Commission Based vs. Fee Only

You might think you know where this discussion is going but I’m going to bet you might be surprised. Because I run a Fee-Based (not Fee-Only) operation, agents are probably sure I will be bashing commissions. However, since I am fundamentally pro life insurance when it is the right tool for the job and appropriately procured and managed, and I often recommend commission products, others will undoubtedly think I am pro-commission. Besides, if your practice is one or the other, don’t you have a moral duty to spend a certain amount of time undermining and criticizing the other approach?

I am not slamming either approach. I am unequivocally stating that each has merits and each has potential issues. Whatever I say is clearly not applicable to all players in either camp but neither camp can seriously state with self-righteous indignation that theirs is a definably better approach every time. There are going to be trust worthy commission based agents and there are going to be crooks. The exact same will be true for Fee-Only and for Fee-Based advisors. Not all car salesmen are bad, but some are. Not all lawyers are bad, but some are. Preachers, doctors, politicians, etc, etc, etc. You get the idea.

Let’s be honest and clear right out of the gate. With many practitioners, they feel it is a zero sum game. If they are fee-only planners, many feel that recommending a commission based product is in direct conflict with their business model and marketing strategies and they will not make such a recommendation even if in the best interest of the client. In fact, they spend very little time evaluating commission based products and have little understanding of them in general. On the other hand, commission based advisors and agents are so sure that fee-only advisors will never ever recommend a commission based product that they will never trust them.

It doesn’t have to be this way. Continuing with the honesty, there is no question that since a commission based advisor can only make money by selling something, it provides a strong incentive to sell something, whether or not it is needed or appropriate. We’ve all seen it and because it is so prevalent, it is a cliche in the market. The abundant cynicism regarding the life insurance industry and its players wasn’t created out of thin air. It’s so much of an issue that professional advisors such as attorneys and accountants too often have an automatic negative reflex and often try to close down transactions. Sometimes this is appropriate but I’ve seen many situations where the desire to protect the client is so strong, they nix plans which are clearly beneficial to their clients. In other words, they are reacting so strongly against an agent they believe is only acting in his or her self interest that they don’t even realize that their desire to be the hero to their client by protecting them from agents is often a result of their very own sense of self interest more than an objective desire to help a client.

I developed my fee-based life insurance consulting practice because there is a demonstrable desperate need for third party, objective analysis from a source which is not trying to sell a product. I don’t know that one can ever be expected to bring 100% objective analysis to the table if they only way to be paid is by selling a commission product. Even if a practitioner is capable of doing so, the typical consumer is often not capable of believing the practitioner is capable of doing so. I get to make sound recommendations to stay the course or take advantage of an internal remediation strategy when it is most appropriate and when I do recommend the use of a new commission based product by an existing or newly introduced agent, the inherent cynicism is not there that I only did so for the commissions.

Even though life insurance commissions are theoretically structured to provide for ongoing management and maintenance, it doesn’t always, or even usually, work that way. When one understands how new life insurance commissions work, they realize the driving incentive to find the new sale. Despite the fact that there are dutiful agents which continue to provide service, it is too seldom the case and even agents who attempt to maintain contact with their clients are sometimes rebuffed because the client is afraid of being “sold” again. Either way, not enough time is generally devoted to the management and maintenance of a policy and the industry compensation system is largely a factor from my perspective. On a more cynical note, I believe the compensation system is actuarially devised to drive new business and to allow existing business to lapse in the most financially advantageous manner for the insurance companies. But does that make them different than most any other business or industry? I simply think it is important to understand.

The “objective, third party” aspect of consulting can really only work on a fee basis. The deficiencies of the existing system causes many problems and is the reason I can have a thriving life insurance consulting practice. There is often an almost desperate desire by advisors and consumers to pay someone who doesn’t have a horse in the race for advice.

Though there is an obvious downside, there are upsides to commission based life insurance sales and one is the exact same thing that can be a downside… incentive. Despite what some people want to believe, life insurance can be the perfect solution to some planning needs and is often a very appropriate plan of action. When this is the case, one should want there to be an incentive to get the transaction done quickly and on an efficient basis. Just as consumers are cynical of agents and commissions, they are no less cynical of other advisors and their fees. The most cynical of them are sure their attorneys are drawing out the process to maximize their billable hours. When one is compensated for time, the perception will be, rightly or wrongly, that there simply isn’t a driving force to get things done quickly.

