To the general public and the majority of consumers, Life Insurance products used to have a squeaky clean image—after all, they were the ones the paid to have Grandpa buried and kept Grandma from losing the family home. Huge hotels and office buildings were built because it was financed by an insurance company (who always notified the public as to who it was by the erection of a sign during construction). The only bad "rap" against life insurance for years was the reputation of the agent as being persistent. Even so, that usually was said with a smile and when Junior was born, the parents would call in a life insurance agent to help them make sure that there was money available in case something happened to the bread winner, and in some cases, even made sure that Junior had some college funds when he turned 18.
About 30-35 years ago, the life insurance industry woke up one morning and found that they were losing market share for the American dollar. The problem was, to put it simply, was that interest rates on investments were climbing through the roof while most life insurance policies were struggling along with an interest rate of around 3% for cash value growth. Life insurance policies continued to increase cash values—which were considered as an "investment" in the policy as it could be borrowed against, or even obtained by cashing out the policy. Companies and agents, in desperation, could only compete by offering higher returns, which was, at that time, selling term insurance (insurers do not make much money on term insurance and agent commissions are very low) and taking the difference between what the term insurance premium cost and what they would have to pay for Whole Life insurance, and putting that amount into investments—usually mutual funds. "Buy term and invest the difference" was the battle-cry of the insurance agents.
This meant that persistency (how long an insurance policy stays on the books) tumbled as more and more Whole Life policies were being "rescued" and a replacement market developed. There was even a successful company that would, for a fee, determine the cash value of a Whole Life (ordinary) life policy, or any policy with a cash value, determine the amount of term insurance that was needed, and go through the required actuarial calculations to replace the policy, which eventually even included issuing the new policy on the insurer's paper.
US insurers could not compete otherwise because of certain requirements in the nonforfeiture laws—a highly technical requirement designed to protect policyholder's cash values basically—but brilliant minds came to the fore and the Universal Life Insurance policy was introduced. The first company to market Universal Life (UL) was a life insurance company owned by a securities firm, incidentally. Soon nearly every company was selling UL policies, even though actuaries were questioning the profitability of the product.
In any event, now instead of replacing a Whole Life policy with Term, now it was replacing it with Universal Life (UL), a policy that was extreme flexible and that could be used for many purposes and still remained an insurance product, subject to certain technical requirements. Variable Annuities had been formed to appeal to investors, but that required security licensing of the agents. The Variable feature was attractive, however, so the UL then evolved into Variable Universal Life Insurance, the best of both worlds. But it was a heck of a replacement tool.
These new policies had two Achilles heels (so to speak): replacement and illustration. Policies were being replaced and agents were getting new commissions. PROBLEM. Secondly, in selling a policy that allowed the insured to participate in the results of the market—when the market went up, their earnings went up, and vice versa—projections were necessary to show just how much money the insured could look forward to having over a period of years. SECOND PROBLEM.
The news media discovered that some agents were replacing many policies with others, from which they received new commissions. When this was done on a mass basis, it started being called "churning"—which was a much better term than "twisting" which, as everyone knows, is illegal. One news story from The Milwaukee Journal Sentinel in 1996 is most informative—entitled "Insurer's Churning Detailed."
Peter Katt knows of one case in which a Prudential life insurance agent sold a Minneapolis man more than a dozen policies over several years, assuring the purchaser that the dividends from his old policies would pay the premiums on the new ones.
"Actually, the agent was funding the new policies by killing off the early ones purely to generate commissions," says Katt, a fee-only life insurance adviser from Mattawan, Mich., who was called in by lawyers to advise policyholders who sued Prudential over its practices.
Katt compares it to a doctor who sets up a transfusion in a hospital ward to save one patient by sucking the blood out of another, and then repeating the process down the row, killing off successive patients to collect more and more money. (Note: This wording seems a little extreme…)
A settlement of $210,000 plus costs has been offered in the case, which typifies the sort of "piggybacking" and "churning" problems that led to a $35 million fine imposed last week against Prudential Insurance Co. of America by a task force of 30 state and local regulators.
Jim Hunt, an actuary for the Consumer Federation of America, advises Prudential customers who think they might be eligible for some of the $100 million or more that Prudential will pay out in restitution to sit tight.
"People ought to just relax for awhile," he says. "Prudential will notify them."
Hunt believes that policyholders with the best chance of collecting money will be those who were persuaded to borrow against an existing insurance policy to buy a new one so-called piggybacking "unless you were given full disclosure about it."
Churning in which an agent talks you into dropping an existing policy to buy a new one also is a prevalent practice that usually makes no economic sense for a policyholder.
That's because the value of a permanent life insurance policy builds slowly during the first few years, when commissions and expenses eat up most of the premium. The money you've spent is lost if you let the policy lapse.
Yet it goes on all the time.
"Raiding your own company's policies has pretty well stopped," Hunt says. "Raiding everybody else's policies has not diminished as far as I know."
A spokesman for the American Council of Life Insurance called last week's developments "an indication that the regulatory system is working" and Prudential's response an indication that "the industry is serious about dealing with these problems."
But Glenn Daily, an independent, fee-only insurance consultant in New York City, thinks attention to life insurance abuses will "be moving down the ladder of size to smaller companies."
"There are more lawsuits now," he says. "And that has more impact than regulators are having. The life insurance industry understands lawsuits. I'm not sure they understand ethics."
