Lack of Transparency re Agent Commissions and Conflicts of Interest
Most agents who sell LIIS work on commission, and these commissions can be very large even on policies marketed to people of modest means. The agent has a strong personal stake in making a sale, and this puts consumers at substantial risk, particularly since LIIS policies are so complex that few consumers can make an informed decision by themselves. Consumers need to understand the agent’s stake in the transaction, which can create a conflict of interest between the agent and the consumer and can result in the sale of a policy that is not suitable for the consumer. A large commission should indicate to the consumer that he or she should approach the agent’s advice with a healthy dose of skepticism. A large commission also should indicate that the insurance company needs to charge high enough fees to pay those commissions and still make its own profits. Even though the commission does not come out of the consumer’s specific policy account, commissions are ultimately paid indirectly by the consumer in the fees paid to the insurer. Consumers are rarely informed of the amount of the commission, nor of other compensation (e.g., trips and prizes awarded by the insurer to top producers) that the agent may receive from making the sale.
Case in Point: Kim H. of San Diego bought an indexed universal life insurance policy from Life Insurance Company of the Southwest. Kim was impressed by the agent’s sales pitch that he could invest money in the policy and then obtain tax free income to fund his retirement. As agents often do, Kim’s agent suggested that the policy be heavily funded up front. Kim planned to invest $105,750 per year into the policy for the first four years (totaling $423,000) and then put in no more money after that. Kim’s illustration showed him investing the $423,000 during the first four years, paying no money after that, and then drawing income of $122,797 every year beginning in year 17 and continuing to year 36, and at that point Kim’s policy would still have a cash value of $159,495. See LSW Policy Illustration. This all looked great to Kim, so he bought the policy. Kim later learned that the agent received a commission of $67,592 out of Kim’s first year premium of $105,750. Kim says that if he had known about the commission at the time he was considering buying the policy, it “would have made me a lot more suspicious of the whole deal and where the money was coming from to pay the commission, which was obviously from me.”
Kim ultimately lost his entire $105,750 investment, as fees consumed his policy until it ran out of money and lapsed about three years after he bought it.
Insurers are aware that high commissions may be a red flag and thus have a financial interest in keeping the subject of commissions from coming up in agents’ conversations with consumers. But any time an agent runs an illustration for a consumer, the agent will want to know what commission the agent will earn if the consumer buys the policy, which is usually based on what insurers call the “Target Premium.” The problem for insurers is that including such information in the illustration could spark an inquiry from the consumer about commissions, which may in turn result in no sale.
Case in Point: Life Insurance Company of the Southwest included the Target Premium information in the illustration with a single unlabeled and unidentified number (“51274” in Kim H’s case) in a tiny font under the words “Page 10 of 21” on page 10 of the illustration. According to LSW personnel, the information was included this way so that “with training, the agent could find it but the client would have a tough time, so the agent would not have to explain what that premium represented.” See 4/18/14 Trial Transcript in Walker v. Life Insurance Company of the Southwest.
Potential Public Policy Approach:
LSW’s handling of this issue confirms what common sense tells us – consumers would be helped by knowing what stake the agent has in the transaction. Far from being hidden in some kind of indecipherable code on the bottom of page 10 of an illustration, the agent’s stake in the sale of an LIIS policy should be clearly disclosed to the prospective policyholder. This includes disclosure not only of cash compensation, but also non-cash compensation.