Paying For Life Insurance: How Policies Are Priced

by Silicon Valley Blogger on 2012-12-0617

We compare low cost life insurance vs commission based policies vs those you can buy through fee only insurance agents.

Every financial plan should have a risk management or insurance component. Yes, we all know the importance of life and disability insurance, and health and long-term care. And, annuities, despite their criticism, also have a place when some people need the tax-deferral and/or guaranteed income options. But, the use of all these products falls right smack in the middle of the heated fee only versus commission advisor debate. But, this debate has been primarily investment centered and has not focused on the risk management component as much.

You may have already decided on which side of the debate you sit — you may be comfortable paying commissions to your advisor or you may have chosen to work within a fee-for-service model. Where you fall on this issue may ultimately lead you to the type of insurance you do get. Historically, insurance has been sold via high commissions, but like the rest of the industry, this has evolved to include other fee models. The choice is up to you and whether the level of conflict of interest in the various choices will be acceptable for you.

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Paying For Life Insurance: Reviewing Insurance Payment Models

Let’s go over a few systems that agents use to sell insurance, shall we?

1. The commission-driven system is the traditional approach.

2. The low load approach that’s direct to consumers.

3. Through a fee only life insurance advisor.

There are actually pros and cons for each approach, and it turns out that it’s not always about the money. If you’re going to buy insurance, do be aware about how each of these systems work!

The Commission-Driven Life Insurance Payment Model

The traditional system tends to be the most expensive, in my opinion. Life insurance companies will compensate their agents with super high commissions, particularly for the first year. I am familiar with this because my sister worked at State Farm, and they had this model in place. Commissions would often amount to 50% to 90% of first year premiums.

The challenge of signing new customers up for life insurance in itself merits these types of high commissions. No surprise then, that this structure is considered the compensation linchpin of the life insurance industry.

You may wonder why these commissions are on the high side — well, it’s not an easy road to actually convince people to buy insurance, is it? So a skillful salesperson who does the job gains his or her rewards accordingly. So it makes sense that the insurance agent’s (e.g. salesperson’s) goal is to try to generate the highest premiums he can get; he’s not necessarily around to give you the highest quality recommendation, the most accurate analysis of your policy, or even the best service. Due to consumer behavior, this type of work demands the kind of compensation rates that are set by companies. After all, it’s the market that sets those rates.

Want Cheap Life Insurance? Here’s Where To Get It

Now there’s another option for more savvy consumers who’d like to take the reins on policy shopping. So what about the low load approach that is done direct-to-consumer? Companies in this bucket will simply give you contact information so that you can call a toll-free number for what you need. Or you take the initiative to go on the web, do the research needed and figure out your options before you end up purchasing a policy.

Here’s more on affordable insurance policies and providers.
How To Buy Low Cost Life Insurance

When you buy a cheaper policy, there’s a portion of the premium set aside for costs. Those folks involved in selling you your policy are usually paid a salary so they aren’t as “in your face” as the commission oriented agents. This option is probably better for you if you’re more the type who prefers the soft sell. This is the option that more knowledgeable and financial savvy consumers take in order to keep their costs low.

The Fee Only Approach To Life Insurance

The third system available to consumers who are shopping for life insurance (or who are seeking insurance planning and policy analysis) is the fee only approach. Fee only insurance agents are paid with a fixed fee. Make sure that if you go with this type of payment method, that you aren’t secretly being made to pay a commission.

The pay here can either be hourly or fixed rate (say a percentage of the policy). In this situation, there is no secret agenda to sell something more to you for extra. Typical fee only agents are objective plus lower cost as a result of this set up.

Consumers who don’t believe that life insurance planning and policy analysis are all that complicated, who are seeking “cheaper” policies, and who are reluctant buyers who need to be pursued, far outnumber consumers who may see value in paying hourly fees for objective fee only, insurance advice. This is why most life insurance consumers opt for the commission-driven and low-cost products.

In the end, it is up to you and me to determine which model works best for our situation. For me, I am always most comfortable making a purchase decision with someone who is as objective as possible, but who currently does not have insurance needs that require more thorough analysis. It’s up to you how you prefer to work with an advisor — just know that under different arrangements, the advisor will have different motivations.

With contributions from Todd Smith.

Created March 23, 2010. Updated December 6, 2012. Copyright © 2012 The Digerati Life. All Rights Reserved.

{ 17 comments… read them below or add one }

basicmoneytips March 24, 2010 at 3:59 am

I am personally not a big fan of term life insurance. Although I must say it can be cheap and provide something for your family upon your untimely demise. It is probably better suited for people in the range from 25-45, but after that I would switch to something else. Rates on term will go up and you are really wasting money if you outlive the policy. Whole or universal life at least offer a savings type option.

John Smith March 24, 2010 at 5:33 am

Thanks a lot for making me aware of the above comparison between low cost life insurance and commission based policies. According to your situation people should invest in the kind of insurance that works for them. No matter what we choose to do, just make sure you are insured if your life situation calls for it.

RJ Weiss March 24, 2010 at 9:05 am

I agree that term life insurance is the way to go, I just don’t agree that anyone who sells it to you is looking to maximize their own commissions and that most consumers are “tricked” into buying life insurance. Can you please give me some examples of what you mean by tricked?

Silicon Valley Blogger March 24, 2010 at 9:31 am

I can give you my personal take on this as a consumer of many insurance products. I also have many friends in the business, including a relative who gives me the scoop on the insurance industry on occasion. From my experience, I’ve seen that there are certainly agents who try to marry your requirements to the goal of making money from the transaction. I’ll say that the most successful agents may be those that can persuade you of what you need (they can recommend the most “optimal” plan that can pad their pocket too). It’s all about finding the happy medium — and if the customer is happy, then the agent has done his/her job.