Daily, who discussed life insurance churning in this column a year ago, says it is not just rogue agents who do this. There is pressure on all agents because there are too many insurance salespeople chasing too few prospects.
He estimates that for each of the nation's 200,000 full-time agents, there are only 133 likely customers.
And many agents don't understand what they're selling. A life insurance policy is one of the most complicated financial instruments you can buy.
"These guys aren't financial analysts," Daily says. "They're salespeople."
So they make promises without any way of knowing if they can be kept. And more of these sale pitches will be coming back to bite the parties involved.
For example, the next big potential source of life insurance litigation, according to Katt, will be over what he calls "vanishing premium" promises made by agents during the 1980s. "Buy this policy, make just seven payments and it will be fully paid," was the claim.
"They went nuts with this for six or seven years," he says.
It actually will take 27 years to pay off those policies, according to Katt, because the dividend rate on which the assumption was based was at a historic high of 12.5% in 1984 and 1985 (against a 6.5% postwar average) in Prudential's case.
"We're claiming that they had a duty to tell consumers how implausible the vanishing premium idea was," Katt says.
Prudential did not return my phone calls.
The biggest scam today? According to Katt, it's "exaggerated guarantees" in which guaranteed performance comparisons are made by some agents to get consumers to switch policies. Guarantees that are out of line with industry norms probably are not supportable, he says.
Insurance companies may be powerful, Katt notes, but they aren't governments and can't set interest rates or collect taxes. "(They) don't print money or have aircraft carriers," he says. "How can they make these promises?"
It wouldn't take an international financial meltdown or a lethal airborne virus wiping out half the world's population to make the "guarantees" impossible, either, says Katt.
"Just a balanced budget in Washington," he says. Insurance companies invest heavily in fixed-income investments. Lower prevailing interest rates that could result from a shrinking federal deficit would throw off the assumptions on which the "guarantees" are based.
"Life insurance," he says, "is a legally regulated criminal enterprise."
A rash of policyholder complaints about misleading sales practices has fueled a growing number of class action suits against life insurance companies. The offending practices usually take one of two forms: "churning" (also known as "twisting") or promises of "vanishing premiums."
Life insurance companies take the money they collect in premiums and invest it - that's how they make their money. In the case of permanent life insurance policies such as Whole Life and Universal Life, companies then apply some of those investment earnings back to the value of your policy.
During the early 1980s, interest rates were high and it looked like they'd keep on climbing. So, life insurance companies projected the rate of return from investing today's policy premiums to the point to where the policy would be paid off in a few years—seven was common—and the insured would never have to make any premium payments on that policy again. [Comment: In retrospect, one has to wonder at the gullibility of grown adults…]
As it turned out, those rosy projections weren't accurate. Interest rates fell, and customers who'd been told their policies would start paying for themselves kept getting premium notices in the mail. Angry policyholders protested, only to be told insurance company projections weren't guaranteed. But if they wanted to keep their insurance coverage, they would have to start paying premiums again—regardless of what the agent told them. In some cases, customers were able to prove they were not informed of that when they signed up for their policies. As one would imagine, the insurance Departments heeded the call to battle and results were encouraging.
The Missouri Department of Insurance claims since the mid-1990s, state regulators and class-action litigation nationally have secured hundreds of millions of dollars in policyholder awards for "vanishing premium" violations.
Texas insurance commissioner Jose Montemayor says some common sense can help protect you from "vanishing premium" or "churning" scams. "Ask yourself whether the agent has your best interest in mind or is just trying to get a higher commission," Montemayor says.
The largest churning scandal in the history of the insurance business involved some of the big boys," namely Metropolitan Life and Prudential, plus State Farm and Nationwide. Smaller companies were also affected when the crackdown occurred as the hungry and successful lawyers broadened their net to include even the smallest. Now, let's discuss how this all happened.
Way back in the early 1980s, as stated earlier, when interest rates were in the solid double digits, there was a hoped-for rapid increase in the sale of "interest-sensitive" life insurance policies. The primary policy was Universal Life and also Variable Life policies to a lesser extent.
This is "old news" to anyone who was in the life insurance business at that time as the Wall Street Journal and the New York Times, and every other major newspaper in the country printed article after article—everyone wanted to be a "giant killer" and take on the large insurance companies. This was all a result of the push the insurance companies had made for their new products—referred to by some agents as "go-go" products.
What is really interesting and not really presented to the public was the fact that the life insurance companies pushed hard for NEW customers, making it plain that they much preferred that these policies only be sold to new customers. Some even reduced commissions on replacements, and all replacements were, supposedly, reviewed by the home office before acceptance. The companies knew that "churning" existing money was not in their best interest.
Sure they might replace some of the ABC Company's policies and get new premium that ABC lost, but realistically, they were also frightened that their own company could become the "ABC" company. Besides, they had to pay new agent commissions on the churned business, and at the end of the day, there really was not that much gain in premium income—sometimes there was a loss even though different business had been written.
The agents, on the other hand, set their sights on far easier, far more vulnerable targets: existing customers with existing Whole Life policies that had substantial built up "cash value." The sales pitch went something like this: It simply didn’t make much economic sense for policyholders to continue earning dividends in the single-digit range on Whole Life policies, when they could instead be earning double-digit returns by buying these new interest-sensitive policies.
