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Part of understanding how to buy life insurance smartly is knowing how agents get paid. Commissions can play a big role in which policies agents promote and how much coverage you get for your money.
How insurance commissions work
Commissions vary by policy and company, but life insurance agents often receive 80% to 100% of the first year’s policy premium as commission.
“In fact, most of the time companies are in the hole in the first year,” notes Glenn Daily, a fee-only insurance advisor in New York City. Those commissions and other costs are why most permanent life insurance policies, such as whole life insurance, build no cash value in the first year.
If the policyholder stops paying premiums and allows a policy to lapse in the first year or two, the agent may have to pay back up to 100% of the commission to the life insurer.
Assuming the policyholder continues to pay premiums, agents typically continue to collect smaller commissions in subsequent years. Add it all up, and 15% to 25% of all the premiums you pay over the life of the policy could go to commissions and other costs, such as office expenses, according to Daily.
Life insurance companies paid out $11.5 billion in commissions on standard individual life insurance policies in 2014, according to a computation by data company SNL Financial, based on filings with the National Association of Insurance Commissioners. That was 9% of premiums collected on these policies. Commission shares varied widely among top insurers, from a low of 2.7% of premiums at Guardian to a high of 17.7% at Aegon.
Life Insurance Commissions
The share of premiums on standard individual life insurance policies going to commissions varied widely among top companies in 2014.
Commissions paid (billions)
New York Life
American International Group
Principal Financial Group
* Not including subsidiary American Life Insurance, which does a significant share of its business outside the U.S. Source: SNL Financial, based on filings to the National Association of Insurance Commissioners.
Why you should care about agent commissions
Since the commission paid is a percentage of the premiums, agents have an incentive to promote pricier policies. This could be a reason for them to recommend more expensive permanent life insurance policies over cheaper term life insurance, even if the commission percentage were the same.
Life insurers do sometimes pay higher commission percentages for permanent policies, increasing the allure to agents. Consider this possible bias when you’re evaluating advice from an insurance agent, especially one who’s pushing a permanent policy when your needs can be met by a term life policy.
Finally, commissions slow the accumulation of cash value in permanent life insurance policies, especially in the first few years of the policy.
» MORE: Compare life insurance quotes
How to be a smart customer
One simple step you can take when buying life insurance is to ask insurance agents about their commissions.
“Agents have told me nobody asks,” Daily says. “People are reluctant to ask that because they don’t want to be confrontational.”
In New York, where Daily works, state law requires agents to disclose their commissions to customers — but only if asked. States commonly require agents only to disclose that they get a commission, not the amount. Model legislation from the National Association of Insurance Commissioners, often used as the basis for state laws, only requires disclosure of commissions if a customer is also paying an agent directly.
You might also consider buying from a “low-load” insurer, such as TIAA-CREF, which has salaried “consultants” rather than commissioned agents.
Most people who need life insurance are best off sticking with term life insurance, which has lower costs and commissions. That said, consumers who want to buy cash value life insurance through traditional insurers can lower the total commission by blending term and permanent policies to start with, and then buying additional permanent coverage over time to replace the term life component. The term life coverage has a lower commission, and the added permanent coverage (called “paid-up additions”) typically pays a relatively low commission of around 3%, according to Daily.