Back in November, the Wall Street Journal ran a piece titled “Draining Away!” about life insurance policies collapsing due to low interest rates and policy owners losing their money. Wow! That’s quite the news!
Of course, I am being facetious as this is something I’ve been writing about and warning the market about for years. In fact, articles about this have been everywhere for a long time and I have them on file from back in the nineties, including a Wall Street Journal article I was instrumental in forming from 2009. Over a decade ago articles were stating “due to the low interest rate environment…” and that was at a time when interest rates were at a level people would kill for today.
In the big picture, though, this is a good thing as it once again attempts to highlight issues I can hardly believe are still so unknown and misunderstood. Sometimes I wonder if almost anyone will “get it” until the issues affecting their own policies smack them in the face.
By and large the article is fine but I would like to take issue with just a few things which I feel might leave readers less than fully informed. The authors might actually understand something about life insurance but I just don’t know. I do know that often authors don’t have first hand knowledge about the subject matter and having conversations with a handful of people and companies and trying to put it together in any kind of comprehensively meaningful and accurate format is not a task I would want to take on.
First, the article starts right off referring to Universal Life policies. Yes, UL policies (differentiated from Guaranteed UL policies) are fairing poorly and in general are performing more poorly than Whole Life but if anyone reading this came away with an idea that whole life isn’t being dramatically affected, they are making a grave mistake. In fact, the quote “Whole-life buyers most often pay set premiums that cover fees, such as the cost of insurance…” simply and definitively is not true for a vast majority of whole life policy as they were purchased. The bottom line is that whole life policies are suffering as well and suffering terribly. They may not be as likely to completely collapse but a significant majority of them are underperforming original projections by a meaningful margin and will likely not produce close to expected results. In fact, though UL policies may get into trouble more easily, over and over again the biggest disasters I see are with whole life policies. This is largely because when UL policies collapse, the policy owner “only” loses everything. When Whole Life policies collapse, they can collapse in dramatic fashion and trigger income taxes on phantom gain. Sometimes this is catastrophic. In such cases, losing everything looks quite attractive in comparison because at least you are not in hock to the IRS for something you “never got”. And yes, this can, and usually does happen even if the policy owner never takes a single dollar out of the policy. For consumers and advisors who don’t know this, for the love of goodness, find someone who can coherently explain this to you. Give me a call if you can’t.
At times I am accused of unnecessarily beating up on whole life but I repeatedly see consumers and advisors in the market errantly believing that whole life is not affected by a multi-decade slide in interest rates like universal life is. By and large whole life policies are crediting dividends half of what they were in the mid eighties. Assuming this doesn’t substantively affect policies is like believing that if you did your retirement planning assuming a 10% market return but you only realized a 5% return over time that your plans would still pan out. It’s ridiculous.
Short pay strategies, term blended contracts and whole life policies with loans can be very sick in this interest rate environment. And yes, dividends are directly related to interest rates though some try to disassociate the two. I’ve seen a “10 pay” turn into a 60 pay. I’ve seen projected loans (on policies where not even a dollar of money was removed from the contract) grow to unsustainable levels and collapse policies while generating tax on gain (at ordinary rates) greater than the entire expected death benefit. It is difficult to comprehend the scope of the potential financial disaster associated with a collapsing whole life policy.
The article also references utilizing whole life cash value for retirement income. This is certainly possible but only advisable for those who clearly understand the parameters of a well managed plan and the devastating repercussions for not fully realizing the importance of meticulous attention to detail over the life of the policy. Sometimes I’m not a big fan of strategies, even when they are legitimate, when I have little confidence that consumers will follow the rules and not be hurt when they inevitably make mistakes. It’s so easy for an agent to sing the virtues of a plan when the potential downside may be decades away, long after the agent is out of the picture and the enthusiasm and commitment in which the plan was launched has long passed.
The piece states that UL policies carry high fees and commissions that typically aren’t apparent to the buyer. Absolutely true, but also true across the range of life insurance products, including whole life and even term. Actually, one of the supposed benefits of universal life, which proponents touted when the product type was developed, was the transparency of the product as it related to fees rather than the “black box” of whole life.
More than once the article references that if interest rates stay low or don’t rise soon, they will have problems. News Flash… increasing interest rates will absolutely, positively not rescue most policies which are already suffering. The laws of time value of money and the added expense on the policies of a reduced cash value make this impossible. Improve performance? Possibly. But “improving” the performance of a policy to collapsing at 75 rather than 72 is hardly worth touting.
One of the main things many consumers do not understand is that life insurance is a “dollars in, dollars out” financial transaction which works just like most any financial transaction, time value of money and all. There is nothing magic about life insurance. If you get off track early in the transaction, it is difficult to make it up later. If you did your retirement planning assuming 10% and you earned 5% and you didn’t realize this until well in to your fifties, is there anything you can effectively do about it? No. Same thing goes for life insurance.
More than once the article talks about throwing more money at a contract once it runs dry. This is very misleading. It doesn’t work this way. Once you run dry with most policies, just about the only scenario which validates continuing to fund the policy is when death is foreseen in the not too distant future. In many contracts, once you hit empty, the insurance carrier can not even provide a projection showing what cash flow is needed to carry the policy because it would run afoul of funding limits in place due to insurance and tax laws. Really. It’s not uncommon for me to ask a life insurance company for ledgers showing required premium to hold a policy past life expectancy and they reply by stating “Sorry, can’t do it.” The bottom line is that policy management is required from the beginning. Even when increased funding can rescue a policy, it is not uncommon for the premium requirement moving forward to be double or more of what has been historically paid.
