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Oh, the Humanity…

It’s time for another telling of an old story. Over the course of my career I have seen an evolution in awareness relative to issues with life insurance policies. Even though life insurance policies have been “under performing” since the interest rates started falling in the eighties, during presentations a decade or more ago (twenty years into sinking interest rate markets and dividends) when I asked an audience of professionals how many of them had dealt with clients facing these issues, very few hands went up, often times none. Of course their clients’ policies were suffering but they and the policy owners simply weren’t aware of it at that point.

Definitionally this had to be the case and anyone with even a cursory understanding of life insurance could know this was happening even if they didn’t personally witness the carnage. If you left the top down on a convertible when you went inside and later you saw that it was pouring rain you could certainly infer that the seats were getting wet though you weren’t actually watching it happen. The problem is, often one doesn’t think about problems until they slap them in the face. When you slide into the seat later in the day you will instantly be made aware of the issue you now need to deal with.

People generally understand that your car interior will get wet in a rainstorm if the top is down. People haven’t always understood (nor do many today) that life insurance policies don’t work like they think they do and diving crediting rates will tank their policies without sufficient remedial action.

Today when I relate what is going on in the market and ask an audience about their experience, heads are nodding and hands are going up. It seems like we’ve started turning a corner regarding awareness, though decades late. A lot of people have been slapped int he face. Sometimes I’m tempted to think we’ll get to a point where this is universal knowledge and I won’t have to tell people to put their tops up if rain is in the forecast. Unfortunately I fear this will take more time than many people have and many will never get it. Too many will refuse to believe until their own cheek is stinging.

I get pessimistic when I experience what I have in the past month. Recently I have had a handful of cases which are nothing short of disastrous. I get this all the time but there has been a re-cent spike of spectacular meltdowns. Multiple insurance carriers were represented. These cases involved whole life, universal life and variable life. Some were single life and some were survivor life. In each of the situations the insured individual(s) were relatively old and in poor enough health to be uninsurable but any given one of them could live another decade or more. In each situation the policies were brought to me when they were on death’s doorstep and options were very limited. Each policy owner or grantor had committed tens of thousands, hundreds of thousands or even millions of dollars of premium to the contracts. In each situation not a soul understood what was happening until they were slapped in the face. These are people with top drawer counsel and it made not a lick of difference.

Not a one of the policies was reasonably salvageable by simply pouring money into the contracts as the numbers would be outrageous relative to resources and death benefits. The IRR on the transactions relative to reasonable life expectancy wasn’t attractive to even those who had the funds available. (This is absolutely not always the case.) Some carriers were prevented by tax & Insurance law from even creating projections which showed the policies even theoretically being salvaged. The bottom line was that some of the policies were so underfunded that they legally couldn’t accept enough money to keep them afloat to life expectancy or policy maturity. Most of these policies were so underwater that not even the life settlement market cared to make offers.

A few of these policies had huge loans on them; some created by actually borrowing significant funds from the contracts, some from internal automatic premium loan provisions and accumulated interest for covering premiums which weren’t paid out of pocket.

Some simply lost everything they put into the contracts and everything they expected the death benefit to ultimately accomplish. Some are losing a whole lot more. One took maximum loans from the policy because that was the only source of funds for needed expenses. The result is a collapsing policy with massive phantom gain tax consequences. For those not familiar with how this works, when a policy with a loan collapses, the loan is considered forgiven debt which is taxed as ordinary income… phantom income. How is the couple who cleaned out their policy values because they needed the money now going to pay the taxes due as a result of the calamity? All they remember is that the policy was sold on this very concept. And it was. But some-one was supposed to be minding the store.

Why is this still happening at least at the rate it always has been happening? I’ve been predicting it for years (which is about as savant-like as predicting getting wet in a rainstorm). Why is there no better education of consumers and advisors? Why aren’t the salespeople’s feet held to the fire? The answer is multifaceted but simple. There isn’t money to be made in keeping people out of trouble. In fact, there is money to be made in allowing, if not encouraging, people to find themselves in these situations.

As always, there are certainly great advisors and great agents who do a great job keeping their clients in the clear. It takes no stretch of the imagination, however, to understand these great advisors with well-educated clients are too few and far between. In the meantime, the dregs of the balance will be deposited on my doorstep in a last ditch effort to salvage something out of the train wrecks. Sometimes I can perform miracles and sometimes I have to look someone in the eyes and tell them they are hosed. It’s not pleasant.

Please, please, pay attention if you aren’t already. Please bring talent to the table if you don’t have it. Please be proactive while something can be done about it. Please don’t listen to the agent who categorically says it can’t happen to the policies he sells. Please be the advisor your client expects you to be.

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