It did not take long for some agents to realize that Whole Life policyholders usually had enough "cash value" in their policies that could be applied to the new interest-sensitive policies and that way the policyholder did not have to pay premiums for some time in the future. On top of that, some policyholders could replace their Whole Life policies with a higher death benefit, and premium payments, while they would eventually be higher, didn't have to be paid right away. All that PLUS, policyholders could have faster cash value buildup with the new policies and as the market rose, so did their "investment."
This is almost too good to be true and with sooo many policies to be replaced, this was setting a prairie fire in the insurance business leading to ultimate widespread abuse. There was a lot of money to be made, so with a few misplaced words, the insurance company has new business so it is happy. The client has all the good kinds of policies and he doesn't even have to pay for it right away—maybe never! And the agent, if he got enough replacements and first year commissions, he can winter in Florida every year.
It was just too easy to mislead (just a little) the economics of the situation in order to convince even the most tough-skinned nay-sayer that he needed to take advantage of this deal. Temptation was too great all the way around. Not only was there money to be made, there was the satisfaction that the agent could shaft (to treat unkindly, look it up) the insurance company, the insurance company could shaft another insurer by getting some of its business; and the insured could shaft the former insurer. Win, win, win (almost). But how about the companies that had a persistency problem due to so many of their policies being replaced (churned)—and that included the "big boys?" They could either complain, sit on their huge assets, or join the fray (which is what some of them did).
"Ethics" —who cared?
This party didn't last much past midnight (so to speak) and the interest rates started declining. At first it was a modest decline and the insurers just tightened their belt, but the rates keep tumbling. [Interesting sidelight, the interest rates paid today on interest-sensitive plans are about what was being paid on the old Whole life plans when all this occurred.]
Premium payments that were not supposed to be due for years—if ever—suddenly became due and payable. What was the policyholder to do? He had two choices, either lapse the policy and forget it, or pay the premium. Most paid the premium because otherwise they would be out of life insurance and even if they could qualify for another life insurance policy, the rates at his now (attained) age would price it almost out of sight.
Policyholders were irate, they had been lied to, obviously, and they were "ticked" off, to say the least. Insurance companies were investigated, sued and there was all kinds of accusations thrown around.
Anyone who has been in the industry for any time knows that far-and-away the majority of the insurance people, from company Presidents down to the agent, are honest and ethical people. So what happened? A few "bad apples" actually spoiled the "barrel." There was a lot of finger-pointing, but when all was said and done, there were just a few unethical people in key company positions who, with the assistance of uncaring and unprincipled agents, jumped on the roller coaster for the ride to make a few bucks. Some, unfortunately, made a lot of money, but if they had replaced policies according to their insurance company guidelines, what could be done? In some of the most flagrant cases, there were lawsuits that dribbled all the way down to the agents.
The unfortunate result is that the life insurance industry lost face and these few caused a blemish on an old and very honorable industry. If the scandal that erupted was confined just to the very large insurers, that would be bad, of course, but opportunist lawyers have gone after not only the companies, but general agencies and in some cases, individual agents. The ones that really got hurt were the smaller insurance companies.
If one were to be judgmental about this situation, they would not shed too many tears for the demise of the reputations of some of the smaller companies—or the actual demise— because they were obviously involved and implicit in the scandal. With a large company, when less than 10% of their business is concerned with replacement business, either being replaced or replacing other policies, this is of minor importance. Unfortunately, some of the big names were "dragged through the courts" and were "exposed" by the press, and it will take a few more years before the stigma of unethical behavior finally wears off.
Some of the smaller companies, on the other hand, were necessarily aware of what was going on as with some, the majority of their business was replacement. Not only were they replacing policies rapidly, they contracted with agents to do the replacing and replaced policies became the largest part of their new business. There were trips (Aruba was popular) for those who "qualified" by premium income, company cars, and bonuses that were outstanding in this business. However, many of the smaller companies just were not able to withstand the assault by lawyers and regulators, and had to either merge or sell their remaining block of business and close their doors. (Most of them merged and even if the business was not worth what it should have been, agents contracts are like gold to some of the insurers.)
The companies and the agents still lost because of negative publicity and diminished trust, and policyholders will also lose because of a generally weakened life insurance industry.
In Florida, for instance, the Insurance Department arrived at a $5.5 million settlement with American General Insurance Company and affiliated and associated companies, who all cooperated in the settlement. From 1982 through 1997, up to 207,000 Floridians who bought life insurance from eight American General Corp. companies were victimized by deceptive sales practices including churning. The eight life-insurance companies agreed to pay a total of $5.5 million to settle charges that they routinely engaged in deceptive sales tactics.
Additionally, the agreement gives Florida an "outreach program" to help provide quick restitution to the life-insurance customers who bought up to 231,000 policies from the American General companies during the 15-year period. Florida had also negotiated with Prudential and John Hancock and received large settlements from those companies also.
The "churning" scandal is now in the past, much sooner than most believed was possible. The reason that it was handled so rapidly was that the lawyers were successful in representing their wronged clients, and the insurance industry "bellied up to the bar." While internally, there were upheavals, to the general public, the insurance industry is about back to where it was prior to the scandal. On the other hand, a life insurance agent is considered just above lawyers and used car salesmen in the eyes of the public, but that was that way even before "churning."
