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James G Bridgeman, FSA, MAAA


Presented in the Proceedings of the International Conference On Insurance: The Momentous Millenium


sponsored by the Confederation of Indian Industry


New Delhi


November 1999 


                                                This essay will argue the thesis that the act of selling traditional life insurance policies to individual families – the very sale itself, quite apart from specifics of the subsequent financial performance of the insurance policies sold – creates tangible economic value to the families involved and to the society and economy to which they belong.  It follows that a just portion of the created value logically ought to accrue to agencies of the sale, usually insurance agents and the companies that they represent.  Furthermore, it follows that any money’s-worth analysis of just the post-sale financial performance of the life insurance policies sold will misrepresent the total value equation to the families, society and economy.


                                                If true, this thesis calls into question many “politically correct” (or should one say “financially correct”?) attitudes about life insurance “distribution”, its costs and (supposed) inefficiencies, and the likely future of the world-wide life insurance business.  Indeed the very word “distribution” tends to ascribe only passive cost characteristics rather than active value-creation attributes to the act of selling.  While the issue is most acute for the much-maligned life insurance sales process, the thesis may apply in some measure to sales of other forms of insurance, pensions and financial services, as well, including social insurance and pensions and commercial privatization of portions thereof.


It long has been the fashion among financial journalists and analysts outside of the insurance business, and often among participants in the business itself, to decry the high costs associated with selling traditional life insurance policies face-to-face by agents.  Depending on the specific product, market and company involved, the agent making a sale might keep anywhere from 35% to 80% or more of the first year’s premium as commission.  Overrides to the people and organizations who recruited, trained, and supported the sales agent, together with the insurance company’s direct costs to support the sale, might consume another 45% to 75% (or more) of the first year premium.  Surely, says the fashion, there must be a better way!


Many observers view these costs as a pure (and regrettable) expense drain from the value of the life insurance contract to the family who purchases it, and from the value of the transaction to the insurance company that underwrites it.  At best, the observer might ascribe some kind of educational value to the activities of the agent, explaining the need for and desirability of life insurance.  Perhaps some additional value accrues from specific services provided, such as helping in the selection process among complex products (and maybe among companies), negotiating a favorable path through underwriting and rating program alternatives, organizing the mechanics of the sale, and expediting subsequent paperwork and enquiries.  But, goes the story, any rational calculation of the value attributable to all of these activities falls an order of magnitude short of the total selling costs observed.  The only remaining issue is what’s to be done about this scandalous situation.


As compelling as this view seems on the surface, it would be surprising if it represented the whole truth.  In much of the world, life insurance markets behave in highly competitive fashion and have done so for a long time, with well-capitalized competitors who measure themselves largely by market share and increasingly open to foreign entrants if domestic competition isn’t enough.  Furthermore, industry-wide and worldwide the numbers of agents recruited and turned over annually are legend, as are the energy and diversity devoted to attempts over many decades to train and motivate agents better.  Economic theory and natural selection each demand that these competitive pressures should have purged from the scene long ago such gross operational inefficiency as the common wisdom ascribes to the life insurance sales process.  True cartel mechanisms, even if they could have survived for the many generations that life insurance has been sold this way all over the world, offer no explanation for the anomaly.  The preponderance of the supposed unearned “rents” inures not to any hypothetical industry cartel, but rather to the sales people and the organizations that support them, as varied, fractious, and ungovernable a group as might exist anywhere in the business world.


The rejoinder to this argument generally will point to some fundamental and systematic failure in the market for life insurance itself as explanation for the survival of such an inefficient sales process.  The possibilities cited might include products inherently too complex for purchasers to understand, cash flows that only an actuary (or financial journalist) can evaluate, lack of disclosure, absence of comparative data, obscure sales channels, clumsy delivery vehicles, restrictive regulation, fraudulent practices, and so on, depending upon the observer.  (Does the list reveal by its very length and variety a lack of specifically credible explanatory power?)  At this point usually come the recurring predictions of imminent demise for the traditional life insurance sales process.  The modern age offers (choose one: direct marketing, bancassurance, cross-selling, or – the current favorite – Internet sales) to circumvent past market failures and save society, the insurance business and the families who buy life insurance from the depredations of the old-fashioned life insurance agent. 


Again it would be surprising if this “market failure” view represented the whole truth about the remarkable historical persistence of the traditional life insurance sales process.  Some of the competing “distribution” methodologies cited as more efficient than traditional agency sales have had an entire generation (some of them two generations) in which to prove their mettle.  Strangely enough, to this day they still remain hopeful contenders for future sales, not proven heavyweights in the ring.


While direct marketing and bancassurance have demonstrated occasionally here and there the capacity to sell respectable volumes of automobile, dwelling, personal accident, or term life insurance, there is no demonstrated success for selling traditional life insurance products this way.  Apparent exceptions to this rule (such as bancassurance in France) always turn out to involve pre-sold products.  For example, in France, the tax law pre-sells a life insurance bond – i.e. the concept -- to everyone in the country who is not a pauper.  The vaunted bancassurance technique simply gets them to buy one of what they already wanted here rather than there while banking. 


Although an enterprise can be sustained, and families helped, by selling term life insurance through mass marketing channels, the difficulties involved should not be ignored when judging the comparative merits with traditional sales.  Considering the fairly small number (world-wide) of direct or bank marketing efforts to sell term life that have produced both independently successful and sizable results, after many years of talk and effort, it might be judged even harder to succeed at than traditional life insurance sales.  Except for a handful of world-class operators, the mass marketing approach seems to make a lot more sense as a revenue enhancer within some other business that actually pays the rent. 


The reason may not be far to seek.  A straightforward actuarial calculation illustrates that 20 to 30 times as much term life insurance coverage must be sold to generate the same long run savings value to families and society, or gross profit potential to a company, as does the sale of traditional permanent life insurance coverage.  In fairness, since term life has so much lower a premium, it will carry more insurance coverage per sale.  But it still will require selling term life to at least 5 or 6 families in order to generate the same savings value to them and to society, or profit potential to a company, as selling permanent life insurance to one family.  These ratios need to be kept in mind when judging the potential and the performance of any supposed new and more effective way to sell life insurance.  Is it more effective and more efficient by those orders of magnitude?  In the right circumstances and in the hands of a superb marketing organization sometimes the answer will be yes.  But the size of the hurdle explains why none has yet dethroned the traditional sales method in the broad market worldwide.  Internet sales are subject to the same actuarial and economic hurdle because the hurdle derives from the level of gross margins, not from transaction costs.


Ultimately, it ought to surprise on sheer economic grounds if the traditional life insurance sales process were truly as inefficient as so many observers maintain.  In the long run, rewards flow with value creation or economics doesn’t mean much.  And all economic value stems from value to a customer.  Successful traditional life insurance sales people and organizations have reaped large rewards for perhaps as long a run as any generic economic entity that is still extant in something like its original form.  Before rejecting them for some modern thing better, it could behoove the analyst to suspend disbelief long enough to explore seriously what large quantum of true value to life insurance customers those benighted sales people and organizations might be about creating, all unknown to the analytic mind these many years.  


Let us consider an emerging middle class family.  Define it to be one whose discretionary spending capacity is rising, at least a little, compared to its own recent history.  The reason might be that the entire economy is advancing or that just the family itself is improving its standing relative to the economy for reasons of seniority, education, prior thrift or any other cause.  On this definition, the family could live in an emerging market or could be itself emerging within a mature or a stagnant market.  Its actual levels of income, spending and saving could be small or large so long as discretionary spending, at whatever level, is growing.  Let us compare the state of that family’s finances and lifestyle before and after a successful sales call from a traditional life insurance agent.  Let us also compare the state of the society and the economy in which the family lives before and after that successful sales call.


By definition, with discretionary spending capacity on the rise the family’s consumption expenditures and maybe its savings are on the rise before the agent ever arrives at the door.  If the agent is smart and well supported by a marketing organization he won’t even knock on doors where consumption expenditures are not rising.  In fact, our family’s more recent improvements in discretionary spending capacity probably will not yet be fully committed to new consumption expenditures, installment payments, life-style habits, or savings levels or programs.  Maybe the family has ideas, tentative plans or partial commitments to such.  Maybe they don’t yet.  But one thing can be virtually assured.  They have given no serious thought, taken no concrete steps, toward obtaining or increasing a life insurance program, certainly not permanent life insurance with cash values. 


If the life insurance agent doesn’t arrive, or fails to succeed, the fate of the family’s recently enhanced discretionary spending capacity soon will be sealed.  A combination of consumption expenditures or installment payment commitments, support for more expansive life-style habits, and (one hopes) higher commitments to ordinary savings or investment programs will consume the new capacity.  The result for the family might be a new (or later model used) car a few years sooner than otherwise or a better make of car.  Perhaps furniture or a household appliance or entertainment unit sooner or better than would have occurred without the new spending capacity.  Most likely some marginally new habits of entertainment or eating out or leisure or travel would develop.


For most families such commitments and habits rapidly assume all but an irrevocable character (excepting only for some families, alas, the savings.)  These commitments and habits would fairly soon come to immobilize the new spending capacity.  Even with the purchase of durable consumer goods, within some number of years, often small, the useful lives will have expired leaving little or no tangible value for the expenditure made, and probably an all but unavoidable requirement for a replacement expenditure.  For non-durable goods and services, the intangible experiential values are the only ones ever created by the expenditure. 


