Welcome everyone!
Posted by David Barkhausen in General on June 19th, 2009
Please visit frequently for a conversation about life insurance from a consumer’s point of view. Our consumer tips and commentary supplement more than 40 articles at our Life Insurance Advisors, Inc. website. Come back often for ongoing money-saving advice and insight that you won’t get from companies and agents and only rarely, if ever, from the financial press. Please post your comments and questions, and spread the word about the blog.
Wall Street Journal Article on “New Lease” for Whole Life Insurance
Posted by David Barkhausen in General on March 3rd, 2010
A Wall Street Journal article last Saturday discussed the “new lease” on “long derided” whole life insurance due to what can be competitive risk-adjusted returns on certain policies.
Space limitations prevented the insightful author, Leslie Scism, from discussing in detail how the cash value and death benefits from some of the best policies can be significantly enhanced by structuring them to minimize sales commissions. She was kind enough, though, to cite figures I gave her noting how, in one example, with the typical agent-sold policy, the cash value would not equal the premium outlay until year 12; whereas, by designing the same policy with minimized commissions, the cash value almost equals cumulative premiums by the third year.
These cash value differences in the first and early policy years are magnified over time and substantially increase both cash values and death benefits in the efficiently designed, commission-minimized policy.
The article did not mention a key point – that the consumer will not hear about low or no commission alternatives from agents, and inquiries about such possibilities will be met with a range of reasons why it’s not possible or desirable to pursue them.
The Journal article is at least part of a slow trend among more conscientious and independent journalists covering personal finance to let out some of the most closely guarded secrets within the life insurance industry. That development is certainly long overdue.
Life Agents Fight New York Commission Disclosure Rule
Posted by David Barkhausen in Commission Disclosure, General on January 15th, 2010
It should come as no surprise that life insurance agents’ groups at both the state and national level have joined forces to try to prevent the required disclosure of life insurance commissions in New York State.
Such a regulation would really represent a breach in the World of Oz curtain that has stood between life insurance consumers and the opaque world of “life insurance magic.” Since New York is often viewed as a trend-setter for insurance regulations, the adoption of a commission disclosure requirement would be a major advance for consumers and could herald the more widespread enactment of such a rule by other states.
With predictable hyperbole, the agents’ lobbies contend that such a regulation would “decrease sales, decrease financial protection, increase unemployment, hurt the state economy, and increase the burden on state government programs.” Perhaps surprisingly, they said nothing about the impact on global warming. Nor, of course, did they explain why the same commission disclosure mandated for the sale of securities, including even variable life insurance and annuities, should not apply to other life insurance products.
We will see where all of this leads – whether it’s truly the start of a long overdue pro-consumer move by life insurance regulators, or whether, as some speculate, the proposal will be thwarted or watered down to only require disclosure in the rare instance that the consumer requests it (probably in writing). It’s a positive sign anyway, and they don’t come along very often in the realm of life insurance regulation.
If the link still works, look here for the story: http://ifawebnews.com/2009/12/17/agents-groups-flood-n-y-regulators-with-opposition-to-compensation-rule/.
More on A Fiduciary Approach to Life Insurance
Posted by David Barkhausen in General on November 20th, 2009
A recent e-mail from a life insurance brokerage firm touted a fiduciary approach to life insurance that was somewhat intriguing. This firm is not fee-only. They do sell insurance. But they emphasized the “application of fiduciary standards requiring transparency, disclosure, and minimization of costs.”
That leads to a critical question of whether an individual or firm licensed as an agent or broker and selling insurance can really take a fiduciary approach to life insurance. I think the answer is potentially yes. But strict conditions would have to apply. Some of the important ones are cited by this firm claiming to take a fiduciary approach, particularly disclosure of commissions and other important aspects and risks of a policy, and the minimization of costs (including commissions wherever possible).
If a fee-only approach isn’t used, it would need to be at least fee-based, meaning including fees as well as commissions as sources of compensation. Most importantly, it would also require a commitment to advise the client about all the best potential sources and types of policies, including those the agent or broker advisor is not, and could not be, licensed to sell. These should include policies from no-commission companies and those from highly-rated companies that only sell policies through their own agents.
