A Sense for Money
A number of our readers have asked how to get reliable financial advice when buying insurance or investment products. This week’s post gives some insights into this topic by providing an overview of the various types of advisers that operate in the financial services sector, their key characteristics and how they are incentivized.
Insurance agents are required to pass an examination before being granted a license to sell. You can therefore rest assured that licensed agents have had some formal training. The key characteristic of buying insurance from an agent is that the agent is only allowed to sell the products of one insurance company. This ensures that an agent will have a good understanding of his company’s products. The limitation is that he cannot offer you the product of another company, even if the other company’s product is better, cheaper or more suited to your needs.
Now, dozens of insurers operate in the market, with hundreds of different products. If you are wedded to one particular agent then you are also wedded to one particular insurance company. This may not be a bad thing if it is a quality insurer, but you should always remember that even the best companies can have some excellent products and some rather average products. Moreover, your agent may not even be aware of the products offered by other insurers so you could end up losing out on a good deal offered by another company.
Brokers are also required to be officially licensed although they operate on a very different basis from agents in that they are able to offer the products of any insurer. A good broker should therefore take time to understand your needs and will then survey several companies in the market to find which particular product best meets your individual needs.
Many bank employees are allowed to sell insurance products, including simple protection products that are linked with savings accounts, and products that provide you with life and health protection when you take out a mortgage or a car loan.
There are also telemarketing staff who will call you from time either to try to sell you simple protection or savings products or to try to set up a face to face meeting with a financial adviser. Such staff are also often licensed agents who have sat the examinations and who represent a specific insurance company.
If you are approached by an adviser, or indeed if you approach them, one of the first things you need to do is to understand what type of adviser they are. Are they an agent who can only sell you the products of one company, or are they a broker who can offer the products of many companies? Another thing to establish is what type of license they have and their qualifications? Do they have an up-to-date license which entitles them to be selling the products they are promoting? Only when you have established these parts of the jigsaw can you start to put their advice into perspective.
It is also important to understand how advisers are motivated and incentivized. As a general rule, an adviser might expect to earn:
• For a lump sum investment policy: 3 percent of the premium paid by the insured.
• For a regular premium policy: 30 percent of the first year’s premium and 3 percent of future premiums
If you plan to invest US $10,000 per annum, for example, the adviser will get US $3,000 when you take out the policy and US $300 in subsequent years, while he would only get US $300 if you invest a lump sum of US $10,000. These levels of commission are substantial, and very often consumers are surprised at their magnitude. The numbers quoted in the example show why it is that many advisers like to steer customers toward large regular premium policies. These commissions apply to all sales adviser channels and so clearly need to be paid for out of your premiums.
One of the consequences of the high “front end” commissions on regular premium policies is that if you cash in a policy in the first year or so, you will lose most, if not all, of the premiums you have paid. Of course, the above numbers are an example only and commission rates vary between products and companies. Very often the commission will be shared between the various parties in the chain: between the bank and the bank sales person, or between the agent and the agency manager.
The point, however, is that whoever your adviser, you need to be comfortable that they are recommending a policy because it is best for you, rather than because it pays the highest commission rate. A good way of probing this is to ask the adviser directly how much commission is payable on the product being recommended and how this compares with commissions payable on alternative products.
Don’t be embarrassed to ask such questions. After all, advisers will often ask you some very personal questions about your financial, family and health situation. In fact, in some countries, commission disclosure is compulsory, so every customer sees explicitly and in writing the commission that is payable on the sale of a policy.
Next week’s post will continue this topic and give some more tips on which type of adviser may be best for your particular situation.
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