Commissions and Fair Value
Plybon & Associates, Inc. 6518 Airport Center Drive
Greensboro, NC 27409 336.292.9050 336.292.4618 Fax
www.plybon.com
Prepared and Researched by
Commissions are rarely discussed and frequently misunderstood by buyers of life insurance. The majority of individuals acquiring life insurance are not fully aware of the complex series of activities the life underwriter team often engages in to earn the commissions they receive. However, in general, most buyers are content with the life insurance underwriter earning a commission for their expertise in procuring the necessary life insurance coverage if they believe they have received fair value for the coverage and services provided.
Following is an example of an actual case, along with an explanation of each of the activities the life insurance underwriting team engaged in to achieve a successful result for the insurance buyer. Taken together, each of these activities contributes to the overall value provided by the life underwriter team.
Joe and Sally, highly successful entrepreneurs, were in the process of selling their business for a very significant sum of money. They engaged the services of a well-respected estate planning attorney, Jessica, to assist them in planning for the ultimate transfer of their estate to their children and grandchildren.
During the planning process, it became evident to Jessica that despite implementing traditional wealth transfer strategies, there would likely still be a sizeable estate tax liability. She reached out to an experienced life underwriter, Matthew, and, on a generic basis, described the situation and asked for Matthew’s thoughts on how life insurance could be used to provide the necessary liquidity to pay the estate taxes upon Joe and Sally’s deaths.
After modeling several alternatives with his staff, Matthew shared his thoughts with Jessica. She concluded that, structured appropriately, life insurance would be a valuable component of an overall plan to help her clients pay estate taxes and transfer their assets to their children and grandchildren.
Jessica introduced Matthew to Joe and Sally and received their permission to add him to the planning team. Joe and Sally agreed to initiate the preliminary underwriting process to determine if they would be able to procure sufficient life insurance coverage at favorable rates.
During the next few months, Matthew had several meetings with Joe and Sally and their team of advisors. In addition, Matthew submitted the case to eight major insurance companies to procure packages (underwriting offer and product) that would best meet Joe and Sally’s needs and financial situation. Joe and Sally had several health issues. One insurance company declined to issue a policy, two companies “rated” one of them, and five companies offered a Standard classification. Rated cases typically result in higher premiums; Standard classifications produce lower premiums than rated cases, but are typically not priced as competitively (i.e., premiums are higher) as Preferred or Super Preferred classifications.
Upon receiving all eight offers, Matthew, in conjunction with his in-house case design and underwriting professional staff, contacted each of the insurance companies to confidentially review the details of Joe and Sally’s health issues and negotiate better pricing. As a result, one carrier agreed to improve its offer to “Preferred,” reducing the annual premium by approximately 15%.
Life insurance was ultimately placed on Joe and Sally. A permanent life insurance policy with annual premiums was purchased by an inter-generational “Dynasty” trust drafted by Jessica. Premiums were funded by an intra-family series of loans.
Joe and Sally paid Jessica a fee for the legal services she provided and in consideration for successfully placing the policy and agreeing to service the policy in the future, Matthew was paid a commission by the issuing life insurance company. Insurance companies pay life underwriters a commission when a case is placed with the insurance company. While commissions may be viewed only as a sales incentive, they serve as indirect compensation for the post-issue services (annual reviews, beneficiary/name/address/ownership changes, premium billing, distributions, and death claims) provided by the life underwriter. Life underwriters typically do not charge separately for these services.
In this case, Joe and Sally perceived the commissions paid as appropriate, as they had received fair value, in their opinion, for the services provided.
What is “Fair Value?”