This particular life insurance brokerage firm says that they represent “families of significant wealth.” Well, that’s fine. Who doesn’t want to do that? But does that mean a fiduciary approach to life insurance is only suitable when working with deep-pocket clients whose policy purchases will provide substantial commissions even when they are minimized (if they even can be)?
A fiduciary approach to life insurance from those selling insurance would be impressive if it observed all of the above conditions – cost minimization and disclosure plus reviewing all the best products whether or not the agent can sell them – and was not confined to the wealthiest clients. Let’s see who can meet that standard? There certainly should be plenty of demand for those who might.
“The Resurgence of Whole Life”?
Posted by David Barkhausen in General on September 18th, 2009
A 4-page special advertising section in the Wall Street Journal yesterday trumpeted “The Resurgence of Whole Life.” The sub-heading read: “As markets waiver, more people turn to cash value life insurance to diversify their investment portfolios.”
I happen to be a believer in high quality, carefully designed whole life type of policies for the right situations, but this conviction is conditioned on some important qualifications explained below. In any case, the claim of a whole life “resurgence” is a gross exaggeration in light of recent statistics from LIMRA (Life Insurance Marketing and Research Association) documenting a substantial decline in overall life insurance sales this year, and a single digit drop in whole life business.
Because the dip in whole life sales was much less than for some other types of policies, especially variable life that typically involves an underlying investment in equities, the claimed resurgence is based simply on the less dire results for whole life.
Anyway, what about whole life and the place that life insurance agents and companies suggest that it should have in one’s portfolio? In fact, the best products from the best companies designed in the most efficient way and owned for the right reasons can make a lot of sense for many people who can afford them.
You’ll note, however, that this last statement is highly qualified. It depends on several conditions: (1) best products; (2) best companies; (3) designed in the most efficient way (i.e., to reduce or even avoid the drag of typical sales commissions and thereby to increase short and long-term cash values and eventual death benefits); (4) owned for the right reasons (i.e., not solely as in investment); and (5) the ability to pay the premiums. Without conditions 1 through 3, you’ll have a poor, or at best mediocre, investment return of the cash value that whole life promoters tout.
Our firm’s website contains similar and more specific advice on how to make whole life insurance a good investment. Under the conditions I’ve mentioned, it can dramatically outperform similar investments on an after-tax, risk-adjusted basis. But you have to know what you’re doing, and the odds of finding that out from anyone in the business of insurance sales are, at best, very remote.
Avoiding Costly Life Insurance Policy Terminations
Posted by David Barkhausen in General on September 12th, 2009
The unforeseen financial shock of the last year has forced many individuals to curtail their spending dramatically, including spending on investments. Those hit most severely by the economic downtown who own cash value life insurance have often found they can no longer afford the premiums. In a large percentage of these cases, they feel the need to drop these policies and switch to term insurance if they continue their insurance at all.
The typical commission structure of permanent insurance causes a substantial, and often total, loss when this happens. The commissions are heavily “front-loaded,” leaving little or nothing to show in the investment component (cash surrender value) of the policy in the first year in exchange for the premium paid. Because of this commission structure, even decent cash value policies generally won’t show the surrender value exceeding the premium outlay for ten years or more.
Avoiding or minimizing commissions – an option insurance agents don’t mention – not only enhances the immediate and long-term value of permanent life insurance but guards against the drastic investment consequences of a policy lapse in the early years of a policy.
The possible future need to change course with a policy is a compelling reason to choose one that maximizes the amount of cash building up immediately within a policy. Even those who think they are only interested in a policy’s death benefit may not anticipate the circumstances (e.g., financial hardship, divorce) that will force them to drop or change a policy during their lives. I have seen these things happen to clients often enough to counsel them to think long and hard about the need to build in future flexibility when selecting a policy. Minimizing or avoiding sales commissions quickly boosts the savings value of a policy. Policy holders can then deal with unforeseen circumstances, such as those of this past year, without incurring an additional heavy investment loss when a policy is surrendered or modified.
Reasons for Decline in Life Insurance Policy Sales
Posted by David Barkhausen in General on September 9th, 2009
A report this week of the steepest decline in life insurance policy sales in almost 70 years prompts speculation of the reasons for it and what can be done to combat this trend. It also leads to questions about the related phenomenon of policy “lapses” – the termination of policies by surrendering them or, for term insurance or other policies with little cash value, by failing to pay premiums. Let’s at least take a look here at the question of the policy sales decline and perhaps the matter of policy lapses in a subsequent commentary.