This is an enigma—insurance agents have a well-deserved reputation of being persistent, to the point of being irritating sometimes. People do not like this, and this does not help their popularity. But, some believe, rightfully so, that is it simply the fact that people do not like to consider their death, and a life insurance agent is a reminder that they will die someday.
If you do not agree with this theory, here is a test. The next time you are on an airplane and you want to read or just not visit, one of the first things out of the seatmate's mouth is, "What do you do for a living?" Just tell him, "I'm a life insurance agent." 99 times out a hundred he will say something inane and then not bother you the rest of the trip. (The 1% are probably agents also…) It works.
Lesson in this story is that if life insurance companies had been more diligent in supervising agent's sales practices, if the agent's selling interest-sensitive policies been completely honest with policyholders in describing the downside, many experts and pundits believe that this "mess" could have been avoided, or at least mitigated.
Others, many of whom are intimately involved in this situation, honestly believe that the whole thing was human nature. The agents were not convinced that they were lying—lying agents could not have sold that many insureds on replacing their policies. Insurance companies were desperate to put a plug in the dam as their business was being replaced by their insureds taking their money out and buying mutual funds or other investments, often without the knowledge of their agents. Many companies were slowly bleeding to death so it is rather difficult to criticize the executives who were preserving the stockholder's (or with mutual companies, the policyholder's) assets. State regulators were aware of what was happening, but did not have the legal means to really stop it, and by the time that the regulations were in place, it was a little late for some. Credit must be given to the regulators as they worked overtime to stop this draining of business, to stop the training and recruiting of replacement agents, and of working with the companies in settling policyholders' complaints.
There is one theory in respect to what attributed to these situations, which, if reversed, could have helped at least slow down the replacements:
F As a whole, Life Insurance Agents rarely, if ever, contact their policyholders after they sell the policy. They do not SERVICE their business, as property and casualty agents usually do.
If life insurance agents would just keep in contact with their customers, and keep a line of communication open, they would have had a chance to have stopped this as it would have been in the interest of the insured and the agent to have stopped the replacement, or on the other hand, the agent would have been able to work with his client so that he would have had the coverage that he needed and continued with the same company on another interest-sensitive policy.
It has always been a mystery to many who have spent many years in the life insurance industry, as to so many why life insurance agents do not, as a matter of course even, maintain a relationship with their clients. Some feel that the agent doesn't want to take a chance on the policyholder having second thoughts, or asking some questions that they cannot answer and would appear dumb to the insured, or, and this is possibly the main reason, they are just too lazy.
Some agents will never, unless ordered to do so, even deliver the policy!
RULE: ALWAYS, GLADLY, DELIVER THE INSURANCE POLICY TO THE INSURED. IF DELIVERY IS NOT POSSIBLE FOR SOME REASON, SET UP AN APPOINTMENT WITHIN THE NEXT 30 DAYS TO REVIEW THE COVERAGE.
Some insurance companies require this contact. Bless them, and it is a fact of life that their persistency is excellent—which is good for the insured, the insurance company and its owners, and the agents.
In the financially robust 1990's, the public became more and more disillusioned with life insurance policies and life insurance companies, some of it due to the adverse publicity the industry had received, but also the tedious guarantees and the failure of the industry to deliver on the promises created additional resentment. The 1980 tax revisions should have made the newly introduced single premium Variable Life policy, but it failed to keep pace with the growth in other securities so it was met with a yawn. Variable annuities, on the other hand, were less complicated and less expensive and were preferred for high net-worth investors.
The Gramm Leach Bliley Act of 1999 allowed banks, insurers and securities firms to sell each other's products, with the result that insurance companies began advertising themselves as financial services, manufacturers, providers, and even just "corporations." Some even dropped "Insurance" from their names but added other words, such as "financial." Of course, insurance professionals started marketing themselves as financial professional and financial services advisors, offering mutual funds, annuities, private placements, etc.
Basically, the trend now is that there is less of a difference between how insurers, banks and investment broker-dealers approach customers these days.
Interestingly to those insurance "purists," variable annuities have evolved into a single premium Variable Life insurance (SPVL) market and are used more and more in the financial planning process. Variable Annuity sales decreased in 2001, and those who do purchase VAs indicate a preference for contracts which offer insurance benefits, such as income and death benefit guarantees.
Life insurance companies have strived to develop new products and along with new legislation, plans such as Variable Universal Life has been developed. It was not until 2001 when producers started reporting an increase in life insurance purchases. The economy and the war on terrorism had something to do with that. For whatever reason, individual life sales, particularly Universal Life plans, rose by annualized premiums, a healthy 18% since 2000. Fixed annuity sales rose by 36% in 2001 over 2000, and Equity Indexed Annuities increased over this year by 20% .
Many potential life insurance policyowners who are confronted with the fancy illustrations and figures presented by insurance agents are often enticed by the most impressive figures that illustrate a moneymaking financial future. However, it is most important to know the type of methods used by insurers to calculate these projections and recognize the problem with these calculations.
The credibility of illustrations is the second major reason for ethical difficulties with the way that the insurance industry and insurance agents are perceived by the general public. Prior to the interest-sensitive policies being made available, non-participating, guaranteed cost life insurance was a strong part of the market. It performed well as advertised and projected well when compared to most of the mutual companies, which had been generally decreasing their dividends and projections since the 1930's.
