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Understanding Insurance Commissions and Trails

Jeremi Karnell
Mar 9, 2017

As a financial professional and the owner of a financial planning or wealth management practice, you understand the value of a well-balanced portfolio. You work hard to make sure your clients have all the information they need to make sound investment decisions, and you try to accurately assess their risk tolerances.

Establishing and maintaining a balance between stock market investments and their fixed-income counterparts is an essential part of client service. Whether you guide your clients into no-risk certificates of deposit, tax-free investments like municipal bonds, or double-duty choices like whole life insurance, you need to understand the commissions and trails associated with each choice.

Doing so will not only help you serve your clients more effectively, lowering their costs and boosting their returns in the process, but will also help you configure an effective compensation structure for the brokers and advisors who sell these products and serve your firm's client interests.

Insurance Commissions - An Advisor Perspective

From the perspective of your insurance agents, brokers and financial advisors, commissions are an important source of income. Your advisors work hard to find the best investment products for their clients, and should be paid accordingly for their experience, advice, expertise and success.

Insurance commissions enable practice owners to compensate their agents and advisors based on the size of the policy being sold and the type of product (variable life, universal life, term life, etc.).

Since the compensation of the agent is directly tied to these two factors, they may try to steer their clients into the products that pay the highest commissions, but that can lead to a conflict of interest between the agent and your firm.

The Department of Labor Fiduciary Rule, slated to go into effect in April 2017, holds financial professionals to a fiduciary standard when working with retirement funds, and that could create problems with commission-based products like universal whole life and variable life insurance contracts. It is important to review the impact of your current compensation structure, including the awarding of insurance commissions, and make sure your practice is in compliance with the new DOL fiduciary rule.

Insurance Commissions - An Investor Perspective

The impact of insurance commissions is quite different from the client's perspective, and experienced agents and advisors understand this distinction. When a client buys an insurance policy, they want to understand all the costs involved, including both up-front and ongoing trailing commissions.

As a financial professional, it is important to disclose all insurance commissions with your clients. Naturally, such transparency is good for them, but it is also good for business. If your current clients feel that they can trust the advice and guidance of your firm, they are more likely to refer their friends and family members. Their confidence in doing so means more AUM, more commissions, and ultimately more profits.

Different Products, Different Commissions

The world of insurance products and commissions is a vast and complicated one, with myriad offerings and compensation structures. As a practice owner, it is critical to understand how they impact your agents and your clients.

Generally speaking, products like variable universal life insurance, universal life insurance, and variable insurance pay the highest commissions, while term life insurance pays the lowest. Whole life insurance is considered the bread and butter of the life insurance industry, with a solid commission structure but also real value for investment clients.

First Year Commissions

First year commissions are the most visible, and the most obvious to the client. These commissions are paid when the policy is first implemented, and they represent a percentage of the total annual premium payment.

Since these first year commissions are taken directly out of the client payment, they are easy to spot and easy to calculate. Even so, it is important for agents, and practice owners, to communicate the commission structure with their clients and be up-front about the ongoing costs of holding the policy.

Understanding Trailing Commissions

No matter what kinds of insurance products your practice offers its clients, it is important for both parties in the transaction to understand all of the commissions involved. Some investors fail to grasp the importance of trailing commissions or recognize the impact those trailing commissions could have on their short-term and long-term returns. As a financial professional, it is your job to help your clients understand these costs and the value they are receiving in return.

Many insurance products have built-in trails, essentially a commission paid to the advisor each year that the investment is in force. The trail is designed as an incentive for the advisor to periodically review and the client's holdings to ensure they are still appropriate.

Trails are obviously good for the financial advisor, but they can also be positive for the client. Buying an insurance product can be a smart way for young workers to protect their families, but over time, the need for such protection often changes. The presence of the trail gives advisors a built-in incentive to review their clients' holdings and recommend any changes.

The annual review process may reveal, for instance, that the client's children are now grown and out of the house, and that they and their spouse are financially self-sufficient and no longer in need of the insurance contract they own. In that case, the presence of the trail gives the advisor another opportunity to discuss insurance needs with the client and reallocate resources to more appropriate investments.

Insurance can be a valuable part of an investment portfolio and a great way for your clients to balance their investments and reduce their overall levels of risk. As a practice owner, it is your responsibility to effectively communicate costs and commissions with your clients, and they will invariably turn that transparency into the trust and loyalty that sustains your business.

You May Also Be Interested In Reading: A Guide to Understanding Annuity Commissions


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