A Harvard Business School study shows that LIC agents have an incentive to recommend more expensive and less suitable products to consumers. This especially hurts “low and medium income households (which) tend to trust the government insurance companies more than private sector firms”
Do life insurance agents recommend a high-commission product, which is against the interests of their clients? This has been the suspicion all along. And now a Harvard Business School study titled “Understanding the Advice of Commissions-Motivated Agents: Evidence from the Indian Life Insurance Market” by Santosh Anagol, Shawn Cole and Shayak Sarkar, confirms this.
The researchers sent trained auditors into the field posing as customers seeking insurance and then analysed the advice they received. The auditors’ meetings with agents revolved around life insurance, specifically two types of policies: term and whole life. The study found that agents from Life Insurance Corporation of India (LIC) are less likely to recommend a term insurance plan, when it is known that in many cases term plans are the best form of life insurance. The study suggests that the government-owned organisation does not encourage its sales agents to provide better advice and that government ownership does not appear to solve the problem of unsuitable advice.
Interestingly, the study says that consumers who signal sophistication by demonstrating some knowledge of insurance products get better advice. This result suggests that the worst educated consumer may suffer most from commission-driven sales behaviour. In short, the masses, who have a blind belief in LIC, equating it with government, are doomed to suffer the most.
According to the study, “Anecdotal evidence suggests that low and medium income households tend to trust the government insurance companies more than private sector firms, and the government firm might take advantage of this additional trust by pushing less suitable products. Another possibility is that agents employed by government firms are less knowledgeable about term insurance.”
But, its not just LIC agents that are to be blamed. Agents overwhelmingly recommend unsuitable products, which provide high commissions to the agent. The study says, “Agents cater to the beliefs of un-informed consumers, even when those beliefs are wrong. Salesmen are unlikely to impart neutrality to customers even if they have strong initial preferences for products that may be unsuitable for them. In case of sophisticated consumers, agents recommend term policies on top of whole life insurance policies without substantially changing premium payments, as opposed to bringing fairness to the customer and recommending only term insurance policies.” In short, the amount of premium matters to agents as it solely determines the commission they earn at the end of the day.
According to the study, “Market discipline does generate neutrality; with agents perceiving greater competition they are more likely to recommend a suitable product.” Based on an experiment, the study concluded that increasing the apparent level of competition does lead to the agent attempting to bring fairness to the customer by offering term insurance. It also suggests that encouraging customers to shop around when looking for consumer financial products may be a simple way to improve the quality of advice provided by agents. While it is always desirable for customers to ask questions and shop around, Moneylife believes that competition, availability of more information does not necessarily mean better selection because of the similar behaviour by producers and distributors and also behavioural flaws of consumers.
The study concludes that “There is strong evidence that commissions-motivated agents provide unsuitable advice. Agents recommend strictly dominated, expensive products, 60%-90% of the time. Consumers who stated that they had an understanding of insurance products were 10 percentage points more likely to receive a recommendation that included term insurance.” The study found that agents gave correct advice in only 9% of the time; in the other 91% they recommend investment-linked products that are dramatically more expensive.
In the second part of the article we will give more information on insurance company and agents’ behaviour.