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Bringing Clarity to Life Insurance

Just as all mortgage lenders make sure every homeowner has fire insurance before approving any loan and all new car buyers make sure their auto policy covers their purchase before they drive it off the dealer’s lot, almost everyone acknowledges that protecting against catastrophes is a financial planner’s paramount obligation—if not the first imperative. Life insurance assessments and analysis, consequently, are an intrinsic part of any good and thorough financial planning done for individuals, families or businesses.

The life insurance industry, however, has lacked clarity. Unfortunately, it has not adopted the transparent practices that characterize the financial planning profession, because life insurance largely developed independently from its financial planning industry peers. This has resulted in some agents and financial planners having inadequate knowledge of life insurance matters. This article aims to remedy this by providing agents and financial planners with specific information and approaches for successfully addressing how to obtain good value in a life insurance policy.

Nearly 20 years ago, the Society of Actuaries stated, “Sales illustrations [of life insurance policies] should not be used for comparative policy purposes.” And yet, unfortunately, even today, relatively few life insurance marketplace participants—agents, financial planners and consumers—fully understand this fact and its implications. While there is certainly some awareness that an illustration is not the policy, until illustrations and policies are genuinely and separately understood, obtaining good competitive value in the life insurance marketplace will remain a very challenging endeavor—even for those who prefer term “insurance.”

Illustrations of any and all cash value life insurance policies can be made useful, bringing genuine clarity and understanding of these policies to all. From such transformation springs the realization of the critical importance of actually understanding a cash value life insurance policy’s financial mechanics, its operating practices and the insurer’s future financial performance. Given that a policy’s financial performance depends on a series of annual costs and annual rates of returns, there are several ways that financial planners and agents can use the understanding gained from these transformed illustrations. The significance of these changes is manifold: better value for consumers, better product usage, better societal allocation of resources and a transformation in both the practice and the public perception of the expertise, trustworthiness and overall professionalism of those selling and advising about insurance products.

A Review of Cash Value Life Insurance Policy Illustrations and Analytical Approaches

Illustrations show various policy-related values—such as premiums, death benefit and cash values—for every year until the insured’s potential 121st birthday. These pages of numbers, however, are not projections; that is, they are not meant as estimates of future performance. An illustration is simply a snapshot of current or assumed performance; the underlying factors of performance are “illustrated,” essentially remaining constant (or as is) over the years. Illustrations are fundamentally nothing but calculations of numerous policy-related values, based on the assumed and largely undisclosed input factors—the underlying factors of performance.

Countless problems have arisen from misunderstandings of the limited nature of illustrations. The sales scandals of the 1980s and 1990s, where premiums did not “vanish” as proclaimed, are well-known examples. In response, the National Association of Insurance Commissioners (NAIC) mandated multi-page illustrations that now contain not only guaranteed and illustrated values but also mid-point values and definitions of terminology. While mid-point values do indicate there is some uncertainty about the “illustrated values,” they do little to foster the necessary and genuine understanding of cash value policies. Many consumers now erroneously think the mid-point values are somehow more likely and more reasonable than the illustrated values.

More problematically, many insurers and agents currently rank policies as competitive or not based on policy illustrations. Misleading conclusions about a policy’s attractiveness are also frequently drawn, for example, from its illustration’s cash value rate of return after 20 years, without simultaneously acknowledging such attractiveness is merely produced by the illustration’s assumptions (and is therefore virtually meaningless in measuring real competitiveness). Moreover, agents—especially when selling whole life and other cash value policies—often use a supplemental illustration like the one in Table 1; they save the NAIC multi-page form, with its text that tediously covers simple matters while ignoring significant ones, for the insured to sign when completing the application. While there is currently no news in the mainstream media regarding problematic life insurance illustrations and sales practices, there are still extensive and serious problems in the life insurance marketplace arising from the use and misuse of policy illustrations and information.

A review of the literature shows that a handful of approaches have been used to try to analyze cash value life insurance policies. The NAIC introduced the interest-adjusted indices in the 1970s, but this approach is inherently flawed. Its attempt to represent (what is at least) a two-dimensional product with one measurement is as flawed as trying to completely describe a rectangle with one measurement. The NAIC measurements are neither a rate of return nor a readily understood cost and are therefore not helpful in the financial world, where costs and rates are the primary concerns. The measurements cannot be used to compare “dissimilar” policies, and, as currently disclosed and implemented, they are based solely on illustrated values.

Some practitioners still use an approach developed in the 1960s by actuary Albert Linton. This approach analyzes whole life policies by making assumptions about the cost of such term coverage and calculating a yield or rate or return on the stream of “net” premiums (net of mortality costs) and the illustrated cash values. On the other hand, Professor Joseph Belth has proposed a policy disclosure approach that relies on applying an individually chosen discount rate to an illustration’s values to calculate yearly costs. Neither Linton’s nor Belth’s approach, given their assumptions, can be called “disclosure,” as neither provides an explanation of what really is being illustrated or what really occurred, in the case of an actual policy history. Both approaches are akin to viewing a policy through a funhouse mirror—they show you something, but it is not a truly accurate picture.

