What is Distribution Cost in Insurance

Summing up, the distribution cost in an insurance policy consists of all the expenses that the insurer incurs in order to sell its product to you. By and large, this poses a direct impact on the overall cost that you pay (in terms of the insurance premium). With this in mind, let’s learn about distribution cost and how it affects you today.

One Minute Summary:

To sum up, the distribution cost consists of all the direct and indirect costs for the salesperson to sell an insurance product to the consumer.
For this purpose, LIA requires the insurers to disclose the insurance product’s distribution cost and the total deductions in its policy illustration.
Accordingly, you will be able to find this information in either the insurance policy’s product summary, cover page, or the policy illustration itself.
All things considered, the insurer would have taken the distribution cost into account when it prices its insurance policy. This is reflected as the insurance policy’s premium amount.

Part 1: Disclosure on Distribution Cost

As a matter of fact, Life Insurance Association Singapore (“LIA”) requires the insurers to disclose the insurance policy’s distribution cost and the total deductions in its policy illustration. For the most part, this is a mandatory requirement for all the individual life insurance policies. For instance, this applies to

A participating policy, e.g. a participating whole life insurance policy;
A non-participating policy, e.g. a term insurance policy;
An investment-linked policy.

Additionally, if there is a group policy that shares similar characteristics to an individual policy, then LIA’s guidelines will apply as well. In general, for such group policies, the buying decision is usually made by an individual and not the Employer, e.g. a Group Endowment, Group MRTA.

Part 2: The Components of Distribution Cost

To sum up, the distribution cost consists of all the direct and indirect costs for the salesperson to sell the insurance product to the consumer. In detail, there are two main components.

Part 2.1: Cash Payment

Firstly, the cash payment includes all the payments that are made to a salesperson. To list, such payments could be in the form of

Basic commissions;
Overriding commissions;
Production bonuses;
Salaries; and
Other cash incentives.

In general, for commissions, they are usually expressed as a percentage of the insurance premium amount. Moreover, the commission may be paid out to the salesperson over a pre-defined number of years. To illustrate, let’s look at a hypothetical case where an insurance policy pays a first year commission of 40% to the salesperson. On this occasion, if the policyholder pays an insurance premium of $2,000 annually, then the salesperson will receive $2,000 x 40% = $800 as his first year’s commission.

Next, let’s assume that the insurer pays a second year renewal commission of 10% to the salesperson. To this end, so long as the policyholder keeps his insurance policy and pays the second year’s insurance premium, the salesperson will receive a second year commission of $2,000 x 10% = $200. Eventually, for most life insurance policies, the commission payout structure will decay down to zero.

At the same time, the salesperson’s manager or director will also earn an overriding commission from each insurance policy sale made by his salesperson. In similar fashion, the overriding commission is usually expressed as a percentage of the insurance premium amount.

Furthermore, the insurance company will likely have a production bonus structure to incentivise its salespeople to sell more insurance policies. This is similar to any other ad-hoc cash incentives to drive more sales for the company. After all, the more insurance polices the salespeople sell, the more profitable the insurance company is. Summing up, you will realise that a significant portion of the distribution cost goes towards paying commissions to these salespeople.

Part 2.2: Cost of Benefits and Services

Secondly, the salesperson may also receive non-monetary benefits and services. For example, it could be

A subsidised loan;
A sales convention;
Insurance cover;
Office accommodation and equipment; and
General stationery.

Part 3: Issues during Computation

Part 3.1: Two Main Issues

At this time, there are two main issues when it comes to computing the distribution cost for an insurance product.

Firstly, different insurance companies may offer a different remuneration structure to a different distribution channel. For instance, for brokers, it will be the total cash payments and cost of benefits and services provided to the broking firm. Similarly, for agents, it will be the total cash payments and cost of benefits and services provided to the agency force.

In contrast, for a fixed salary or a fixed cost channel, it will be the apportionment of the total costs over the individual contracts in a way that reflects the value of the contract to the insurance company. Finally, there is also the case where the distribution channel is related to an insurance company, e.g. a bank owns the insurance company. In this case, the bank may not need to perform the same level of distribution related activities. As a result, there will be some cost savings as compared to the other distribution channels.

Secondly, the cost of some remuneration items is dependent on factors such as the future business volume, persistency, or the rank of the salesperson. As a result, it may not be possible to pre-determine these factors accurately.

Part 3.2: Not a straightforward addition

Based on the presented issues, if we perform a straight addition on all the disclosable costs, it may then give rise to a misleading result. To illustrate, let’s consider the start-up of a new company. In this case, the shareholders may have used their own capital to fund the very high initial overhead costs of establishing the distribution channel. This is opposed to writing these costs as an expense. Similarly, for established insurance companies, there may be circumstances where LIA allows the otherwise disclosable costs to be excluded. Given that variables and variation, there exists a need to maintain consistency in the disclosure of the total distribution cost between the different insurance companies and the distribution channels.