The sale of a life insurance policy is complicated by multiple factors – the need, in most cases, to contemplate the possibility of premature death; confusing choices and bewildering insurance jargon; and suspicions that a proposed policy purchase will do more to benefit the agent than the insured.
An effective way to overcome some of the natural resistance to the purchase of needed insurance coverage would be to require disclosure of policy alternatives and costs, including the cost of sales commissions. Commission disclosure is required in the sale of securities products but not insurance policies? Does that make sense? Should companies and agents be able to “hide the ball” by failing to disclose the ability to design policies in a way that reduces commissions and increases cash values and long-term death benefits? Is it fair to let this “secret” out to some consumers and not others? Or does it violate the principle of mutuality – the idea that all similarly situated consumers and policyholders should be treated alike?
These are questions that insurance regulators and company representatives have thus far failed to answer. Consumer advocates and the financial press need to maintain the pressure that will force them to do so.
Life Agents’ Group Fights “Suitability” Standard
Posted by David Barkhausen in Fiduciary Standards for Life Insurance Advice, General on July 10th, 2009
Two weeks ago on the blog, I suggested a fiduciary standard for life insurance advice sufficiently rigorous that no life agent or broker can meet it. Their dependence on commissions for compensation and, more so, the restrictive nature of the life company and securities licenses they hold inevitably stand in the way.
I pointed out that the sellers of securities products, such as variable life insurance and annuities as well as individual securities and mutual funds, are held to a much less demanding “suitability” standard in dealing with clients. It is a pretty nebulous criterion, and the aggrieved investor has a very difficult time proving a negative – that the recommended investment was not suitable for the investor’s circumstances.
Even so, the leading organization for life insurance agents, The National Association of Insurance and Financial Advisors (NAIFA) went on record this week opposing even the minimal suitability requirement for their members. They claimed that the May recommendation of the Financial Industry Regulatory Authority (FINRA; formerly, the National Association of Securities Dealers – NASD) would duplicate the regulatory activity of the states.
The claim seems dubious at best. Even to call it laughable would be kind. State insurance department regulations imposing any sort of suitabilty requirements either don’t exist or aren’t enforced. If you hae any experience to the contrary, we’d certainly like to hear from you.
One right-minded, contrarian agent quoted in the online Wall Street Journal article on the subject (”Compliance Watch: Suitability Standard Gets Chilly Reception”) had it right when he said, “For too long, too many sales have been based on questionable suitability only so the rep can make a commission.” Sad, but true. Now what do we do about it?
How Much Life Insurance Should You Buy?
Posted by David Barkhausen in General on July 3rd, 2009
The usual broad-brush suggestions for amounts of life insurance coverage are way too low. Read most any general recommendation on the subject in the financial press, and the typical rule of thumb is for 5 to 10 times annual earnings. That suggestion is never explained or justified with any analysis. Nor is any account made of an individual’s or family’s varying circumstances.
A calculation of life insurance needs is generally made overly complicated. The simplest and most sensible method, though, is to think in round numbers of the amount of income that you would want dependents to have, adjusting for inflation, and for how long in the event you died tomorrow. Be realistic about the income earning potential of a dependent spouse who may currently be out of the work force or employed on a part-time basis. And don’t bank on an assumption about your spouse’s future remarriage and the wealth or income that might bring.
So, for example, if you’re earning $100,000 and figure that your family will need every bit of that without you, that’s your income replacement target. The analysis can be refined by other factors later, such as an assumption that income will go down when children are off your payroll (and stay off). Just assume, for now, that the replacement income figure stays constant but adjusts for inflation.
What amount of investment assets will be required to generate that income? Financial planners suggest that, at retirement, consuming more than 4%-5% of principal annually will risk the distinct possibility of depleting it. So if that replacement income has to last even longer than the typical retirement period, you shouldn’t count on consuming any more than that percentage each year. Five percent should be the maximum and less is safer, especially if the investment results of the past year have any lessons for us.