Others use homespun analytical approaches, often focusing on one aspect of these three approaches, such as rate of return of cash values or death benefits on premiums paid. Still other practitioners, who advocate viewing cash value policies as packages of options (not an invalid perspective, as almost anything can be viewed from an options perspective, but not a particularly useful one), have then either failed to provide the costs of such bundled products or have erroneously confused analysis of an illustration for analysis of a policy. All such approaches fall short of proper, accurate and complete analysis of a cash value life insurance policy.

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An Informative Illustration: Its Construction and Use

Cash value life insurance policies, while bewildering to many, are fundamentally simple products. Annual costs and compounding rates are the building blocks of these policies and the basic input assumptions that create the illustration. Merely using a whole life policy’s illustration, as shown in Table 1, and its embedded information, as shown in Table 2, presents this whole life policy’s illustrated values in a much more informative way. This informative illustration is constructed by reverse-engineering the illustration’s values. To do so, the illustration’s current values in Table 1 are discounted by the illustration’s assumed dividend rate, and the guaranteed values are discounted by this policy’s guaranteed interest rate. Given that this particular whole life policy was issued in 1989, the then-current illustrated rate was 10%, and the guaranteed rate was 5.5%. Just as it is essential when disassembling a house to take it apart by its components, it is similarly essential in deconstructing an illustration. Only by discounting with the rate used to construct the illustration does one acquire the specific stream of cost assumptions used in the illustration.

In addition to calculating the maximum and illustrated streams of annual costs for the total amount of coverage provided, it is useful to calculate the cost per thousand dollars of coverage by dividing each annual cost by that year’s specific at-risk amount. Only then, after the illustration’s specific stream of annual cost assumptions has been extracted, is it appropriate to use a user-chosen discount rate (in this case 5%) to discount the stream of costs to calculate present value figures, which then can be compared with other similarly calculated figures. And, as will be discussed below, the stream of total annual costs can be disaggregated into its three primary components: (1) sales-related, (2) taxes and (3) claims. The last includes all other non-sales and non-tax costs, such as underwriting and administration, which can be compared with, or expressed as, a percentage of the relevant maximum Commissioners Standard Ordinary (CSO) mortality table figures.

From this straightforward information, users can readily see the input assumptions regarding maximum annual costs, illustrated annual costs, illustrated costs per thousand dollars of coverage and the compounding rate(s) on which the illustration was built. Users can also readily comprehend that the differences between illustrated and guaranteed values are a function of: (1) the differences between the guaranteed and illustrated annual costs and (2) the differences between the guaranteed compounding rate and the illustrated rate applied to cash values. This informative illustration perspective does not prevent or preclude a more traditional approach in which an illustration might be re-run at a lower interest rate or be “mentally modified” to adjust for seemingly favorable and unrealistic mortality costs. Similarly, it does not prevent or preclude any practitioner from conducting any conventional rate-of-return analysis, such as a rate of return that the cash values provide on the premiums, which is simply a netting of the impact of insurance costs out of the illustration’s rate.

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This perspective provides a more structured, straightforward and simple framework from which to make, disclose and analyze policy features. For example, Table 2 shows that the insured in a whole life policy, belying common agent misrepresentations, does not pay for a lifetime of coverage upfront and that the annual costs of coverage continue to increase as the insured ages. Table 2 could be amended to include any other Table 1 values, such as dividends. Table 2 brings a transformative understanding to the otherwise opaque NAIC and traditional illustrations. The illustration is shown to be the consequences of its assumptions, and those assumptions are revealed.

When a client buys a cash value policy, she is actually buying the insurer’s operating practices and future financial performance, not the illustration. Again, the illustration is not the policy; demystifying the illustration leads to a vivid understanding of this fact. When consumers and planners fully understand the mechanics of an illustration—that it is based on assumptions regarding annual costs and compounding rates—they are motivated to demand information relevant to assessing such matters for the actual policy. Insight and understanding lead to inquiry.

While no decision should ever be based on a sales illustration itself, by demystifying conventional illustrations, the informative illustration shines the spotlight on the input factors that are worthy of evaluation. Policy illustrations no longer remain simultaneously alluring and bewildering. Moreover, when the product’s factors of performance are revealed, they can be evaluated. Obviously, such evaluations require knowledge of financial benchmarks
of attractive performance, which can be assembled from various sources of financial information. While reviewing such approaches is outside this article’s scope, one common approach to assessing future performance is reviewing (correctly, and with all the appropriate caveats) the competitiveness of past performance.