I want to relate a story about a case I was involved in a few years ago. Without going into detail, the commissions/fees on the case were significant; well into the six figures. This was a situation where the client was going to sell an unwanted asset for a relatively low amount and we were able to find him an offer which would net him an additional seven figures; over $1,000,000 extra! In the eleventh hour, the purchaser came to us stating that due to tax law, the transaction could not be completed. That sounds pretty concrete. I dare admit that if I had simply charged an hourly rate or project fee and there was nothing in it for me to make sure this case came down, I don’t know that I would have put a lot more time and effort into it. I would have stated the facts and no one would have questioned or blamed me. But because six figures were at stake, the gloves came off and we proceeded to turn over every stone to find a way to make it happen. We were up against the tax law interpretation of one of the largest law firms in the country. We were told point blank by a specialist in the industry this transaction wasn’t going to happen. But, we discovered the errors in their interpretation, provided solid legal and tax guidance, got them to restate their findings and completed the transaction. The client walked away with a lot of money he never would have had solely because of the driving force of the large payday for us. While that incentive can be used for evil, there is not doubt whatsoever it can be used for unduplicable good as well. Clients and advisors need to understand the benefit of commission based incentive to get things done.

The lure of commissions is often the only reason ideas are brought to the attention of consumers but this again can be a good thing. I know of no one in the market who either works on commissions or a fee basis who is doing so predominately for the good of society. Do I even care if the sole reason a telemarketer tries to get me to refinance my house is because she gets paid for it? As annoying as she may be when she calls during dinner, if it is unequivocally in my best interest, the incentive is entirely irrelevant.

After I wrote the bulk of this post I ran across a piece by Roccy DeFrancesco. I don’t know a lot about this gentleman and I read only a few chapters in one of his books including one titled “Fee-Only Advisors”. I don’t know what his over-arching philosophy is or if his attitudes are rooted in bias or from objective observation and I don’t really care. But, it would be difficult for me to relate more clearly my feeling about Fee-Only, Fee-Based and Commission Based advisors than he relates in his writing. Of course, everyone who finds something which backs his or her observations and position is going to feel it is objective and self-evident but Roccy’s piece just makes so much sense when read with an open mind.

As Roccy states, the Fee-Only approach sounds so good it is easy to deem its merits self-evident. One problem is, the way the market is set up, many of the best products are commission based and an objective, empirical study will show this for some classes of products. The rub is that an advisors pledge to do the best for their client by not taking commissions will eliminate from consideration, in too many situations, the best or most appropriate products in the industry. Roccy gets into more detail as to why some markets’ best products are commission based. Again, for the record, I’m not anti Fee-Only and I know and trust a number of Fee-Only advisors but the concept of “best” is not that simple.

Finally, I would like to comment on the views of some hourly billing professional advisors regarding commission based transactions. A cliche is the situation where the estate planning attorney or accountant works diligently for a long period of time bringing value to a client and watches an agent, who might be technically incompetent but very good in sales and marketing, walk away with a huge commission for very little apparent work. I can clearly understand how this could be unsettling and I experience it myself on occasion. I’ve talked with an attorney who told me that it seemed ridiculous that since he couldn’t automatically charge 10 times as much for settling an estate that was ten times as large, why could an agent automatically get paid ten times as much for a $10,000,000 life insurance sale versus a $1,000,000 sale? I won’t try to fully elaborate on this but one main issue is that, and this is admittedly simplifying the matter, the attorney gets paid for all of his hours and the agent gets paid for very very few of his. It’s the fundamental difference between hourly and contingency billing. The agent may seem to be unconscionably overpaid for the transaction that comes down for little apparent effort but no one ever pays attention to the countless cases he poured his heart and soul into which never closed or the $250,000 term policy on a young person he just put the same amount of time and effort and staff resources into which culminated in a $100 payday which is a money losing proposition. Some cases could be multi-year engagements with hundreds of hours into them which pay literally nothing. I’m not going to feel sorry for them because it’s a free market and they can choose to work how they want, realizing the potential consequences, but I feel they are owed an understanding about how the market works and the realities of their practices.

This isn’t much different than a car salesman who works tirelessly for a modest sale only to watch the potential customer walk across the street at the end of the day to buy from another dealership. But, the next day, a consumer he’s never met might walk in the door and run into him by pure chance and say, “I want the red Mercedes SLS AMG Roaster and here’s the check. Can you have that delivered to me this afternoon?” It’s just the way it works. In general, one gets paid for effective sales and marketing and making things happen and sometimes luck plays a role. We all have our respective crosses to bear. The advisor who complains about clients going to Office Max for a cheap fill-in-the-blank legal document rather than paying $500 an hour for quality counsel has his or her own problems with perceived value. The insider’s perspective will always be substantively different.

The bottom line; no methodology is perfect, each has it’s merits, practitioners choose their respective weapons based on ideology and perceived marketing success, and it’s very good that there are competing models in the market.

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