Bill Boersma: On Life Insurance

Recently I read the August 13, 2016 New York Times on-line article “Why Some Life Insurance Premiums are Skyrocketing”. It sounded sensational enough to get my attention and there was a glint of a good message and it made a number of valid points but, based on what I understand about the market, it was also somewhat misleading. The misleading aspect of it centers on the purported cause of the skyrocketing premium increases.

Before moving ahead, I want to make something clear. Those who know me understand that I am not an apologist for the life insurance industry as much as one of its biggest cynics though I am a “life insurance guy”. On the other hand, the insurance companies are not always the bad guys and I consider it my duty to cry foul when they are unfairly criticized by people or entities who don’t know any better or who have an agenda. I have consistently been one of the most stalwart advocates of life insurance when understood, designed, implemented and managed appropriately… and when carriers don’t hose the policy owners.

Reasonable people can disagree on the future of the industry, if a given carrier will be solvent over time, the kind of insurance which is “best” and the appropriateness of given regulations and financial maneuverings. I feel that a carrier which increases the mortality costs of a policy when it hasn’t realized an increase in mortality experience is taking an unconscionable action even if it is contractually allowed. However, let’s talk about the real reasons behind most policy “premium” increases.

First of all, why do I put “premium” in quotes? Because the universal life policies referenced in the NYT piece don’t have true premiums like traditional term insurance and whole life policies. They have projected payments which are calculated based on a given set of assumptions in play at the moment the policy is issued. These assumption must and will change over time and there is no chance that they will not. When the assumptions change, including policy crediting rates based on interest rate markets, the projected payments change with them. The rub? Most policy owners have absolutely no understanding of this.

When someone has been paying a given, level premium for 25 years and then discovers it is skyrocketing, it isn’t because the insurance company has suddenly increased the premiums or expenses that much, it’s because the cash value in the policy is being depleted and that increase is what it takes to keep the policy alive and to fund ongoing policy costs. Why is the cash value depleted? Because the double digit crediting rates of yesteryear have vanished and the policy cash value is crediting at or close to the minimum guaranteed rates today which are generally in the lower single digits. The “premium” didn’t increase 25 years into the policy. Someone didn’t understand and no one was minding the store and the policy owner is 24 years late proactively increasing the payments to compensate for the decreasing interest rates.

As an aside, a legitimate beef consumers may have with insurers and agents is why there was, depending on carrier, little meaningful warning during all of those years the interest rates were decreasing when there was a crystal ball regarding the impending consequences.

I’ve been preaching the same message for many years but here’s the analogy again; you did your retirement planning years ago expecting to earn 10% on average over time and you sock enough money away to hit your target accumulation goals. However, if along the way you realize you aren’t getting your assumed 10%, you don’t realistically expect the retirement of your dreams will magically materialize without you stashing away more money, right? That’s the way it works. A simpleton gets that. If you run short it’s because you weren’t paying attention to the markets or you realized what was going on but you didn’t account for it. Is it anyone’s fault that the S&P 500 index averaged less after you made your plans or that you were invested aggressively during one of the huge market drops? If developing markets returns or government bonds rates didn’t pan out as expected, you might be frustrated but I doubt you are blaming the fund manager.

To repeat, many modern life insurance policies don’t have fixed payments like old fashioned life insurance or like your 30 year fixed mortgage. They have fluid payments like retirement planning and so many other things based on fluctuating market conditions. In a decreasing interest rate market this could work in your favor for things like financing, but it will not for accumulation based transactions, which is exactly what many death benefit oriented life insurance transactions are though they are often not perceived that way.

