Understanding Medicare Supplement Commission Structures: Original Premium vs. Total Premium
When it comes to selling Medicare Supplement policies, commissions are the primary incentive for independent agents. But not all commission structures are created equal, and how commissions are calculated can significantly impact the agent’s earnings and the insurance company’s bottom line. The two primary methods insurers use to pay commissions are: based on the original premium or based on the total premium.
Commission Basics in Medicare Supplement
First, let’s review how commissions typically work in the Medicare Supplement market. Carriers pay a percentage of the premium in exchange for selling and servicing policies. This commission is usually higher in the initial period (e.g., policy years 1-6) and then reduced for the remaining life of the policy. The distinction between original premium and total premium affects what "premium" the percentage is applied to:
Original Premium Model: Commissions are paid as a percentage of the initial premium at the time of sale, and that dollar amount stays fixed over the life of the policy — even as the customer’s premium increases.
Total Premium Model: Commissions are calculated on the current premium paid by the policyholder, so when premiums increase due to rate changes, the agent’s commission increases accordingly.
Financial Impact on the Insurance Company
From the insurer’s perspective, these models carry different cost structures and long-term financial implications.
1. Original Premium Model: Lower Long-Term Cost to the Carrier
In this model, the carrier locks in a fixed commission amount tied to the original premium. As a result, as premiums increase over time — due to inflation and rising healthcare costs – the insurer does not pay higher commissions. This provides greater cost predictability and lower long-term expenses.
For example, suppose a policy is sold with a $1,600 initial premium, and the commission rate for policy years 1-6 is 28%. In this scenario, the company would pay commissions of $448/year. If the premium increases to $1,788 in year two, the company still pays $448/year so that the insurer captures $188 more revenue without a corresponding increase in commission expense.
This model is financially conservative and appeals to insurers looking to limit expenses so that they can offer more competitive premiums.
2. Total Premium Model: More Expensive, but More Agent-Friendly
In contrast, with the total premium model, commissions grow as premiums increase. Using the same example, if the premium starts at $1,600 per year and rises to $1,788 in year two, the 28% commission now generates a $501 commission expense.
For the carrier, this means higher commission expenses over time. These additional expenses must be factored into pricing and profitability projections.
However, this model offers stronger long-term incentives for agents to retain clients and provide ongoing service. From a competitive standpoint, some carriers adopt this structure to attract top-producing agents and foster long-term loyalty.
Long-term Impact
Now let’s look at how these two models impact the expected profitability over the lifetime of a Medicare Supplement policy. In this analysis we are assuming:
Commission rates of 28% in years 1-6 and 5% in years 7+
Premiums increase by 2% for aging plus 8% for medical trend
Annual termination rate of 15%
Cash flows are discounted at 3.5%
Here is how the premiums and commissions would project under these assumptions:
On a present value basis, the Original Premium Commissions are equal to $1,803 (12.8% of lifetime premiums) and the Total Premium Commissions are equal to $2,387 (17.0% of lifetime premiums). Under this set of assumptions, the Total Premium model costs 4.2% more of the expected lifetime premiums. Medicare Supplement plans are typically priced to produce a pre-tax profit margin of 4-10%, so this incremental commission expense is a material component in the pricing.
There are several factors that could help to close the profitability gap between the two compensation models. The Company could expect that the Total Premium Model could generate more favorable experience (i.e., higher persistency or lower claims) so that the profit margins still meet their requirements. Or the Company could expect to generate higher sales volume so that the aggregate lifetime profitability justifies using the richer compensation structure.
Conclusion
For carriers, the decision between these models is both strategic and competitive. Paying commissions on original premium may control expenses, but it could make it harder to attract and retain high-performing agents. On the other hand, paying on total premiums offers stronger long-term alignment with agent interests but can impact profit margins. Whether based on original or total premium, understanding the financial and strategic implications of each model is key for making informed decisions in a competitive Medicare market.