A word about dividend projections here, as this was the first time that life insurance policies were sold at a certain premium, however, the policyholder was entitled to dividends that were declared by the insurer annually, and the policyholder could take the dividend in paid-up insurance, added to the cash value, or other methods from the active minds of the actuaries. Non-participating insurance was devised somewhat to counter the mutual companies' projections. Then the Supreme Court ruled that the "dividends" of the mutual companies were really return of premium—which is what they really were all along, although the mutuals could insist that the Board of Directors had to agree that the money was available. After all, the mutual companies were owned by their policyholders and were (supposedly) operated in their interest. There are those who maintain that a policyholder has no more influence in the company's management than a non-policyholder—perhaps, en masse they could influence management, perhaps.
Anyway, mutual policies were sold with "projections."
In 1952, according to remarks made by F. Stitt, CLU at an industry meeting in 1990, a 45 year old male could purchase $100,000 of Whole Life from Mass Mutual at $4,089 with a 20-year average net payment projected at $3,195. Travelers would issue the same policy with a guaranteed 20-year average payment of $3,100. (For those who do not have a calculator handy) Travelers guaranteed payments were $95 less than Mass Mutual's projected net payments without any adjustment for interest on the higher Mass Mutual in the early years. With the advantage of being able to look back, it turns out that at the end of 20 years (by 1972) the total net premiums paid to Mass Mutual was still $53 more than the non-par premium of Travelers in 1952.
Based on projections and history, Travelers was the best buy.
Okay, now comes the fun part (?)—Mass Mutual says that they would have had the best buy, by far. The 20 year net payment on a Mass Mutual policy bought in 1952 was, in fact, $2,526, taking into consideration the actual results of dividends and updated programs offered by Mass Mutual, showing that the dividend increases in the 1980s have more than offset the difference between them and non-par companies. In this case, mutual companies outperformed non-par companies, and many stock (non-par) companies issue mutual policies so as to compete.
So what does this have to do with anything? Well, the 1952 assumptions were quite simple and easy to understand and most companies used similar interest rates, mortality and expense assumptions—still, they all had to follow the siren's songs of steadily rising interest rates with the results that the dividends soared. Today, every company has its own secret formula of yield, mortality, expense and persistency that it uses to arrive at the premiums.
Using more up-to-date premiums, for a $250,000 policy (Policy A), for a 50 year-old male non-smoker, the premiums would be $5,247.50 annually for a little more than 11 years. The cash value would have grown from 6.25% to $172,681 in 30 years.
Another policy (let's call it Policy B) promised $90,000 more in cash value within the 30-year period than Policy A , as it would be effectively offering a 8.12% rate of return, and the policyowner would stop paying premiums one year earlier than under Policy B.
Policy B would seem to be the better policy, right? However, let's look at the 4 principal assumptions used in premium rating Policy B.
When put to the test by actuaries, reality did not conform to the assumptions of Policy B, and Policy A policyholders actually enjoyed higher benefits than those who chose Policy B.
Hard to believe today, but in 1994, for instance, illustrations were showing a 12 percent rate of return for their investments. Since the results over the past 20 years shows that to be high (way high), present rates are around 5.01 percent and some experts believe that this might not be an accurate projection within a long-term historical context.
Obviously, since actuarial science does not include a course in crystal ball gazing (does it?), certain "assumptions" must be made to come up with the premium. These assumptions can be based upon a mortality table, the experience of the insurer over the past 5 years, projected improvements into the future, lapse assumptions (persistency) (which are very often unrealistic) and or any number of mathematical processes.
Current yield rates are often quoted, usually without reference as to whether they are net or gross, and if net, net of what? Do companies increase expense and/or mortality assumptions in order to advertise high-yield assumptions? Don't bother asking the insurer as assumptions are the "family jewels," just as the source code is to programmers. Some think that the insure companies' secrecy is nonsense, a holdover from the 50-60's when the industry did not want anyone to know how inefficient it was.
Perhaps the question should be—does it really make that much difference now? Answer should be "probably not" as much difference as investment income, both on the company's own internal portfolio and that of interest-sensitive policies.
During the Great Depression, insurance companies would send personnel from the home office to local offices to help process policy loans promptly when the banks were closed or in default, or delaying payment on withdrawal requests No one lost money on their life insurance. Public trust of insurance companies was very high
Just prior to the advent of interest-sensitive plans, life insurance companies were notoriously overly cautious and inefficient investors—not all of it the fault of the insurers as much as it was because of tight regulations. But when the interest-sensitive plans started making headway, the insurers had to have more competitive products and the only way that they could do that was to have a more aggressive investment philosophy. One major California insurer even invested heavily in "junk" bonds and was offering highly competitive plans until the Insurance Department shut them down as the regulators were concerned that the policyholder's money was not being safely invested. (Interestingly, the company had a higher rate of return on investments, which was passed on to the policyholders in their interest-sensitive policies, with no defaults, until the regulators shut them down.) One of the problems was bad publicity by a securities dealer who invested his client's money in junk bonds, and when some of them tumbled—as is apt to do in these situations, the SEC went after him full bore. The adverse publicity made "junk bonds" a bad word to investors even to this day, although still most people do not know what they really are except for those who made millions off them-but I digress.
F When using illustrations to market insurance, it is wise to be aware of the
financial position and rating of the insurer and share this with the client.