In fact, there is a very telling line in the article which may seem innocuous but is incredibly important. “…companies that sell policies that run for decades… face a challenge: how to fund policies that were sold back when their actuaries couldn’t envision a world of interest rates below 8 percent…” What’s the issue? It’s not the life insurance company’s job to fund the policies. It is the policy owner’s job to fund the policies. This is a primary misunderstanding in the market. The companies simply credit the prevailing rates. If those rates aren’t high enough to ensure a satisfactory outcome, that isn’t their fault or their problem. The policy owners shoulder the risk in the types of policies being written about. It’s like saying mutual funds face a challenge of funding investors’ retirement plans when stock market rates underperform expectations. This just isn’t the way it works regardless of how we want it to be.

The article is correct in that interest rates are very low. You might as well tell me it is lighter when the sun is out. However, if interest rates go down, your “premiums” are supposed to go up. Yes, they are supposed to go up. If your car runs out of gas it is supposed to stop on the side of the road. If you eat too much, you are supposed to get fat. If you leave the milk on the counter, it is supposed to spoil. You see a pattern? Don’t get pissed at the milk. Maybe you can get pissed that your kid left the milk out like you can get pissed that your agent never really explained how things work. Or you can get disappointed with yourself for not remembering what your agent said like you get disappointed with yourself for not remembering to put gas in the car.

Let’s assume the cost of gas was $1.50 a gallon when you bought your car and it took $30 to fill up your 20 gallon tank. If years later gas costs $3.00 a gallon and you still put $30 of gas in the tank, you shouldn’t be surprised that you can only drive half as far. If you were, I’d simply back away from the conversation because it would mean you were too dense to reason with.

As with some other industries, the insurance industry is struggling somewhat due to the ongoing low interest rate environment but simply stating that leaves a hole in carriers’ finances that policy owners are forced to fill is too easy a cop out. Executives of carriers which are proven to have actually raised rates to cover unassociated financial shenanigans deserve their own special level in Dante’s underworld but insurers who decrease crediting rates (which increase required payments) reflective of market conditions are, in fact, whether you like it or not, doing what they are supposed to do. Anything less would be as reasonable as your money manager crediting you with 10% when the market is actually down for the year or your milk putting itself away.

Many people are losing their policies. This is true. Even some wealthier people can’t come up with the money for the dramatic increases required to keep their policies in force (or deem it an unworthy use of money). As with all things time-value-of-money-related, the longer the period to realization, the steeper the bill to get back on tract. If cognizance takes too long, you may find yourself S.O.L. If you realize you are dramatically off course regarding your retirement funding when you are 60, there is not a lot you can do about it now. You are going to work a lot longer and/or reduce your standard of living. That’s not a theory, it’s a law. But you can manage surprises if you understand, pay attention and take timely and appropriate actions.

The Times article is replete with photos of forlorn seniors gazing off into space or with eyes downcast to the floor and I truly feel bad for them. I’ve met with innumerable people who simply had no idea. But pitting the merciless corporation and greedy executives against the vulnerable consumer isn’t going to do a damn bit of good. Even with carriers who are increasing internal charges, policy “premiums” were increasing long ago, completely independent of any shenanigans, and policy owners simply weren’t writing checks to keep pace. God knows the carriers aren’t blameless and I’m hired to go after them when they’re screwing people but don’t go after the company which built your car if you didn’t put gas in it.

If a policy was managed appropriately from the beginning, the “premiums” would have already increased substantively, the cash values would be correspondingly higher, the mortality cost exposure would be meaningfully mitigated and any additional increases for policy charges would be a small fraction of what they are experiencing now and may be entirely manageable. If you funded your retirement plan assuming 10% over the years of your working life and ended up experiencing a return hundreds of basis points lower, the increased contributions now required to fund your retirement would dwarf any increase due if your money manager increased his fees today.

There is one thing I can’t be sure of regarding this piece. I don’t know if the authors actually understand the big picture and are choosing to somewhat mis-posture facts for the purposes of sensationalizing the piece or if they are writing about something they don’t fully understand. Either way, it is not entirely fair. To be sure, there is justifiable blame but it absolutely needs to be spread around to a lot more parties, including the agents and the policy owners themselves.