Agent Theory, Incentivisation and Insurance commission rebate
January 29, 2024 | Money Philosophy
Recently, I’ve been watching an introductory finance course on Coursera - Financial Market by Yale. It covers the basics of finance and is quite interesting.
Why it’s “insurance sales” but not customer service
What is the social significance of finance? Is it just about making money? Apparently not. The greatest value of financial markets lies in the optimal allocation of resources across time and space. Insurance, as an ancient financial tool, exemplifies this advantage well: based on mathematical models such as binomial distribution and the law of large numbers, insurance disperses individual risks, allowing money or resources to be timely and appropriately allocated to those in need.
However, in the 19th century, society’s acceptance of insurance was not high. The fundamental reason is that insurance is counterintuitive: insurance encourages people to pay for things they wish it will never happen, as if betting on one’s cherished health and life.
Two important milestones that made insurance widely accepted are:
- In the 1840s, Morris Robinson (Mutual Life of NY) first proposed the insurance sales model that is still in use today: hiring sales agents with high salaries to sell insurance door-to-door.
- In the 1880s, Henry Hyde (Equitable Life Assurance Society) first introduced the concept of cash value in insurance products.
The sales agent model promoted insurance through sophisticated sales tactics, and the introduction of cash value made people psychologically recognize the value of insurance, encouraging long-term holding. This allowed insurance, a financial tool proven by statistics and sociologically beneficial but psychologically challenging, to become widespread and play its positive role.
However, problems associated with the agency sales model and the concept of cash value in insurance have persisted. The Principal-Agent problem, which includes fundamental conflicts of interest and information asymmetry between the principal and the agent, remains a topic of discussion till today. Insurance with cash value also adds additional costs, which are ultimately borne by the customers. These two issues remain the “elephant in the room” in the insurance industry.
Incentivisation
Insurance companies lack the motivation to promote financial education because they are incentivised by agent sales model and high-profit cash value products. In the 1990s, Singapore banned insurance rebates to prevent brokers from inducing customers to buy unreasonable products through rebates. The ban was lifted in 2002 as the insurance market matured, and the government shifted from a regulatory to a supervisory role, allowing rebate practices that were not inducement to purchase. However, rebates remain a controversial topic, another problem remains: advisors may recommend high-commission but unsuitable products to profit themselves. The fundamental issue is still the conflict of interest and information asymmetry in agency theory: customers and advisors act out of their own interests, leading to disagreement in product selection. The assumption in financial theory that people are driven by self-interest (which is true in most real-life scenarios) further exacerbates the conflict of interest under the commission system, leading to an information bias between financial advisors and clients, eventually turning into a game of interests.
Therefore, from a regulatory perspective, it’s difficult to strictly define rebate activities. Currently, the local brokerage FSMOne in Singapore offers insurance services, quietly stating that some products are eligible for 30%-45% rebates. The Singapore government also mandates insurance companies to offer zero-commission term life/whole life insurance Direct Purchase Insurance that can be bought directly from insurers, which can be viewed and compared on CompareFIRST.
Aside from the sales-driven agency model and cash value-packaged insurance products, what better ways are there to improve insurance penetration and serve society better?
Government Policy: For example, ObamaCare, which attempts to address the criticized American healthcare system, incentivizes Americans to buy medical insurance through tax incentives and other reward-penalty systems, increasing insurance coverage. Similarly, the Singapore government has increased insurance coverage and reduced selection bias through policies like MediShield, CareShield, and CPF Life (Learn how to buy insurance from Singapore Government).
Social Education: Only when people’s financial literacy improves and they recognize the value of financial tools beyond making money can they better accept and effectively use them. Singapore government websites like Money Sense, MyMoneySense and CPF Board are working hard to popularize financial literacy and develop digital tools to help citizens improve their personal financial management skills.