Agents who are professional and concerned about the loss of trust by the public have a conundrum when they insist that the insurer would only invest in high-quality investments so that their financial rating will increase. Yet at the same time, they are the ones that want interest-sensitive products that can compete on the investment level with returns from mutual funds and other such investments. It is a little difficult to have it both ways.
In 1990, some of the better educated and most successful life insurance agents were pressuring the insurance companies to make every effort to gain back the public's trust. At that time, agents were concerned with banks entering the insurance business, but it was felt that they would not push for insurance sales and any interest would be short term, transaction oriented and insurance would be treated like a commodity. On this point, they were right on, as that is what happened.
A second item of concern was rebating as California and Florida struck down their rebating laws and agents were concerned that the rest of the country would follow. Didn't happen because the regulators listened to the concerns and since rebating laws had been passed, simply made the requirements so strict that it was not profitable to rebate—matter-of-fact, nearly impossible. And that is a good thing.
They also made suggestions as to commission design. Suffice it to say that there have been problems with the commission system for years—particularly of the high first-year commission and much lower renewals, mainly since property and casualty agents operate for the most part, on level commissions. Nothing much has happened, and probably won't, since the old adage of "life insurance is sold, property and casualty insurance is bought" still rings true, plus the fact that P&C business is mostly for relatively short term and must be adjusted, reviewed and renewed regularly. Therefore, P&C agents must be paid on a level basis, otherwise, human nature being what it is, there would be little if any servicing of the clients.
Non-Variable Life insurance policies have two basic documents that are delivered to the new policy owner, the policy and a policy illustration. If the plan is a Variable UL or Variable Whole Life policy, then there must also be a prospectus delivered. The policy is a legal contract as it specifies the terms and conditions under which the policy is issued and the death benefit paid. The policy will specify the insured, the death benefit, and the premium (whether stipulated or flexible).
The policy illustration is really just a finely crafted work of fiction, stating and projecting variables (changeable ones at that) far into the future with assumptions that are current but not guaranteed. And what do they do with these assumptions? They are treated as constants. Still, these two documents are unrelentingly forced together by insurers and their agents and by the expectations of the marketplace.
Policy illustrations, instead of being part of the legal contract (policy), are just marketing documents that attempt to highlight the best aspects of the financial potential for the policy—nothing more and nothing less. It is no better or no worse than advertising materials whose purpose is to attract the potential buyer to buy this policy (instead of that other policy).
However, since the invention of the flexible premium Universal Life policies in 1979, the illustration has become something of a chore that it cannot possibly or reasonably accomplish—to solve the dilemma that it is hard to sell a policy when the policy has no premium in the traditional sense.
Therefore, the illustration has now become the tool to calculate a premium based on some integral and incessant assumptions about future expenses, policy earnings, profit margin and mortality charge. The insurance company does reserve the right, however, to increase those expenses and/or change the policy earnings expectations, and by doing so they are repricing the policy over time, subject to the maximum charges, and in the case of Universal Life, minimum crediting rates as itemized in the policy.
This is a practical description of a life insurance policy illustration and is not intended to show that there is anything inherently wrong with Universal Life or Variable Universal Life (or indexed Universal Life) or their illustrations. It is just that agents must fully understand the difference between the policy and the illustration, and have a pragmatic and useful approach to manage such policies.
F There is a big difference between a life insurance policy and it's illustration, and it cannot be emphasized enough that the illustration is just that—an illustration—and is not an inherent part of the life insurance policy.
A series of illustrations from Revealing Life Insurance Secrets, Richard Weber author, illustrated the different in what the policyholder had to pay for a million-dollar policy at age 45, in good health.
Non-par Whole Life $15,255 guaranteed
Par Whole Life $18,810 guaranteed
No-Lapse UL $8,041 guaranteed
UL $10,400 calculated funding premium
Variable UL $7,178 calculated funding premium
The details as to how these premiums could vary so much depended upon (Quick class, what is the magic word?) ASSUMPTIONS. These figures were actually computer generated, hence the "accuracy" of the numbers. Much of the unsuspecting public feels that if a number is "exact" it must be correct.
What to believe? In 1992, the Society of Financial Service Professionals attempted to help agents, insurers and customers to understand the confusing and difficult insurance language and in particular, the assumptions that create a "good" policy illustration. The Society came up with an Illustration Questionnaire, and the introduction states:
"…sales illustrations are useful in developing the best combination of policy specifications to achieve the buyer's objective. However, illustrations have little value in predicting actual performance or in comparing products and companies … sales illustrations are usually designed to present potential benefits and costs under a set of non-guaranteed assumptions more optimistic than the guarantees … (and) the risks associated with the possible inability of a product to achieve the higher illustrated benefits, or lower illustrated costs, than those generated by the guarantees are borne by the policyholder."
The National Association of Insurance Commissioners (NAIC) in 1995, in its presentation of Model Regulations for life insurance policy illustrations, defined the purpose of an illustration as
F "Clearly disclosing how the policy being illustrated will work, distinguishing that which is guaranteed and that which is not."
Also, the NAIC said, the illustration must be "understandable to all parties involved in the sale of insurance." Regardless of the efforts of the NAIC over this 12-year period, today's illustrations are just not capable of accomplishing the intent of the NAIC's objectives. One of the main reasons is the advance in the technological ability to create all sorts of "what-if" situations never before realized, to the point to where a computer-generated illustration can prove that the world is square and that the sun will come up every weekend if so desired. So, what to do, what to do?
It was remarked recently that if something like life insurance, a basic commodity to most, can be priced so differently by so many different policy illustrations, it would not make any sense logically. There are more than 1500 life insurers domiciled in the United States—plus several from Canada that operate here—so there certainly are competitive forces at work. As a general rule, companies of the same type that market the basically-same product are at work, so it can be expected that these companies incur generally the same broad costs and have the same basic returns over the long periods of time characterized by insurance companies. It is not the same as describing the differences between a Volkswagen and a Rolls Royce.
F When life insurance is priced, there is always the non-guaranteed hypothetical illustration, and then there is reality.
According to the "Occam's Razor" principal (named after William of Occam):
F One should not increase, beyond what is necessary, the number of entities required to explain anything. (Principia Cyberetica Web)
Applying this principal to determining the true value of an insurance risk, the true fact-of-the-matter is that for any given age, gender, medical, and financial risk profile, there is (or should be) a level premium that would be completely sufficient and profitable for the policyholder and the life insurance company in respect to the life of the insured and to the providing of a death benefit of the insured regardless of when that may occur. When it is attempted to charge or pay an amount that is lower than this number, which is fully sufficient and guaranteed cost, this would create a level or risk that is not known to the typical policyowner and cannot be fully determined when the insured dies. In other words, one might way, succinctly, "Keep it simple, stupid."
To start at the top, as it were, all conclusive analysis and research has determined that the duration for fixed income for retirement withdrawals reaches its maximum at the five-year period. Therefore, other investment opportunities, such as a short-term government bond ladder for fixed income may be appropriate. Studies also indicate that mutual fund bond funds are not the best vehicle for a retiree's fixed income portfolio because they are burdened with various fees, and control of the portfolio it out of the hands of the investor. Fixed income mutual funds are generally "Institutional Funds" with less stringent fees. However, these funds target institution and require a large commitment to participate (like for $5 million in some cases). Obviously, they are not designed for or marketed to the average investor. Therefore, the bond ladder appears more appropriate for the fixed income portion of a retirement withdrawal portfolio.
In respect to mixed allocations, it would appear that there is more importance of asset allocation in retirement planning. The best arrangement would probably be an ever-moving target that is flexible enough to change annually. Obviously, this is riskier and more volatile, but such investments with decreased initial withdrawals seem to be the best for long-term-strategy. In addition, the ability of latitude regarding mandatory withdrawal amounts is most important as this allows for the flexibility that is needed during the time when asset value decreases and the cash flows are erratic.
Finally, there seems to be no single strategy to analysis and selection of the optimal life insurance policy and program, regardless of the decision for Whole Life, term, traditional or innovative insurance strategies. Life insurance strategies are best tested regularly and reviewed on an annual basis so as to be certain that the security and flexibility that is needed for the optimal insurance approach are being achieved. Regardless, there are a number of universal guidelines that can be drawn.
There is little argument that consumers will benefit from a diversified portfolio, the most ideal investment portfolio is clearly depending on the unique resources and needs of each individual investor. The strategic objective for insurance as an investment tool is therefore an ever-moving target that has the flexibility to change annually to fit the individual's changing needs. There are certainly times when investors should be prepared to accept more risk as a tradeoff against loss of returns. Although somewhat riskier, slightly more volatile investments with decreased initial withdrawals may even be the best approach for long-term strategies. Also, the latitude that is provided regarding mandatory withdrawal amounts is of predominant importance. Therefore, there is flexibility which is needed when the asset value decreases and the portfolio experiences fickle cash flows.
RULE: CONSUMERS THAT ARE SHOPPING FOR LIFE INSURANCE POLICIES, ANNUITIES OR INVESTMENT OPTIONS SHOULD ALWAYS BE EDUCATED ABOUT THE VARIOUS FEATURES OF THE POLICIES, THE CHARGES THAT ARE INVOLVED AND THE RISKS INVOLVED BY PLACING THEIR MONEY WITH INSURERS AND OTHER COMPANIES.
When the consumer makes well-informed decisions and they are satisfied that they are able to support their investment without the need to make large withdrawals that could endanger their policies, then the agent can assure the policyowners that they will be able to benefit from the many financial options and investment instruments that are now available.
Specifically, the following section is offered as the result of various studies and recommendations from various financial and insurance sources.
These recommendations and advisory notations submitted as the result of various studies are mostly included and discussed within the text, but are placed here for emphasis.
It is obvious that various types of life insurance policies have different prices and perform differently, therefore prospective policyowners must make comparisons among various insurance companies based on the level of risk, credited interest rates, surrender/mortality/expense charges, investment (and other) expenses and fees, and taxes. To be honest about it, except in a very few cases, by this time the prospect is hopelessly lost—which is understandable as many agents are lost here also.
F An agent must do a credible balancing act when presenting the factors that make up the premium/investment in insurance, so that the prospect will be comfortable with his final decision,
The balancing" refers to providing the prospect sufficient information so that they can make an intelligent and informed decision, and still not overwhelm him so that he will make no decision. If too much information is presented in a short period of time (which is all that most agents get) the prospect will not make a decision, and often will just call a competitor and ask "What do you recommend?" When discussing a securities program, the use of the prospectus is invaluable. Prospects are able to study the investment and feel comfortable knowing that the prospectus is totally honest as the federal government says it is.
