This week, Senator Elizabeth Warren announced that an investigation she launched in April of 15 major annuity providers revealed an industry-wide kickback scheme where agents steer customers into possibly-inferior financial products favored by a life insurance company in return for lucrative personal rewards.
Agents who pushed clients into favored financial products received rewards from the annuity providers including free luxury cruises, trips to the Latin America and Europe, and other gifts. 13 of the 15 annuity providers investigated admitted to offering such kickbacks. One of the 13 who admitted involvement in the scheme was American International Group (AIG).
The conflicts of interest problem in the life insurance industry is part of a larger problem in the financial services industry as a whole. The Department of Labor sent Wall Street on the warpath recently by proposing a rule that would require financial advisors to disclose any conflicts of interest they might have when giving retirement advice.
Senator Warren’s report [PDF] details a culture where kickbacks are the norm with disclosure nowhere in sight. Customers of life insurance companies generally have no clue that the agent giving them advice on annuities has an interest in selling them a certain financial product because the agent would gain a personal reward on the back end.
The report claims that this practice by annuity providers and other financial advisors is legal due to a loophole in the law, and cites a study from the White House Council of Economic Advisers stating the annual cost of conflicted advice for customers is $17 billion [PDF]. The cost is measured in customers receiving lower investment returns because their advisor sells them less-suited financial products for their needs due to the conflict.
In her office’s press release, Senator Warren said, “Companies shouldn’t be allowed to offer expensive vacations, prizes and other kickbacks to agents in exchange for selling costly, second-rate investment products to unsuspecting customers,” and that the investigation “highlights the need for a strong Conflict of Interest Rule.”
While there has always been an inherent conflict in the financial services industry related to the dynamic between advisors and customers — known in economics as the principle-agent problem — allowing straight up quid pro quo kickbacks for steering customers towards inferior products exacerbates the problem. The point of regulations should be to align the advisor and customer’s interests as much as possible. Disclosing conflicts of interests and banning kickbacks would be a solid step in that direction.