Savings and investment expenditures, of course, will carry an ongoing value commensurate with the original expenditure made, the time values expired, the risks assumed and the fortunes experienced.  This value will be net (if you think about it) of the implicit economic costs for the on-going option easily to liquidate the position and spend it.  And, obviously, net of any liquidation actually diverted to consumption purposes.  It will reflect also the accumulated value of recurring savings and investment expenditures at the same level, but only to the extent that any recurring savings program carved out of the original higher discretionary spending capacity has survived the human urge for more immediate gratification. 


By contrast, what if a life insurance agent arrives before the increased discretionary spending capacity becomes irrevocably committed?  If the agent is a good one, she will probe and reveal, sometimes for the first time even to the family themselves, the family’s hopes, fears and plans – the inchoate ones as well as the obvious.  Maybe one out of ten or fifteen times a very good agent will convert successfully what is revealed into cool reason and emotional spark or weight in just the right way.  The family will commit a legitimately sustainable portion of its newly available discretionary spending capacity into recurring premium on a permanent life insurance policy.  It is not a fully rational process.  It can be exampled but not reliably taught.  It will link with identifiable financial anticipations such as educational costs, weddings, births or other family events, career plans, retirement plans, desire for occupational independence, or an infinite number of other possibilities.  But it will be driven by the satisfaction of personal, social and value-laden emotional needs.


Regardless of the experiential values achieved what economic value results for the family?  Clearly, if the insured death occurs the family is infinitely better off in a financial sense for having the policy.  But they are almost always better off than they would have been without the permanent life insurance policy even when no death occurs.  Yes, they will have foregone a substantial premium cash flow.  No, not for many years will the policy cash accumulation exceed the investment value had the premium cash flows been faithfully saved in a conventional savings or investment vehicle. 


But that is not the alternative.   Had the family been irrevocably committed to deploying that portion of its new discretionary spending capacity into recurring deposits to a conventional savings or investment vehicle, rather than into consumption, no sales person on earth could have convinced them to divert it into permanent insurance premiums.  The analysis could not have sustained the comparison, and almost by assumption the emotional commitment could not have been overcome by the “attraction” of a permanent life insurance premium.  Had the commitment been shallow enough to be diverted immediately into life insurance premium, then it surely would never have withstood the ongoing human urge for diversion into consumption expenditure.


(Another way to view this is from an option-value perspective.  The financial dynamic of a well-designed life insurance contract usually must provide an obvious purely financial incentive to keep paying premiums once the first year or two’s financial sacrifice has been borne.  In some sense this means that the insurance policy owner has surrendered the option to forego (sensibly) future premium payments in favor of consumption expenditures.  Compared to a recurring investment in a conventional saving or investment program, the well-designed insurance policy after the first premium or two rewards and will continue to reward the family that owns it for having given over that option.  Considering the strength of the human urge to consume, especially when set in a recurring decision context, this option must be of considerable economic value as against an alternative less vulnerable to liquidation into ephemeral consumption.)        


So the successful life insurance sale almost certainly diverted the premium cash flows from discretionary spending capacity that was either completely uncommitted or else tentatively committed to consumption expenditures.  If uncommitted it would most likely have found its way largely into consumption expenditure in the end, anyway.  As previously described, if put into consumption expenditure the result for the family ultimately would have been purely experiential residual values, at best, with no tangible residual economic value.  Thanks solely to the agent’s success in making the life insurance sale, the family has the economic values in the insurance contract at its disposal rather than none.  From the viewpoint of the family involved, the consumer against whose viewpoint all economic value ultimately arises, the act of making that life insurance sale created value out of nothing.  Or more precisely, out of the skill and effort required to make the sale, not least the effort required to invest time and heart in at least 9 families who did not buy before getting to the one who did.


In a phrase, the life insurance sale is an act that converts a series of consumption expenditures into a series of almost locked-in savings or investment expenditures.  This is inherently valuable to the family that benefits from the resulting savings or investments.  But it is an enormously difficult act to achieve.   It compares in no way to the much easier act of attracting expenditures already committed to savings or investments into one vehicle rather than another.  When savings or investments compete directly with consumption it requires enormous skill and effort to bring the victory to savings and investment.  The value of the traditional life insurance sale is in achieving that victory.          