Part 4: How to construct the Distribution Cost Scale

Part 4.1: Best Estimate Approach

In order to overcome the above mentioned issues, the insurer’s appointed actuary will use the Best Estimate approach to derive the distribution cost. For this purpose, there may be instances where the distribution cost scale for each remuneration structure or distribution scale is materially different. In this situation, the actuary will perform a separate calculation accordingly. By and large, the actuary will take the average of the most recent and relevant experience to estimate the cash payments (variable component ) and the cost of benefits and services. Despite that, there may be times when there is a deviation, e.g.

The actuary has reasonable grounds to believe that the remuneration for a certain period will be higher or lower than what has been implied by the experience; or when
There is no such experience available.

Under those circumstances, the actuary will perform the estimation based on the presented business plans.

At the same time, the distribution cost scale will be split into the new business cost scale and the renewal distribution cost scale. Thereafter, the actuary will assess the work carried out by the salespeople during the new business and the renewal phase. This is so as to determine the cost of benefits and services for the new business cost and the renewal cost. After all, it may not be appropriate to assume a 50:50 ratio between new business cash payments and renewal cash payments.

Part 4.2: Construction of Scale – Suggested Methods

As an illustration, LIA has suggested some methods for the insurers to use to construct the distribution cost scale:

New Business Distribution Cost Scale = New Business Cash Payment Scale + New Business Cost of Benefits & Services Scale
New Business Cash Payment Scale = First Year / New Business Basic Commission Rates + Adjustments for all other New Business Cash Payments (e.g. override, production bonuses)
New Business Cost of Benefits & Services Scale = New Business Uplift Factor x New Business Cash Payment Scale
New Business Uplift Factor = New Business Cost of Benefits & Services / New Business Cash Payments

To explain, New Business Cash Payments and Cost of Benefits & Services refer to the total cost of the components listed in Part 2. In detail, this will be based on the most recent experience for each remuneration structure. Additionally, the actuary may perform any appropriate adjustments based on the average experience of all the products for each remuneration structure.

In like manner, we can apply the same process to derive the Renewal Cash Payments Scale and Renewal Cost of Benefits & Services Scale.

Finally, let’s reproduce the anticipated Cash Payments and Cost of Benefits & Services for each remuneration structure. In order to do this, we will apply the Cash Payments Scale and Cost of Benefits & Services scaled derived to the anticipated new and renewal businesses.

Part 4.3: Review of Distribution Cost Scale

On the whole, the actuary will review the distribution cost scale at least once in year. In the event that the remuneration figures have become misleading, the actuary will advise the insurance company to review the structure accordingly.

Part 5: The Impact of Distribution Cost

As can be seen in the earlier sections, the insurance company will factor the distribution cost into their pricing. As a result, higher distribution cost will likely lead to a higher insurance premium for the policyholders.

Despite that, there are also insurance products that have lower distribution cost. For example, Direct Purchase Insurance (DPI) are sold without any financial advice. Given that there are no commissions charged, their insurance premium tends to be relatively cheaper as well.

Part 6: Where to find the information on Distribution Cost

At the present time, the insurance company will inform you on the distribution cost in one of the following three formats:

Part 6.1: Product Summary

Firstly, you may find more information about the insurance product’s distribution cost in its product summary. To point out, this information is commonly found in an accident and health insurance policy, e.g. a personal accident plan, or an integrated shield plan. For this purpose, the distribution cost is usually summarised within a few sentences. As an illustration, here is an excerpt from an integrated shield plan’s product summary:

The total distribution cost of this product is 74% of the additional private insurance coverage premium for the first year. Thereafter, the cost will be 5% to 11% of the additional private insurance coverage premium for the renewal years.

Part 6.2: Insurance Policy’s Cover Page

Secondly, you can also find a summary of insurance product’s distribution cost on its cover page. In general, this information can be found within the first two to three pages of the insurance policy’s cover page. To point out, this is a common practice for a participating whole life insurance policy, an endowment savings plan, or a term insurance policy. For instance,

How much will you need to pay for advice?

The Total Distribution Cost for this plan is $3,597 as shown in the Policy Illustration. This makes up 7.19% of the total premiums payable.

Part 6.3: Policy Illustration

Thirdly, you may find the insurance product’s distribution cost within its policy illustration. In like manner, this is also a common practice for a participating whole life insurance policy, an endowment savings plan, or a term insurance policy. For this purpose, the insurer will usually use a table to present the cost breakdown. For example,

How much are you paying for distribution cost?

This table shows the total costs of distribution that the insurance company expects to incur in relation to your policy. This includes the cost of any financial advice provided to you.

Part 7: Conclusion

All things considered, you do not have to pay any additional cost for distribution. For the most part, the insurer would have taken this cost into account when it prices its insurance policy. Additionally, the insurer’s appointed actuary will conduct a regular review on its insurance product’s distribution cost. This is so as to ensure that its pricing remains competitive on the market. In any case, I reckon that most consumers would not be overly concerned about the insurance product’s distribution cost. Instead, what’s more important to the actual insurance premium amount that they pay.

First Published: 23 July 2019
Last Updated: 14 July 2024

PZL Blog | Singapore

Table of Contents: