurance only” crowd claims that neither the benefit of cash value nor the benefit of a fixed forever premium are worth the high cost and the exorbitant commission you will pay the agent who sells you the policy.

While I can certainly find examples where this claim that commissions rates of 80-100% are true (sort of) that by itself doesn't validate the argument that the benefits afforded by whole life insurance are useless.

But hold that thought for a moment and let's dive into what exactly life insurance commissions are on various products term life and whole life included.

Term Life Insurance Commission Rates

The life insurance product for which the 80-100% commission claim is most true is actually term life insurance.  But only for a specific type of term life insurance.

Level term life insurance–meaning it has a level premium for a period of time–lasting 20 years or more often pays commissions rates around these figures (except in the state of New York).  In some cases, the commission rates paid on term life insurance can be even higher than 100%.

This simply means that if you buy a 20-year level term policy with a premium of $1,000 per year the agent will earn $800 to $1,000 on the sale.

Sort of.

If you cancel the policy before the end of the first year, the agent will owe all or some of that commission back to the insurance company.  In some cases, if you the insured die within the first year, the agent might also owe all or some of that commission back as well.

Generally, term life insurance commission is only paid in the first premium year and agents earn no future “renewal” commissions.

Level term life insurance with a level period of fewer than 20 years pays a lower commission rate.  Usually ranging 60 to 70%.

Annually renewable term life insurance (rare but not entirely unheard of) usually pays the lowest commission rate of around 50% of the premium, but the 50% commission is payable on all increases in premium.  For example, if you pay a premium of $200 per year the first year the agent will earn $100.  If your second-year premium is $220, then the agent will earn $10.

This commission usually continues on all increases until the insured cancels the policy or the policy reaches the year where it is no longer renewable and terminates.

Side note: when a level term policy reaches the end of its level premium period, the policy effectively becomes an annually renewable term policy.  At this point, a rather large increase in premium occurs followed by several smaller increases.  Agents usually receive commission payments for this renewal (premium increase) but the rates paid for this vary widely.

Whole Life Insurance Commission Rates

Whole life insurance commission rates average about 55% of the base whole life premium.  But, there's a common practice of paying “expense allowances” on whole life premiums.  The idea behind an expense allowance is that it compensates the agent/broker for undertaking a number of expenses otherwise shouldered by the insurance company.

These are expenses like support staff, office space, technology expenses, general office expenses, etc.

Generally speaking, only independent brokers or agents who have left the career company office to establish their own office and pseudo-independent operation receive expense allowance payments (i.e. your typical career insurance agent working for a big name life insurer is probably not receiving an expense allowance on the life insurance business he/she produces).

Expense allowances vary, and insurance agents are often under a non-disclosure agreement when receiving one.

This idea behind the non-disclosure agreement is to prevent agents from discussing with each other what a company was willing to pay them motivating other agents to negotiate a higher payout.  Most life insurers use a standardized tiered production requirement for expense allowance compensation to also avoid this.

For example, you must produce X amount of business with the company in order to be eligible to receive Y expense allowance payout.

While the intention of the expense allowance is to cover operational expenses, we can think of it collectively with the standard commissions paid on whole life insurance to arrive at a total payout to the agent.  This average across the industry to something in the neighborhood of 85% paid on the whole life premium.

As is the case with term insurance (an all life insurance contracts) if the policyholder cancels the policy within the first year, the agent will owe all or some of the commission back to the insurance company.  Also in some cases, if the insured dies within the first year, the agent could owe some or all of the commission paid back to the insurance company.

Notice that I've been specific about calling out the commission rate payable as on the whole life insurance premium.  This commission rate is not applicable to most riders added to a whole life policy and is certainly not applicable to the paid-up additions rider.

The commission rate paid on paid-up additions averages about 3% across the industry.  So for whole life policies that seek cash value as a primary goal (i.e. those that make heavy use of paid-up additions) the majority of the premium paid generates a commission to the agent of approximately 3%.

To be sure, the agent would certainly earn that 85% rate mentioned above on the base whole life premium.

Whole life insurance policies do pay renewal commission to life insurance agents.  This is a percentage of the base whole life premium that the insured pays each year.  Renewal commissions average about 5% of the base whole life premium paid.

Renewal commissions exist because there is anticipation that the agent who sold the whole life policy will need to provide further assistance to the policyholder in years following the sale.

