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The Middleman Myth

Is cutting out the middleman really cheaper when buying insurance?

We’ve all heard the neat marketing maxim that goes along the lines of, “Cut out the middleman and save”.

It sounds compelling, doesn’t it? After all, why should I be paying this middleman (or middlewoman) for helping me buy a product when I would save if I just did it myself? It’s a neat mental fallacy which “direct” players across various industries use to convince you that the middleman is simply a rent seeker who increases what you will pay for the product.

Let’s unpack whether or not this is true

We know life insurance best, so for the purpose of this article we will examine the notion that a middleman, such as a financial advisor or broker, means that you will pay a lot more compared to “cutting out the middleman”.

We’ll compare two scenarios:

  1. A client who uses a broker, where that broker earns the maximum regulated upfront commission
  2. A client who goes directly to a provider and cuts out the middleman

In both cases, we will assume the monthly premium is R250 and that the client is middle-aged (older clients pay less upfront commission for various legal reasons).

Scenario 1

How much does the middleman earn?

On this R250 per month policy, the broker would earn commission of R2,550 in the first year and a further R850 in the second year, bringing the total commission to R3,400 - more than a full year’s worth of premiums.

Scenario 2

How does this compare to going direct?

We may be tempted to say that the comparative cost is zero, but what a broker is doing is providing an important marketing function. In fact, direct product providers need to spend significantly on marketing to make potential clients aware of their existence and why they should buy their products.

In the category of life insurance, direct product providers make use of a multitude of sales channels - with one of the most effective and popular being paid search on Google. Paid search is where advertisers will bid on particular search terms (in this case, search terms like "life insurance") and will pay Google every time somebody clicks on the sponsored link.

Unfortunately for life insurers, because there are so many companies bidding, the life insurance search terms are incredibly expensive. In fact, in 2018, the cost of a top-of-page click (which is more effective) on this search term varied between R104 – R420 per click. Now, this is where things get interesting.

Clearly, not everyone who clicks on this link will end up buying a life insurance product. Not even close. So there are two key variables which are measured and tracked closely.

  1. The conversion rate (the proportion of unique site visitors who actually buy a product)
  2. The size of the premium

The size of the premium is important since we know that the cost of the click is the same regardless of the premium size, unlike commission (in scenario 1), which is directly related to the size of the premium.

At the extreme, a R400 cost per click which converts 0.5% of unique site visitors (i.e. 1 in 200 site visitors end up buying) has an effective cost of acquisition of R80,000 per sale!

At the other extreme, a “cheap” R100 cost per click which converts 1 in 20 visitors to sales has an effective cost of acquisition of R2,000 per sale. At this stage, it’s worth pointing out that a 5% conversion rate of visitors to buyers would be a product and site that are performing phenomenally well.

If we assume that the premium in both scenarios is R250 per month, we can establish that the cost of acquisition would be in the range of R2,000 – R80,000 for a direct sale (scenario 2), compared to just R3,400 commission paid to the broker (scenario 1).

So, what's it all mean?

We have made a number of simplifying assumptions above - for example, ignoring the additional overhead costs which go into supporting a broker sales channel (which can be significant) - but the point is that it’s not a foregone conclusion that cutting out the middleman would save a business meaningful costs which would result in cost savings for clients.

In fact, there is every chance that a direct-to-client business model could be more expensive. On the plus side, for a client, any product provider who uses a direct-to-consumer business model needs to work tirelessly to create an economically-sustainable system.

For the average client, this usually translates into better products (since better products sell in higher volumes) and better client experiences (since better experiences convert to sales better).

We've always known, but can now see it in our data, that human beings are nuanced creatures. There is no large homogenous group of clients who exclusively want to deal with a human, and neither is there a huge group of clients who never want to deal with a human.

At Sanlam Indie, we let clients determine the terms of engagement. For those who want to help themselves without any interaction, they can get themselves quoted and covered online in under 10 minutes. For those that want a little assurance from a real person - we're here for them too. And everything in-between.

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