I would find the insurance company comments comical, if the weren’t so infuriating. To state they are working with policy owners to find solutions and their policy statements contain details so consumers can react accordingly is preposterous. First of all, most policy statements are completely meaningless in the hands of consumers. There can be no realistic expectation that the typical consumer can come to any meaningful conclusion based on what he or she gets in the mail. I regularly deal with policy owners worth millions, hundreds of millions, or even billions of dollars, surrounded by the best counsel money can by, who have collapsing policies because not a one of them understood the transactions enough to manage them. They misunderstand the transaction so badly that they don’t even know there are questions to ask let alone to ask the right questions (unconscious incompetents?) Getting the consumer and advisor market all the way up to being conscious incompetents would be a significant victory. The household name insurance carriers referenced in the piece are the same names on the tops of statements and ledgers I receive on a daily basis and I can factually guarantee there isn’t a one of them which doesn’t have some portion of their portfolio bound for failure and inevitably leaving the policy owners out in the cold with no coverage, possibly problems with the IRS and a justifiable sense of wasted resources and disappointment. I have never seen an example of a single carrier proactively seek out policy owners facing these issues to bring remediation strategies to the table. I can’t say it has never happened, only that I have never witnessed it and I witness a lot. On the contrary, I have seen examples with every big name, high rated and respected carrier where the policy owner was blindsided by these issues and had no reason to believe anyone would have spoken up before the carriers sucked every dollar of cash value from the policy only to send a lapse notice with a premium due bill.
Even though many policies are doing poorly, the minimum guaranteed interest rate may be significant given market alternatives today. 4% and 5% minimums are not uncommon. On the surface this may sound attractive but be very careful. Too many (almost all, it seems at times) people actually believe their cash values are growing at the stated interest or dividend rate and this is never the case. Whether they simply misunderstand or have been mislead (too often the case) only cash values which haven’t been consumed by mortality fees and policy expenses are credited with that number. When an insured is young and the mortality charges are very low, and after the policy has been in force a while and the company has recouped the afore mentioned expenses and commissions, this may work out. However, most universal life policies I review ultimately have significantly declining cash values which end up killing the policies, thus the point of this article. Just this week I was reviewing a policy with a gentleman who had a policy with a 5.5% crediting rate who was incredulous that his policy was falling apart. This is no different than if you were actually earning a good market return on your 401(k) but you were simply spending it down faster than it was growing. It’s also like someone who is earning $100,000 net a year but is living on $125,000. It’s not rocket science but simply a matter of economic realities. While policy crediting rates are important, I urge consumers to largely ignore them and to the extent they care about growth of cash value, depend solely on independent internal rate of return calculations. It’s like caring that your car gets 40 miles to the gallon. If the fuel line is leaking and leaving half of your gas on the highway, how much does it really matter that the fuel which manages to find its way to your engine is being burned efficiently? If you think you are getting 40 mph and you aren’t paying attention to the gauge, you’re going to end up on the side of the road. If your policy is getting an attractive rate of return but you aren’t watching the gauge, it will end up in the same place.
Finally, this article, like so many I read, talks about consumers asking their agents or insurance companies for “in force” illustrations. First, let me state for the record, these projections are very important and most policy owners have never viewed one after the point of sale. But, and this is a huge but… and forgive my apparent arrogance, I almost never see consumers who know what to ask for or how to interpret what they receive. These ledgers can be run multiple ways, under multiple assumptions, using multiple variables to accomplish multiple outcomes. It sounds so good and easy but IT JUST DOESN’T WORK! There, I said it. Let the criticisms rain down on me. If I saw even one in a hundred consumers, or even professional advisors, understand what to order and what they were looking at, I might change my tune. Life insurance may not be rocket science but you do need an independent and objective expert on your team to understand and help manage it.
Without a life insurance specialist asking for the appropriate information and then explaining it in plain English, this is an exercise in futility. But I need to further expound on this. Even if the agent is still in the picture, which is too seldom the case, does it make sense to solely depend on that individual for advice? Though too infrequent, there are clearly conscientious and dutiful agents who routinely meet with and guide clients appropriately. For any client with a policy subject to the issues of this article, and they are plentiful, just how do you foresee the conversation with the agent going? Let’s take a stab at it.
Client: Mr. Agent, I just read a WSJ article stating that I should ask for a so called in-force illustration. Please get me one.
Agent: OK, Mr. Client. What would you like to see?
Client: Aren’t you supposed to know that?
Agent: You’re right. I’ll order one.
A couple of weeks pass
Agent: Mr. Client, I emailed you the ledger for your review.
Client: All I see is 23 pages of numbers which make no sense to me.
Agent: Well, let me explain. You see at age 72, when all the numbers turn into asterisks? Well, that is when the whole thing goes down the shitter.
Client: Excuse me?
Client: Uhhhhh, why am I discovering this now?
Agent: That’s easy. I never explained to you how interest sensitive this policy is and the potential downsides of not managing it meticulously over time. I have seen how focusing on that information often gets in the way of the sale.
Client: But isn’t it your responsibility to help me with that?
Agent: Sure it is. But I got paid up front to sell you what I did and I don’t make any more money paying attention to you later. I’m spending all my time looking for the next sale so I can get a new commission.
Client: I can’t believe I’m saying this but I guess I can appreciate your honesty.
You know, I’m not even being facetious here. This is reality. Not the actual conversation, but it is the reality too often. Another version of the conversation would have the agent admitting he or she didn’t really understand the policy much more than the client and being as surprised as them but that conversation will never happen either.
The more realistic conversation has the agent spinning and dodging and evading and running in a way which would make a star running back envious. Yes, this will enrage the responsible, conscientious portion of the agent market but not being honest about the rest isn’t going to help anyone. What do they say about finding solutions? The first step in fixing something is to admit there is a problem?
The end story? Good article in theory but no meaningful answers and too much opportunity for misunderstanding and confusion.