Some theoretical niceties of utility theory may appear to cloud this conclusion as viewed at the time of sale.  But the practical view from the time that the useful life of some durable consumption expenditure would have expired leaves no doubt about the economic conclusion.  And this is largely without regard to the precise level of financial performance achieved under the insurance contract, since the comparison is against zero ultimate tangible value that would have resulted from the consumption expenditure.  Even considering experiential values, the satisfactions tapped by the good insurance agent originally to achieve the sale are likely to be of longer duration and more human worth than the long-term residual of the experience from most consumption expenditures.


What about the society and economy in which the family lives?  Without the life insurance sale, a series of consumption expenditures would have ensued, or perhaps some level of savings or investment into vehicles vulnerable to immediate redemption demands.  Such vulnerability either would have precluded use of the funds for long term fixed investment or would have allowed it only at the cost of introducing an increment of fragility into the financial system.  The preponderance of consumption expenditures makes the major effect simply the immediate resulting stimulation of economic activity to produce and deliver the consumables.


With the life insurance sale, however, a series of investments ensues.  The traditional life insurance sale converts erstwhile consumption expenditures into savings and investments. Furthermore, owing to the financial inducements built into the life insurance contract to stay in force once sold, these investments can be deployed into long term fixed uses without introducing nearly as much financial fragility into the economy as would such deployment of more easily redeemable funds.  Better yet, such investment flows immediately reappear in the economy as consumption expenditures, anyway, that is, as expenditures for the goods or services that comprise the fixed investment project.  So the life insurance sale creates value from nothing (or, again, from the skill and effort deployed to make the sale) for the society and economy.  Namely, equivalent consumption expenditures as would have occurred without the sale wind up stimulating demand, but on the way they result in the creation of productive long-term assets.  (Niceties of relative import content in immediate personal consumption versus development goods may cloud the specifics of the conclusion, but compared to no new fixed investment without the life insurance sale the conclusion must broadly obtain.)   


Finally, purely from the moral perspective, surely the society is better off whose families devote more of their economic priority to, and find more of their emotional satisfaction in, caring for the long term needs and development of their members and less in satisfying immediate consumption desires.  The traditional life insurance sales process builds upon stimulation of the former satisfactions at the expense of the latter.


Even apart from the societal and broad economic values involved, actually to quantify the specific economic value created by the traditional life insurance sale for the family involved would be highly problematic.  Fortunately as in all such questions classic liberal economic theory provides a foolproof answer.  Ask the marketplace; ask the consumer.  The value created for the family involved must be materially larger than the rewards allowed in total to the sales agent, the supporting organizations and the insurance company involved in the sale.  After all, their total reward must be only a fraction of the value they created for the consumer, the family involved with the sale. 


But perhaps a sense for the significance of the value created can be gleaned from the sheer difficulty of making such a sale.  What is your basic attitude toward hearing from a life insurance sales person?  Why is it that most of the carefully screened, carefully trained, and (exorbitantly?) well rewarded life insurance sales people who enter the profession are gone within just a couple of years?  Why is it that a typical surviving one makes 20 or 25 unsuccessful sales calls to achieve just one sale?  Why do even the great ones require 10 or 15 failures to achieve one success?  The answer is that they create value by contravening human nature for its own benefit.  To convert discretionary spending out of consumption and into locked-up savings or investments is profoundly unnatural. 


Remember always that expenditures already earmarked for savings or investments rarely find their way into traditional life insurance policies.  The life insurance sales person competes with the car salesman, the electronics emporium, the shopping mall, the travel agent, and with the customer’s own natural inclinations, but not with the bank or mutual fund salesperson.  The traditional life insurance sale thus creates enormous value for the family and for the society and economy involved.  High levels of reward for those who can achieve this outcome successfully are natural and well earned. 


This is not to say that the rewards should know no limits.  Indeed, rigorous control and management is required to keep sales costs within reasonable bounds, while still providing sufficient incentive to motivate the difficult value creation required.  It is arguable that successful management of this difficult balance is the most important value-creating activity of life insurance company management.  By comparison, investing to achieve a spread or providing transactional services are easy.  Finding the point of low enough, but not one-dollar lower is more art than science.  Similarly, to maintain ethical standards among people whose skills run to convincing people to do what they really didn’t start out wanting to do, to buy something they really didn’t wake up that morning feeling they needed, is not easy.  How to be sure that they only exert that power when it is in fact in the customer’s true interest?  But to pretend that such skills properly applied cannot create enormous value is to ignore reality.  And to imagine that they can be replaced easily by something cheap (or electronic) is pure delusion.


These extensive ruminations have considered only the traditional life insurance arena.  It may be that aspects of this way of thinking and analyzing a sales process could provide valuable insight into the role of commercial skills and enterprise in other insurance, pension, or financial services.  It may be that they could offer unique insight into the value that might be provided to families and to society by introducing commercial participation in appropriate parts of social insurance and pension programs.    


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