I believe that the term “tricked” really just means the introduction of the “upsell”. I don’t know a single person who hasn’t been presented with an “upsell” before. Another example I have: I had an insurance agent come to the house to discuss some things I needed. He proceeded to present me with a whole SLEW of products I cared nothing about. I already knew what I wanted and what my family needed and yet he came up with many more elaborate set ups for us. Now I appreciated the introduction to all these other products, but heck — a lot of them were annuities and I had the feeling these sales agents LOVE the annuities since they can expect nice commissions from those sales. The thing was, the agent kept trying to persuade me that these were right for me…. if I were a vulnerable client who wasn’t sure about how to proceed (rather than someone already experienced and highly knowledgeable of these topics) then it’s very likely that I would have fallen for this guy’s solicitations right there and then. Used car lots function that way too!

Needless to say, I took the info I received and shoved it into the back of my closet. Maybe I’ll check them out another day. The best thing to do in situations like this? Don’t sign up right away even if they insist you should. Tell them “you’ll sleep on it”.

Kristine March 24, 2010 at 1:39 pm

Informative article. I agree that there may be some life insurance agents who are motivated by commissions, but not all. I have purchased whole life insurance policies, and I know my life insurance agent made hefty commissions. So? He did his job. He provided value to us by explaining to us the difference in life insurance policies, and he received his end of the value exchange.

Silicon Valley Blogger March 24, 2010 at 3:49 pm

On the subject of life insurance, I just want to put in a word for my only recommendation: buy term life. It’s the best kind of insurance. No fuss, and well, probably not much of a gold mine when it comes to commissions. But whatever — it’s the cheapest way to go. You’ll save tons of money that won’t be going into your life insurance account. Instead, funnel your savings to an index fund or mutual fund. You’ll make more money that way in the end. And you have full control of your investments.

Why use a whole insurance policy as a source of investment? I still don’t get it. But people do it because:
(a) they are not that secure about what investments to own
(b) they don’t understand their investment options too well
(c) they want the convenience of combining insurance with investments
(d) they’ve got really good salespeople working on them
(e) they want to stay insured forever (I disagree about this, but it’s your call)

Did I miss anything? Would be interested to hear what others think.

Joe D April 10, 2010 at 5:04 am

Well, I went direct to consumer, but I think paying someone directly for their time is a little more fair.

dave June 3, 2010 at 10:11 am

Term life insurance is the least expensive and the best way to go as far as life insurance. Since term life insurance is cheaper than whole you can afford to buy more coverage and also you do not have to invest like you do in a whole life policy.

Both Suze Orman and Dave Ramsey endorse term life insurance.

Life Insurance Quotes October 7, 2010 at 5:47 am

Life insurance is an important decision, especially when you have a family to look after. You should do a little research and know the benefits and drawbacks of each type of life insurance policy, then talk to agents or a financial advisor about what type makes the more sense for your specific situation. Have even basic background info before talking to a professional will help quite a bit.

JGVFinance October 21, 2010 at 3:00 pm

Money will always factor into our lives and when planning your financial road map, life insurance should be considered. Life insurance can really make the difference in whether you can have the chance of living a financially stable life.

JGVFinance October 25, 2010 at 3:02 pm

More on life insurance: I have always make a point for myself to designate a beneficiary or beneficiaries. I have read a lot of stories where couples die almost at the same time or within six months to a year and for most of these people they do not update or simply forget to change their beneficiaries and it does cost a lot of money that goes to uncle Sam or the government by paying too much taxes. Letting your estate decided by someone else is not really beneficial to your siblings if they are designated to received the proceeds of your death benefit.

It is a sad occurrence and oversight when the policy owner forgets about this.

It is a sad occurrence and oversight when the policy owner forgets about this.

Matt October 28, 2010 at 1:22 am

Whole insurance policy as a source of investment? Well:

– Some people find it attractive because of the added security and cash value that a whole insurance policy offers.

– The funds can be borrowed against or used as collateral to secure another type of loan.

But still I’m sticking to my term life!

Saccharin October 28, 2010 at 5:32 am

I have been thinking about getting life insurance for myself and my family. However, it could get so painstaking at times. There are just too many details. But reading these tips, and having the details laid out for me like this… Looking for the best life insurance deal doesn’t look that daunting. Thank you for sharing this info. Cheers!

ditchtheboss November 14, 2010 at 1:51 pm

Thank you for posting this article in my weekly Financial independence compilation.

Hope to see another one soon!

Life Insurance Guy December 12, 2010 at 3:02 pm

Life insurance has turned out to be a pretty safe investment considering what the market has done over the last decade. You can’t go wrong with a whole life policy and term is surely important for families.

WPBonds January 3, 2011 at 3:02 pm

Life insurance is vital in modern day living. You need to make sure those you leave will be supported.

Mike August 3, 2011 at 4:40 am

This is another good one. One thing I would like to add about buying term insurance over the web is that you won’t always get the best deal. Sure you can quote 300 different companies but ultimately the rate you pay will depend on your health and how the underwriters view you. A good agent will be able to get you from Standard to Preferred or Preferred to Super Preferred with a well written letter, their own reputation or other factors.

Underwriters have criteria they have to follow but they usually have some wiggle room to make their own judgement call on your rate. If you just apply online, they really don’t know anything about you and are prone to be more conservative.

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