A Guide to Understanding Annuity Commissions
May 6, 2011 by Sheryl J. Moore
By Sheryl A. Moore
May 5, 2011 — One of the most misunderstood features of fixed and indexed annuities is the commissions that they pay to producers and distributors. In fact, no other product feature has been more miscommunicated, misunderstood or just plain misquoted in the media than compensation paid on these fixed annuities. That being the case, I thought a little overview might be in order.
First, a few definitions:
Street Level Commissions – the maximum advertisable commission that can be paid to a producer on a fixed or indexed annuity product (i.e. a marketing group cannot run a promotion in a magazine saying that the commission paid on an annuity is greater than the street level amount). Producers may be paid more or less than street level; typically the amount paid is based on the producers’ level of annuity production and their annuity premiums paid.
Commission Overrides – the amount of commission that is paid to the marketing group for any contracted producers’ fixed or indexed annuity production. This commission override is paid in consideration for the services that the marketing group performs including contracting, licensing, marketing, sales assistance, continuing education and more.
Heaped Commissions – a commission structure where fixed and indexed annuity compensation is paid up-front to the producer in a lump sum. This commission is typically paid at the time the annuity contract is issued to the annuitant and is based on the amount of premium paid into the contract. Generally, heaped commissions will pay a greater percentage commission than other commission structures.
Levelized Commissions – a commission structure where fixed and indexed annuity compensation is paid to the producer over a period of years as opposed to all (heaped) up-front. This commission is typically paid at the time the annuity contract is issued as well as on a limited number of subsequent policy anniversaries (ranging from two to five years). Generally, levelized commissions will pay a lesser percentage commission than a heaped commission structure, but over a longer period.
Trail Commissions – a commission structure where regular commissions are paid, based on the annuity’s account value and made payable to the producer after the annuity contract is issued. Trail commissions are usually offered in addition to some form of heaped commission. In fact, an annuity may offer a number of trail commission options, each varying in the amount of heaped and trail commission paid. Trail commissions are typically
paid on a monthly or quarterly basis and may begin as early as month two of the contract. Relative to other commission structures, trail commissions will pay a much lesser percentage commission.
NOTE: some annuities offer a combination of three commission structures that can often be changed with each new piece of annuity business submitted by the agent.
Now that you understand the terminology, let me aid in your understanding of fixed and indexed annuity commissions.
Differences in Distribution Channels
There is a fundamental difference in the commission amount paid on annuities in different distribution channels. These differences make comparisons of commissions paid on annuity products sold across different channels an apples-to-oranges comparison. Case in point: the career (captive) agent distribution generally provides many benefits that the independent agent distribution does not receive with contracts. The career agent is an employee of the insurance company who often is provided health and dental benefits, office allowances and other perks. The independent agent does not receive any of these benefits when contracting with an insurance company and for that reason the commissions paid on products offered to independent agents are relatively higher.
Another comparison that is not comparable is between the commissions paid on variable annuities and fixed or indexed annuities. Securities such as variable annuities (VAs) generally pay commissions every year, based on the value of the contract. This commission structure helps ensure that the producer maintains their integrity in the servicing of this security, which can lose value as a result of market performance. If the VA producer does not managing the assets inside of the contract properly, he/she will face a reduction in their commissions paid as a result. Fixed and indexed annuities do not use this type of commission structure because they cannot decline in value as a result of market performance. For this reason, commissions on these fixed insurance products are generally paid one time, at the point-of-sale.
More than 96 percent of all indexed annuity sales have the heaped commission option selected, if the agent is given a choice of more than one commission structure. As of the fourth quarter of 2010, the average heaped street level commission on indexed annuities was 6.37 percent. This figure was even lower for older-aged annuitants, as commissions to older purchasers are generally reduced by 50 percent on both fixed and indexed annuities.
Commissions Paid After Year One
More than two-thirds of all indexed annuity products permit additional premiums after the initial contract payment. Some of the insurance companies offering such products pay a commission on subsequent annuity premiums paid. In general, such commissions are typically reduced 50 percent or more from the first-year heaped commission amount.
Although more than 52 percent of all indexed annuities offer a trail commission option, less than 5% of all indexed annuity sales have a trail commission option selected if there is an alternative heaped option available. Trail commissions are generally 1 percent or less on indexed annuities.
Marketing Organization Commission Overrides
The override commissions paid to the marketing organization on fixed and indexed annuity sales are generally considered proprietary information and not publicly available. Like street level commissions, a marketing group’s overrides are not a stated, fixed amount and can differ between two different marketing groups. If there is more than one marketing group in the contracting hierarchy, an override is payable to each of the marketing groups in the multi-tiered distribution model. This is most commonly seen with large marketing consortiums and those that market proprietary products that are made exclusively available to a select few.
As a whole, commissions paid on annuities in the independent agent distribution are down over the past two years. Many insurance companies have had to make commission reductions as a result of limited capital and historical low-interest rates since the market collapsed in 2008. However, the typical commission paid on fixed and indexed annuities has never been in the double-digit range. Although such products are frequently advertised, they simply do not account for a significant portion of sales. So the next time you read about the “huge” commissions paid on these annuities, consider the source and their knowledge of the subject matter.