The second stage is to refer the prospect to AM Best, Standard & Poor's, Moody's or some other source. Most experienced agents will have copies of the latest report from at least one of the guides, otherwise the prospect may insist on searching for the financial report at the library (or somewhere) and once he stops and gets sidetracked the agent will probably never see him again. So—
RULE: ALWAYS CARRY COPIES OF A RECENT REPORT FROM AM BEST OR OTHER GUIDE ON THE COMPANIES REPRESENTED, AND DISCUSS THE FINANCIAL STRENGTH OF THE INSURER EARLY IN THE PRESENTATION. THAT IS A FORM OF "SPEAKING FROM STRENGTH."
If the agent is not a qualified professional planner, it is important that such professional be available to provide objective and quality advice and to answer questions. If it is necessary to bring in an expert or professional, bring him in after all the "nuts and bolts" have been discussed so that his role will be primarily to fortify what has been presented.
Prospective policy and annuity owners must take into consideration several basic items, including:
RULE: WHEN MARKETING PRODUCTS THAT USE ILLUSTRATIONS, BE PREPARED TO SHOW THE SAME ILLUSTRATIONS USING ONE OR TWO PERCENTAGE POINTS BELOW THE CURRENT INTEREST RATE AS SHOWN ON THE ILLUSTRATION.
Every effort should be made to make sure that the prospect understands the calculations and the figures involved (as much as is possible).
Replacements and churning—replacements MUST be accomplished only when it will affect the policyowner positively and he will be in a better position than if he stayed with his present plan. Take into consideration the early commissions paid (use whatever percentage is paid) by subtracting it from the early gain and see if the new plan still grows significantly.
Again, repeated over and over, the prospective purchaser of interest-sensitive life insurance, or Variable Annuities, MUST recognize the risk that they assume by investing in such a product as their yield can fluctuate and they must be aware of that.
Agents can help avoid liability suits by helping their clientele recognize that illustrations that are provided are not guaranteed projections of performance of the interest-sensitive policies. The best way to do that is to provide more realistic figures by using more conservative assumptions.
STUDY QUESTIONS
1. When Universal Life insurance and other interest-sensitive life insurance policies were first introduced in an attempt to offset the drain of funds from insurance policies to investments with a higher return, they were an excellent tool, but they had two problems,
A. cost and commission.
B. understandability and cost.
C. replacement and illustrations.
D. definitions and coverages.
2. If an agent asks to replace an existing Whole Life policy with considerable cash value, with an interest-sensitive policy and he points out that with the rapid growth of the cash value according to the presented illustrations, the policy will be paid up within 7 or 8 years. These policies are known as
A. vanishing premium policies.
B. indexed Universal Life insurance policies.
C. variable annuities.
D. 1035 exchange Whole Life policies.
3. The churning and replacing of policies with interest-sensitive plans—Universal Life type policies primarily—eventually came to an end because
A. states regulated the policies out of existence.
B. insurers stopped paying commissions on replacement policies.
C. of adverse publicity.
D. interest rates started declining.
4. The "churning" scandal is basically settled by now, and it was settled rather rapidly because
A. attorneys were successful and insurers cooperated in paying damages to wronged clients.
B. the states' departments of insurance were pressured by the SEC.
C. the attorneys general of the various states banded together and forced the companies to pay hefty fines.
D. of bad publicity.
5. One of the actions that could have at least slowed down the replacement rate at its heyday was that
A. life insurance agents should more often contact their clients after selling the policy.
B. life insurance agents needed to stop servicing their clients so much.
C. clients have become much better educated in insurance matters, thanks to the extended service provided by (primarily) agents.
D. commissions were much too high.
6. When marketing insurance products, it is always wise to be aware of the financial position and rating of the insurer and
A. don't breathe a word of the results to the prospect.
B. always inflate the rating somewhat, enough so that you can always claim you misread it.
C. share it with the client.
D. have it printed at the top of the application form and have the client initial it so that there never will be a question about it in the future.
7. The purpose of an illustration is to disclose how the policy being illustrated will work,
A. and the illustration may be considered as a guarantee.
B. particularly for those who do not understand the policy at all.
C. distinguishing that which is guaranteed and that which is not.
D. and to take the agent off the hook if the results of the policy are not exactly as represented by the agent.
8. When life insurance is priced, there is always the non-guaranteed hypothetical illustration
A. which is, by law, complete and totally accurate.
B. and then there is reality.
C. upon which the agent's commission is determined.
D. which is derived from the experience of the agent or General Agent.
9. Consumers shopping for life insurance, annuities, or other investment options, should always be educated about the various features of the policy, the charges involved and
A. the method of payment of premiums.
B. the penalties for misrepresenting health conditions on the application.
C. the risks involved in placing their money with insurers and other companies.
D. how to beat the system.
10. A good rule to follow when using illustrations, is to
A. show the same illustrations, using one or 2 percentage points below the interest rate shown on the illustration.
B. never touch an illustration unless you are prepared to produce voluminous statistics.
C. never leave the illustrations with the consumer.
D. emphasize that the illustrations are guaranteed to be 99% accurate.
ANSWERS TO STUDY QUESTIONS
1C 2A 3D 4A 5A 6C 7C 8B 9C 10A