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Life Settlements
Subprime Life Insurance
by Bill Boersma, CLU, LIC
Some mortgage salespeople and brokers sold subprime mortgages with escalating payments to consumers who didn’t understand the complex contracts. But, we advisors and producers, who provide permanent life insurance with death protection and cash value, can be proud that our industry is providing security and value to consumers, rather than fleecing them for a fast buck. Or can we?
A while back, a friend asked me to take a look at his life insurance policy. He had paid $500 per year for 19 years on a $100,000 universal life policy that was collapsing in three years. It would require $1,900 annually to hold the policy into his 90s. Insurance tax law limited the policy to a premium that was insufficient to hold it to maturity.
This policyowner got annual statements from his carrier, but no notice that his policy was on track to fail due to changes in the crediting rate. I started to think about comparisons. I imagined having an adjustable rate mortgage (ARM) on my home and the mortgage company not notifying me when the rates changed. I would just keep making payments until I got a foreclosure notice.
Outrageous? This is how permanent life insurance works! Very few policies are guaranteed the way policyowners think they are. Crediting rates on the accumulated value change along with financial markets (usually with some guaranteed minimum). Inadequate policy funding will eventually kill the policy if rates decline as they have for the past 25 years (see chart). Yearly statements may even show the cash value increasing, but possibly not fast enough to sustain the policy through maturity. But the carrier doesn’t provide notice of inadequate funding or define what can be done to ensure the policy’s viability. Also, this has not traditionally been part of producer training for policy servicing.25 Year Dividend Rate History for Cash Value Policies of A Major Carrier
Year Rate Year Rate 1985 11.00 1998 8.80 1986 11.25 1999 8.80 1987 11.00 2000 8.80 1988 10.25 2001 8.80 1989 10.00 2002 8.60 1990 10.00 2003 8.20 1991 10.00 2004 7.70 1992 9.25 2005 7.50 1993 9.25 2006 7.50 1994 8.50 2007 7.50 1995 8.50 2008 7.50 1996 8.50 2009 6.50 1997 8.50 The cash accumulation of a permanent insurance policy is analogous to funding a retirement account. A 25-year old woman can calculate that she needs to invest $2,054 a year if she decides that she will need $1 million in her 401k to retire at 65 and she assumes a 10% annual return on investment. However, if she ends up averaging 8% on her investment, she will only end up with $574,000 if she doesn’t adjust her rate of savings. If the account is not monitored, she will not notice that she is saving too little and will not get the retirement income she needs. If the same thing happens with a life insurance policy with premiums that were set based on assumptions of crediting rates at the time of purchase, the policy will fail.
The bottom line is that the most basic financial investment that consumers depend on to protect their family or business is probably not performing as projected and probably has a shorter life expectancy than they do.
As a long time life insurance professional, what I found while reviewing cases like my friend’s case, is that there were clients whose interests were not being served. My review of the literature convinced me that the problem is very real. My life insurance property management practice has only confirmed that there is a huge problem with the way the industry treats policyowners.
Permanent life insurance is unquestionably one of the most complex and least understood products sold to American consumers. As a consequence, they rely on life insurance carriers, whose marketing message is, “Trust me, I have your best interest at heart.” Even the product name (permanent life insurance) implies that the policy will last a lifetime. Earlier in the decade, the professional media highlighted the fact that most policies were under performing and that many will fail, but this issue has been all but invisible in the past few years. The vast majority of life insurance and financial professionals I meet are unaware of this problem or they are in denial. It’s not unusual for industry old-timers to accuse me of attacking the industry. It’s just been too hard to believe that such a failure could happen in such a solid industry. But with massive failures being experienced in the financial industry, it’s easier to visualize the failure of one’s permanent life insurance.
In dealing with policyowners and professionals, I explain that policies need to be managed like any other financial investment not only to survive, but also to perform as well as possible. This comes as a complete shock. Any well-trained life insurance producer will say that life insurance is not like any other financial investment. Yes, all financial vehicles have unique characteristics, but they have basic similarities. They are evaluated for purchase, monitored for performance, and divested as appropriate. For the friend with the failing policy, we found a $100,000 policy with a lifetime guarantee for less than half the cost of trying to salvage his old policy.
The insurance industry has worked hard to teach consumers that life insurance is a valuable piece of property, but the industry has not made a meaningful effort to help policyowners or agents manage this property financially. How many policies are being managed actively by the policyowner, agent, or advisor? Very few! The industry seems only interested in the purchase phase. Monitoring that includes comparing performance with projections at the time of purchase and with current market alternatives is difficult and rare. We have seen examples of agent bonuses, retirement plans, and even their contracts threatened if they work with a client to improve their insurance portfolio by replacing that company’s insurance contracts. Divestment is actively discouraged. The carriers disparage life settlements, often forbidding their agents from mentioning them, under threat of termination, even when they are clearly in the best interest of the policy-owner.
Here is another personal example. A client said to his agent, “I don’t need this insurance any more and I don’t want to keep paying the premiums, so I’m going to take the cash value and be done with it!” The $4 million policy had about $10,000 of cash-surrender value. We took the policy to the secondary market and brought the client a check for $500,000.
The sad truth is that, too often, the life insurance industry capitalizes on trust and then takes advantage of the client’s ignorance. The industry is not facilitating policyowners to buy, manage, and divest of this asset in a way that suits them and not the carrier. The overall industry’s lack attention to the clients’ best interest is a failure of life insurance.
Placing a policy, periodically reevaluating the need, managing the policy on an ongoing basis and, at times, divesting the policy as efficiently as possible, should all be considered as part of the insurance professional’s responsibilities. Some understand this and do a great job of it. In fact, this is one of the happy convergences of the interests of the client and insurance or financial professional. Once they get past the industry training that says that replacing or settling (selling) policies is rarely in the client’s best interest and is usually done by unscrupulous, self-serving operators, they can do what professionals do with every other financial asset: manage it on the basis of objective financial analysis along with the client’s needs and wishes and be fairly compensated for it.
If you don’t want to find yourself in the same position as subprime mortgage brokers in the eyes of your clients, you need to get current illustrations from the carriers on policies you sold and (usually) give your clients the bad news that they need to increase premiums or find another policy with better performance. With recent advances in products, this is usually possible if your client has not had a reduction in health status. It is time that we all focused on the best interest of our clients first and foremost.
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Bill Boersma, CLU, LIC is the owner and president of Opportunity Concepts, LLC, a life insurance consulting practice located in downtown Grand Rapids, MI. Bill has been featured in the Grand Rapids Press Business section, quoted in Grand Rapids Business Journal articles, interviewed on theGVU Morning Show and speaks at life insurance and estate planning events throughout Michigan and around the country.