Fair value is a subjective concept, and opinions on what is “fair” will vary from buyer to buyer. While every buyer will form an opinion as to what he or she believes is fair value obtained from the placement and servicing of life insurance, each buyer should consider the following factors in evaluating such value:
1. Appropriate product design (e.g., type of product and premium funding design)
2. Competitive underwriting offer (e.g., best nonsmoker offer vs. a standard nonsmoker offer) 3. Competitive product and carrier selection (e.g., product with lowest premium offered by a
life insurance company that has strong financial strength ratings)
4. Expectation of high-quality ongoing service (e.g., policy administration, review, and recommended actions if appropriate)
1) Appropriate Product Design: The insurance industry provides a wide range of life insurance
product types (term, whole life (WL), universal life (UL), no-lapse guaranteed UL (NLG), indexed UL (IUL), variable UL (VUL), etc.) and a variety of choices within each product type. The life underwriter team must assess the insurance need and risk/reward characteristics of the life insurance buyer and recommend the product types they determine are most appropriate. In addition, the life underwriter team makes assessments with a goal to maximize product performance/benefits through premium funding patterns (e.g., one lump sum premium or annual premiums for life), death benefit selection (e.g., level or increasing), and utilizing riders where appropriate (e.g., accelerated death benefit in the event of terminal illness or a long-term care
need). With this level of complexity, a competitive product design assessment and recommendation requires an experienced and skilled life underwriter team.
Further, a significant part of the value of the expertise is often seen in the creative planning ideas developed or sourced by the life underwriter team. While ideas sometimes emerge through collaboration between the life underwriter team and other professionals (e.g., attorneys and accountants), they often originate with the life underwriter team. The insurance is merely an element in a formula designed to help clients fulfill their financial goals and objectives. Effective design and strategy consulting are driven by good listening skills, experience, and an ability to integrate the recommended course of action within the existing structure and environment.
2) Competitive Underwriting Offer: Carriers provide life insurance products with multiple
underwriting classes. In the process of applying for life insurance, an insurance company will assess a proposed insured’s financial and medical information and make an offer of a specific underwriting class. Underwriting offers can range from declined (i.e., no coverage offered) to “Super Preferred” nonsmoker, which represents the best underwriting class of a four nonsmoker class product (where “Standard” nonsmoker would be the least competitive nonsmoker underwriting class). The better the insured’s underwriting classification, the lower the mortality charges, resulting in enhanced product performance (e.g., lower premium).
Typically, an insurance professional will survey multiple insurance companies, attempting to find the most favorable offers. While it may be assumed that the underwriting offers provided by insurance companies are consistent, that simply isn’t the case. Because each carrier has its own underwriting guidelines, insurance companies often provide significantly different underwriting offers for the same insured and may improve offers with more detailed information (and negotiation) provided by the life underwriter team. The life underwriter team collects medical information, submits that information to multiple insurance companies, and negotiates with the insurance companies in order to help secure the best underwriting offer. Underwriting can be complicated by unusual avocations, foreign travel, financial justification, and medical history; and knowledge of these factors (and relationships with carriers) are helpful in the discussions. Negotiating with insurance company underwriting staff, as well as reinsurance (i.e., risk sharing) considerations, can be both complex and time consuming.
3) Competitive Product and Carrier Selection: Based on product design and underwriting, the
life underwriter team determines the most competitive product and carrier. Product competitiveness is determined by illustrated performance and the insurance need (e.g., lowest premium for stated death benefit, highest cash surrender value accumulation for stated premium and death benefit, highest income distributions for stated premium and death benefit, or a combination thereof). In addition, an assessment of insurance company strength is recommended in order to place coverage with a financially strong company (for larger policies, diversification of carrier risk by acquiring polices with multiple insurance carriers may be recommended). The insurance market offers numerous products by product type and surveying the landscape of alternatives requires a skilled and experienced life underwriter team that has access to, and the
capacity to evaluate, multiple carriers and products in order to provide a product with the most competitive overall package (product type, product design, underwriting, and product illustrated performance).
4) Expectation of High-Quality Ongoing Service: In many respects, the purchase of a life
insurance policy is an “investment decision,” not dissimilar to other financial instruments such as stocks, bonds, mutual funds, real estate, etc. No prudent investor would consider purchasing one of these financial instruments without regularly reviewing its performance. Similarly, a life insurance policy should be reviewed on a consistent basis, by a professional, to ensure it continues to meet the insurance buyer’s needs. Whether from missed or irregular timing of premium payments or from product performance that has changed over time (e.g., changes in credited interest rates for UL or equity market performance/volatility for VUL), policyholder actions may be necessary to continue or maximize the value and effectiveness of the life insurance policy. This is best determined by performing an in-force insurance policy review. Even if the insurance policy appears to be performing well, there may be opportunities to increase value/performance by exchanging to an even better performing policy.