Universal Life Insurance Commission Rates

Universal life insurance is the most unique among the group when it comes to paying commissions.  Commission rates tend to average around 90%, but the basis for this calculation is not the premium the policyholder pays per se.  Instead, it's a calculated amount of premium based on the death benefit of the policy (dependent on the death benefit option selected) known within the industry as the “target premium.”

For most people buying life insurance products, the target premium has little practical application.

Many people who own universal life insurance policies likely have no idea what the target premium on their policy is.  The only real application of the target premium is computing the commission payable to the insurance agent.

At one time, some argued that the target premium worked as a guideline for non-guaranteed universal life insurance policies as a level of adequate premium the policyholder should pay to ensure against future lapse due to the insufficient cash value in the policy.  No empirical evidence backs up this claim.

So the target premium merely works as a way to calculate the commission due to the insurance agent and I think an example will best explain how this works:

Target Premium and Universal Life Insurance Commissions

Let's say that you buy a $1,000,000 universal life insurance policy and plan to pay a $10,000 premium per year.  You notice in the paperwork that the target premium for the policy is $6,000.

This means the insurance company will pay the insurance agent whatever the commission rate on the policy is using that $6,000 figure.  Let's assume that the commission rate is 90%.  The agent will earn $5,400.

Notice that the agent will not earn 90% of the entire $10,000 premium.  He/she will earn a smaller commission generally around 2% of all funds paid to the universal life insurance policy in excess of the target premium.

Universal life insurance policies also pay a renewal commission.  This commission is generally around 2-3% of the entire premium paid in subsequent years.  The same logic applies here for the renewal commission–i.e. the agent will likely be involved to some degree with policy maintenance.

High Early Cash Value Life Insurance Commission Rates

Products designed to be high early cash value (HECV) policies or ones made that way through the use of a cash value enhancement rider often have a completely different commission structure versus the ones mentioned above.

Both whole life insurance and universal life insurance policies can be on a high early cash value chassis or can transform into this type of product through a rider.  I'll refer to both scenarios collectively for the rest of this blog post simply as high early cash value products.

The commission rate on a high early cash value product is much lower than the commission rate found on more traditional whole life and universal life insurance.  HECV product commissions average around 20% of the premium paid.  That's 20% for base whole life premium (though in many HECV whole life scenarios paid-up additions are limited if used at all) and 20% of target premium on a universal life insurance policy.

There is at least one insurance company I'm aware of that pays a higher rate of commission (basically the standard rate mentioned above) on HECV universal life insurance, but it cuts the target premium on this product down considerably versus the non-HECV style products resulting in the same effect as paying a lower overall commission rate on target premium.

But…

The agent usually receives this 20% of premiums paid for more than one year (often four to five years).

Commission Rates on Blended Whole Life and Max Funded Universal Life Insurance

Now that you have some idea of the commission rates paid on standard policies as well a high early cash value, I want to take a moment to talk about the niche of the life insurance industry that we spend the majority of our time working in.

While we believe life insurance has many applications and works as a great tool for many situations, you will quickly discover by looking around this web site that we hold a specialty in the manipulation of whole life and universal life insurance for the purpose of building as much cash value in the policy as possible.

This happens with the plan to use the cash value in the policy for some later purpose (e.g. college funding, retirement income, personally financing major purchases, having an emergency fund, etc.).

Building a policy to do this correctly requires a lot of careful manipulation of various policy mechanics and does strip out a lot of expenses generally associated with life insurance.  It also by its very purpose removes several guarantees of life insurance contracts.

Given this, it should come as no surprise that doing this does, in fact, reduce life insurance commissions.  The commission rate does not change (usually) but the overall payout to the agent changes substantially.

Let's use an example to explain:

Blended Whole Life Commission Example

Let's pretend that you are considering a life insurance purchase where you will pay $50,000 annually in whole life insurance premiums.

I have designed you a policy that optimizes cash value by setting the death benefit as low as possible without creating a Modified Endowment Contract and making optimal use of blending and paid-up additions.

You look at the proposal and head out to the Internet to collect feedback from people you've never met on this idea because while you may not know their expertise on this subject, the fact that they have nothing to gain from your making a good or bad decision means their advice must be completely unbiased.