Divide the income need ($100,000) by the percentage of annual capital consumption (5%) to calculate the total capital need to produce that income ($2,000,000). A more conservative 4 percent capital consumption rate means $2,500,000 is needed.
From the total capital need, subtract existing investment assets (do not include your house, for example), and then add one-time capital needs that the normal annual income won’t cover (e.g., the cost of college educations). A step-by-step table setting forth this basic calculation is contained in the “Life Insurance: How Much and What Kind” article on my website.
Put all that together, and you likely have an insurance need that is more like 20-25 times annual income than the factor of 5 or 10 that is so frequently mentioned. Don’t be alarmed; the basic cost of term insurance is low, at least for non-smokers in reasonably good health, though rates have recently trended upward after years of substantial declines.
In all likelihood, you are fully covered with the likes of car and homeowner’s insurance. Is your future economic value to your family not at least as worthy of protection?
A Fiduciary Standard for Life Insurance Advice
Posted by David Barkhausen in Fiduciary Standards for Life Insurance Advice, General on June 25th, 2009
For several years, a debate has been raging among those who make their living selling investments and providing investment advice as to who among them, if not everyone, should be held to a fiduciary standard. With discussions of sweeping new Federal regulations, this internal squable is now producing major headlines.
“Fiduciary,” according to Webster’s, means “founded on faith or trust.” In the investment world, it means a willingness and ability to put the client first, without conflicting allegiances or obligations. It goes beyond the legal strictures of full disclosure. It requires serving the client with undivided loyalty.
Such a standard would seem commonplace, but it is the exception rather than the rule in the investment world. Only fee-only advisors, such as the members of the National Association of Personal Financial Advisors (NAPFA), can meet it. Their numbers have grown in recent years, but they remain a distinct minority.
Investment salespersons are held only to a looser “suitability” standard. The question is simply whether an investment is appropriate for a particular investor. Given this vague and ill-defined test, proving unsuitability is a daunting challenge.
The life insurance industry lacks even such minimal consumer protection rules. Neither a fiduciary standard, nor a broadly applied suitability requirement pertains. The latter only applies to “variable” life and annuities because they are funded with equities and are therefore subject to securities regulations. Otherwise, no effective and enforceable regulations of this kind safeguard consumers.
With rare exceptions, life insurance is sold by commission-paid salespersons. They can only sell the policies of companies with which they happen to be licensed, whether or not the products are likely to provide the best, or even good, value. There is no disclosure of policy costs except for the most straightforward products. In contrast to the purchase of securities, no rule mandates that sales commissions be revealed. Where policies can be structured to reduce commissions, lower costs, and increase returns, consumers are left in the dark about these money-saving possibilities.
Given the “Wild West” context in which life insurance sales take place, it’s too much to expect that fiduciary standards will soon rule the day. But a wider, if not universal application, of such guidelines should be the goal of consumers and those charged with protecting them. Here are my suggestions of what they should entail, with more detail on our website.
Full Disclosure: Commissions and other compensation should be disclosed along with any potential conflicts of interest.
Independence and Objectivity: The advisor should be free from obligations to anyone other than the client, such as to life insurance companies with which the advisor is licensed.
Maximizing Value and Reducing Expenses: Advice should aim to maximize returns from an investment in a life insurance policy with the least cost to the client, consistent with an acceptable level of risk. Reducing the cost impact of commissions and other compensation should be a major objective wherever possible.
Access to all Companies and Products: Clients should have access to all of the best product and company options that might be appropriate, which, in some cases, are no-commission products. They should not be limited to companies with which the agent or broker is licensed.
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Unbiased Reviews of Existing Insurance Policies: Independent reviews of the performance of, and potential problems with, existing insurance policies should be performed free from inevitable agent bias in favor of a policy replacement or other action (e.g., selling the policy) that will produce a commission.
While a fiduciary approach to life insurance advice is almost unique, I am not the only one offering it. To my knowledge, there are no more than half a dozen of us across the country advising individuals in this manner. How many of us represent clients who aren’t all very affluent is less clear. In any case, fiduciary life insurance advice is readily available and affordable. If consumers show they want it and know where to find it, a portion of the life insurance industry may, just may, begin to change.
About This Blog
David Barkhausen is president of Life Insurance Advisors, Inc., a fee-only insurance consulting firm.