Ongoing service also includes policy administration such as: premium billing, distributions from the policy, beneficiary reviews/changes, name changes (e.g., marriage or divorce), address changes, ownership changes, and delivery of the death benefit.
Other important services that may be provided include:
• Ongoing management of premium funding over time—a policy on an insured with declining health may be managed via a premium reduction in anticipation of an earlier than expected death.
• Ongoing carrier financial strength reviews—a carrier financial strength rating downgrade may trigger the review for a policy replacement to a higher rated carrier.
• Ongoing administration of split dollar plans. • Ongoing administration of Crummey notices.
An experienced underwriter team with an ongoing service commitment is required to manage in-force policies appropriately.
How are Commissions Determined?
Life insurance is regulated by the states. Each product, including product loads covering distribution costs (e.g., commissions), must be filed with the state insurance commissioner. The amount and timing of commissions can vary significantly by product type and insurance company. Commissions are typically calculated as a percentage of first-year premium, but there are other commission calculations such as “per 1,000 of death benefit” (e.g., .10 per 1,000) and as a percent of account value (e.g., 25 basis points).
In addition, some permanent life products offer the ability to adjust commissions and product performance via “term blending.” Term blending, combinations or blends of base and term coverage for universal life contracts, can reduce commissions and increase product performance (e.g., lower cost/premium). However, term blending may include trade-offs such as weakening of guarantees (e.g., a lower guaranteed minimum crediting rate) or reduction in benefits (e.g., accelerated benefits are not available on the term portion of the death benefit).
Although commissions are commonly expressed as a dollar amount or percentage of premium, it is important to put them in context relative to the death benefit being provided. For example, in the case of Joe and Sally, when calculated as a percentage of death benefit at projected life expectancy, the commission paid would likely be in the range of 10-20 basis points annually. Actual commissions may be higher or lower in a given situation depending on product, age, gender, underwriting class, and funding level.
Commissions and Fair Value
Life underwriters (and their professional teams) earn a commission by providing fair value to the insurance buyer via appropriate product design, securing a competitive underwriting offer, recommending a competitive product with a financially stable insurance company, and providing quality ongoing policyholder service to ensure that the insurance product continues to meet the intended planning objectives.
Generally, commission allowances are comparable regardless of the life insurance underwriting team involved. An astute buyer will select a life underwriter who provides maximum value for the commission received.
For more information, please contact:
Jay Kenerly, MSFS, ChFC W. Luther Pierce, IV, CLU Robert B. Plybon, CLU, ChFC Douglas M. Stone, CLU, ChFC
Chief Operating Officer President Chief Executive Officer Financial Advisor/
and Director of Marketing Business Development
Plybon & Associates, Inc. 6518 Airport Center Drive Greensboro, NC 27409 336.292.9050
336.292.4618 Fax www.plybon.com
DISCLOSURES
Securities and/or Investment Advisory Services offered through M Holdings Securities, Inc. a registered Broker/Dealer and Investment Adviser, Member FINRA/SIPC.
This material is intended for informational purposes only and should not be construed as legal or tax advice and is not intended to replace the advice of a qualified attorney, tax advisor, or plan provider. Pursuant to IRS Circular 230, we notify you as follows: The information contained in this document is not intended to and cannot be used by anyone to avoid IRS penalties.
Death benefit guarantees of variable life insurance products are subject to the claims paying ability of the insurance company.
Variable Universal Life insurance combines the protection and tax advantages of life insurance with the investment potential of a comprehensive selection of variable investment options. The insurance component provides death benefit coverage and the variable component gives you the flexibility to potentially increase the policy's cash value.