After spilling all of your information to the public, Hockeyman75 informs you how horrible whole life insurance is and backs his claims with the newsflash that if you purchase this whole life policy all of your money will go to commissions.

The commission rate on whole life insurance is 85% (I confirmed that in this blog post) and I the agent will walk away with a handsome $42,500 upon your writing the check.

Is Hockeyman right?

The commission rate on a blended whole life policy is generally no different than it is on a standard whole life policy, but keep in mind that this rate is only paid on the base whole life premium.

You look over your life insurance proposal and realize that the base whole life premium on your policy is only $10,000.  So I will receive $8,500 for this.  In addition, the paid-up additions on the policy will pay me an additional $1,200, so all together I'm looking at $9,700 once the deal is done.

Not bad, but certainly far less than $42,500.  It's actually less than one-half of one-half of the amount Hockeyman told you it would be. 

I bring up this example only to highlight how astronomically far off those who suggest that life insurance agent want to sell you whole life insurance (or universal life insurance, which would come out similar in terms of total commissions paid) only for the 80-100% commission they are going to receive on your premium.

While I'm sure there are some people who receive pitches to purchase standard whole life insurance “as an investment,” few of them actually buy.

For those who do–we can certainly find some who did–this doesn't damn the life insurance industry or cash value life insurance.

It's…probably…a bad application of an otherwise great product.  The North Face® makes spectacular jackets that are completely useless to anyone who spends the entire year in Miami.

There is one other point I want to highlight because it sheds a little light on how HECV products differ from blended whole life or max funded universal life insurance.  You'll notice from the example above that the total compensation paid is roughly the same as the commission rate mentioned for high early cash value products.  This is purely coincidental.

But here's the important differentiator…

Blended whole life and max funded universal life insurance don't pay the same commission rate in years two through five like the HECV product does.

Because blended whole life and max funded universal life insurance are instead otherwise normal products within their respective categories, they receive renewal commissions identical to the ones mentioned above under these normal products–roughly 5% for whole life base premium and 3% for universal life insurance.

This very fact should highlight why blended whole life and max funded universal life insurance are superior to High Early Cash Value products for the purpose of maximum cash value accumulation over a long period of time.

Commission Rates are Not Standardized

I've discussed commission rates in broad terms giving ranges because life insurance commission is not standardized.  All companies have different commission schedules for products and they even have multiple schedules in some cases.

What's more confusing about life insurance commissions is the fact that few insurance companies openly discuss commissions rates with agents/brokers.  You'd think this would be a very open and upfront conversation with the prospective agent or broker as an insurance company attempts to convince that agent or broker to do business with them.

While there are certainly some that more or less disclose commissions openly and clearly, most do not.  Getting this information can take considerably more work than it should.

I bring this up only to point out that perpetuating the vast conspiracy that life insurance agents push certain products out of motivation for higher commissions has always caused a bit of a chuckle out of us because we realize that most agents don't really know exactly what they will be paid for placing a life insurance contract with an insurer, or exactly when they will be paid for that matter.

I mentioned the expense allowance earlier.  We might view the expense allowance as a pseudo commission that might even incentivize an agent/broker to recommend one product over another due to higher overall compensation, but expense allowances are not paid with the same timing frequency as standard life insurance commissions.

Sometimes agents/brokers must resort to litigation threats to get paid the allowance owed to them–we have personal experience with this.

Life Insurance Commissions are Not Evil

I want to end making a point that we all need to accept.  Life insurance commissions and life insurance itself is not evil.  Commissions paid on ordinary products where the death benefit is a primary concern are earned by the agent who writes the business.

While there may exist some circumstances where an agent stood in the most fortunate place at the right time, large premium life insurance purchases that open and close quickly are exceedingly rare.  Large premium cases that require no future service work from the agent are even rarer.

The transfer of value is real.  While we may not always see what operates behind the scenes of a life insurance purchase or the maintenance of a life insurance policy, I can assure you there's a lot of hours spent on the behalf of many clients for which there are no invoices.

 

 

About the Author Brandon Roberts

Brandon launched the Insurance Pro Blog in July of 2011 as a project to de-mystify the life insurance industry. Brandon was born in Northern New England, and he currently calls VT home. He attended Syracuse University and graduated with a triple major in Economics, Public Administration, and Political Science.

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