Basic Principle-Agent Model

When I was 19 I interned at Northwestern Mutual, an insurance and wealth management firm. My title was “Financial Representative” and my job was to introduce the firm to a wide variety of potential clients in hopes of selling them life insurance and wealth management products.  I would meet with potential clients to assess their financial needs using statistics, simple finance calculations and basic rule-of-thumb insurance knowledge. For example, I might recommend a simple term insurance policy for a newly wed couple or long-term care insurance for a newly retired person. Each meeting I was accompanied by a senior member of the firm in order to boost my credibility and shared any commissions we earned from bringing in a new client.

On paper, this principle agent model was bilateral stretching directly from Northwestern Mutual to the client. Federal Law, legislation and the term “Fiduciary Responsibility” aimed to make sure that the incentives of the firm/financial representative and the client were directly aligned at all costs. Company policy was set so that all the advice a client was given was 100% in their own best interest and in the best interest of the firm. However, in reality this was not the case. The true model was more like a triangle where incentives rarely aligned with each agent.  Representatives were constantly incentivized to focus on selling products to earn more commissions and were also given financial bonuses as well as prestige from the firm. A simple example follows: The representative’s financial assessment finds that a whole-life policy would not provide any more utility than a term policy to a potential client. Both provide the same level of protection, however the whole life policy is more expensive. In this situation, you might find the representative push the whole life policy to earn more commission.  In this scenario the client receives the coverage needed to protect their family, but is lured into buying the “Cadillac” vs. the “Honda” of insurance plans. As you can imagine, many conflicts of interest arise.

The misalignment of incentives within the insurance industry is well known publically. Often, potential clients enter the meeting with a deep mistrust of the representative. The first job of the representative is to earn the trust and respect of the client. Over the summer I found that open communication, presenting mathematical evidence, discussing the range of options and using personal experience helped build trust. Throughout the course of the meeting you want to make it clear that your goal is to help the person’s family and put yourself in their shoes to make the experience as personal as possible. If the client doesn’t believe you, it is nearly impossible for a sale to occur. If the above-mentioned actions are taken usually the sale in the best interest of the client will take place, however in the eyes of the firm this is the bare minimum level of performance.

If the representative always acts in the best interest of the client they will likely fall behind in terms of average number of sales. Unfortunately, all too often representatives will earn trust and push the limits of their client relationships by convincing them to buy packages or products that are unnecessary. Many representatives will eventually get fired for either underperforming by not meeting sales goals. The best representatives meet both the firm’s and client’s expectations through volume. Instead of upselling clients, the representative will work twice as hard to acquire more clients. This scenario keeps the firms happy with increased number of sales and new clients without the financial representative breaching fiduciary responsibility. As you can imagine, representatives are often enticed to upsell vs. working more hours of the day.