Copernicus and the Life Insurance Market By James M. Carson, Katie School, Illinois State University Life insurers have positioned themselves for reaping the rewards of a soaring stock market. By offering products such as variable life and allowing policyowners to direct investments in equities, life insurers are not left walking the sidelines solely with run-of-the-mill products. Rather, financial services professionals are able to offer, courtesy of the insurers they represent, products that roar like a lion and rage like a bull. Yet, just as the property-casualty market is showing signs of getting some premium air, what will be the effect on the life insurance industry if the stock market catches a dose of asthma? That is, is it reasonable to expect policyowners of variable life insurance to contain their hue and cry after the next stock market downturn and shoulder the responsibility for their decision to play Warren Buffett? The life insurance industry is accustomed to overcoming challenges--indeed, getting to "yes" is part of the industry's raison d'etre. An article in Best's Review (Wincuinas, 2000) chronicles some of the market conduct issues life insurers have faced. Moreover, even Edwin Moses would find an overabundance of hurdles surrounding life insurers’ race toward demutualization. Poe's Raven raps, "Never more"--yet, life insurers are now at the center of attention for their role in selling annuities tied to retirement plans. The pieces framing the annuity puzzle are the four horsemen of annual fees, surrender charges, taxes, and bases. Annual fees on annuities average 2.11 percent per year, compared with .18 percent for index funds (Franecki, 2000). Gains in annuities are taxed as ordinary income, rather than at the capital-gains rate, and heirs do not enjoy a stepped-up basis with annuity funds, as they would with stocks and stock funds. Variable annuities are the fastest-selling investment product on the market, growing at 23 percent per year since 1995, and garnering $421 billion. Given the financial pot at the end of the rainbow, it is not likely that the life insurance industry will quail to criticism that pairing annuities with tax-deferred retirement plans is akin to serving mashed potatoes and french fries. Thus, it appears that insurer legal departments will not feel the pain of the Maytag Man for years to come. Of course, it’s easier to sell ice cream when it’s hot outside. Consumers’ reluctance to let their neighbors reap all the benefits of the rising stock market tide engenders a goldrush mentality that obscures a panoramic view. Thus, the equity-investment portion of variable life appears more like the love boat than does traditional whole life. However, if and when the stock market turns cloudy, rainmakers likely will pour down upon the life insurance industry with yet another spate of suits. Can life insurers change the trajectory of their orbit? If so, what might precipitate such a perturbation? The importance of maintaining consumer trust has led the insurance industry to become increasingly sensitized to issues regarding the ethical conduct of business. Duska (1999) contends that “Leaders in the industry are adapting to the pressure to have companies and cultures that are ethically attuned to the needs of their clients, agents and other stakeholders. Some have done so simply in response to market, regulatory and court pressures, others from a more enlightened sense of social values” (p. 247). To promote ethical practices and to better align the interests of financial institutions, producers, and consumers, however, it is necessary to
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identify structures that contribute to untoward behavior and to explore mechanisms designed to ensure accountability (Carson and Cupach, 2000). One place where accountability has been seriously questioned resides in the insurance agentclient relationship. By definition, an agency relationship occurs “between two (or more) parties when one, designated as the agent, acts for, on behalf of, or as a representative for the other, designated the principal in a particular domain of decision problems” (Ross, 1973, p. 134). In essence, the agent does the bidding of the principal. Since the customer/client relies on a sales agent’s expertise and access to products, the agent and the client share an agency relationship. The client’s trust of the agent rests on his/her expectations regarding the fiduciary obligation of the agent towards the client (Barber, 1983). In other words, the relationship between agent and client assumes that the agent will act specifically in the best interests of the client. The agency relationship between agent and client is complicated by the fact that the agent simultaneously serves another principal. As Kurland (1996) indicates, the salesperson’s employing company constitutes a principal “because it compensates the salesperson for labor rendered” (p. 291). Thus, in addition to serving the client, the agent serves the institution as well. The institution’s confidence in the agent derives largely from its expectations regarding the agent’s sales performance (Barber, 1983). The fact that sales agents service two principals creates the opportunity for competing loyalties. A number of authors have argued that the system of agent compensation affects the likelihood of a conflict between an agent’s and a client’s self-interests. Specifically, these authors contend that the straight-commission compensation system creates a conflict of interest whereby the fiduciary obligation of the agent to the client is compromised (e.g., Basu, Lal, Srinivasan, & Staelin, 1985; Kurland, 1991; Oakes, 1990). Because such a system aligns the agent’s interests more closely with those of the employing institution rather than the client, the agent’s behavior favors the interests of one principal (the institution) over the other (the client). In essence, the agent presumably attempts to sell products that yield the maximal profit to the institution and/or agent, rather than the products that are in the client’s best interest. Although the arguments regarding the potentially inimical effects of the straight commission compensation system for the consumer are cogent, there remains a lack of empirical data to evidence the influence of compensation on agent selling practices. If compensation is not significantly associated with agent selling practices, then strident calls to change commission compensation systems may be misguided. On the other hand, if compensation does take precedence over promoting product suitability/quality for the client, then the efficacy of various solutions to ensuring agent accountability need to be explored in subsequent research. For example, individual insurer attempts to incorporate level-commission compensation structures have suffered from a “first-mover” problem and the loss of star agents. Thus, in light of such evidence, industry wide efforts may be more effective at aligning the interests of institutions producers, and clients. The global results of such a change might be that client interests' move more toward center stage.
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Bibliography Barber, B. (1983). The logic and limits of trust. New Brunswick, NJ: Rutgers University Press. Basu, A.K., Lal, R., Srinivasan, V., & Staelin, R. (1985). Salesforce compensation plans: An agency theoretic perspective. Marketing Science, 4, 267-291. Carson, J.M., & Cupach, W. (2000). The influence of compensation and producer characteristics on product recommendation. Katie School Working Paper (03200001), Illinois State University. Duska, R. (1999). Ethics and compliance in the business of life insurance: Reflections of an ethicist. Journal of Insurance Regulation, 18, 246-257. Franecki, D. (2000). Just say no to annuities. Barron’s, March 27. Kurland, N.B. (1991). The ethical implications of the straight-commission compensation system—An agency perspective. Journal of Business Ethics, 10, 757-766. Kurland, N. B. (1996). Trust, accountability, and sales agents’ dueling loyalties. Business Ethics Quarterly, 6, 289-310. Oakes, G. (1990). The sales process and the paradoxes of trust. Journal of Business Ethics, 9, 671-679. Ross, S. (1973). The economic theory of agency: The principal’s problem. American Economic Review, 63, 134-139. Wincuinas, J. (2000). Market conduct challenges. Best's Review, April, 126-128.