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An Informative Illustration of Historical Policy Performance

Policy comprehension dramatically expands when historical performance is presented on a year-by-year basis, as shown in Table 3 for the illustrated whole life policy. (Again, the policy illustrated in Table 1 was actually a current illustration for a whole life policy sold in 1989; that is how its historical data is now available.) The historical performance shows that the insurer’s dividend rate declined over 20 years and that its actual costs were less than those originally illustrated. This combination of presenting an informative illustration, as shown in Table 2, with the historical information in Table 3 enables marketplace participants to readily comprehend policies and to ask various relevant and necessary questions. For instance, the illustrated 10th and 20th years’ costs were, respectively, $1,230 and $3,100, while in actuality they were $919 and $1,601. Table 3 clearly suggests an attractive policy must provide competitive performance with respect to both cost and rate components.

Again, actual historical policy performance, like any performance, needs to be assessed and understood in context and comparatively; that is, with knowledge of how it was achieved and how it compares with competitive alternatives. Table 3’s format clearly facilitates such comparisons, and many parties—life insurers, regulators, insurance professors, financial publishers, journalists, agents and planners—could play valuable roles in assembling the benchmark information necessary to conduct such comparisons.

The comparison of two policies’ actual performance data shows even more thoroughly the real value of the informative illustration format with its emphasis on policy performance factors. Policy XYZ in Table 4 has, especially over the last several years, significantly greater costs and significantly lower cash value returns. While applying historical performance data should only be done with a full understanding of its limitations (future investment performance being independent of past performance and its possible inapplicability to new products), this comparison provides useful and powerful information regarding policy replacement questions.

Three important observations regarding this policy’s actual financial performance should be noted. First, this policy’s actual financial performance, along with that of all the insurer’s other policies, can be reconciled with the insurer’s actual financial performance—as reported in its annual statement filed with the regulators. Admittedly, sufficiently precise reconciliations can be tediously challenging exercises in data collection and analysis, but, in contrast to some practitioners’ mistaken beliefs, they are hardly impossible. Second, attempts to misrepresent how a particular policy’s historical performance was achieved are largely self-defeating. For example, trying to overstate the policy’s average historical annual rate of return also overstates annual costs, thereby undermining the objective of the attempt to overstate the rate, and can prove irreconcilable with company financials and its other policies’ performances. Third, financial performance on publicly marketed products is not proprietary; preserving the secrecy of such information in the life insurance marketplace merely forces consumers to unwittingly bear the costs and consequences of non-competitive policies.

Comparing Cash Value Policies With Buying Term and Investing the Difference

When life insurance policies are understood as nothing but the functioning of a stream of costs, rates of return on cash values, the insurer’s operating practices and cash value policies’ tax privileges, it becomes relatively easy and straightforward to compare cash value and pure term policies and to help clients understand these alternatives. While many insurers and agents produce illustrations that compare a whole life policy with buying term and investing the difference (the BTID alternative), most comparative illustrations do little to facilitate a consumer’s comprehension of the causes of the underlying differences.

Suppose, for example, that a 43-year-old female client wants $1 million of life insurance coverage until age 63, and she is interested in assessing which alternative (a whole life policy or buying term and investing the difference) provides the best value over this 20-year duration. Table 5 shows the usual comparative illustration values, but it does so with the death benefits omitted (simply to save space, as they could be equal or immaterially different), and assumes the side fund grows without taxes until the end of each analyzed duration.

For the whole life policy, Table 5 also shows the illustrated annual costs, as these reverse-engineered figures are necessary to calculate and to explain the differences in after-tax values shown in Table 6. Table 6 shows that once the whole life policy’s cash value exceeds its cost basis, the differences in after-tax values between these two alternatives depend on three specific and quantifiable factors: (1) the value of the term cost tax shield, (2) the value forgone by any possible greater annual costs of the cash value policy and (3) the differences between the rate of return assumptions in the two alternatives—all calculated applying simple formulas to the basic input data. No significance should be attached to this particular table’s results.

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This analytical perspective and formula bring clarity to the age-old dispute between whole life and the BTID alternative. This dispute is not an ideological matter, rather an empirical one. In particular, the 20th year’s $6,509 after-tax advantage of the cash value policy as shown in Tables 5 and 6 provides no basis for generalization, because its advantage can be seen as arising strictly from its assumed inputs, which, given the assumed difference in rates of return between the cash value policy and the separate side fund (6.5% versus 4%), might well be deemed unrealistic or unjustified. But, again, the numbers in the example have been chosen simply for educational purposes of showing how the formulas work. Table 6’s analysis facilitates comprehension of the reasons why one alternative or the other in any comparative illustration appears superior. This comprehension, just like the above comprehension of an illustration, leads to natural follow-up questions regarding the real-world performance factors of the two alternatives.

The advantages of a cash value policy do not arise from its somehow avoiding the ever-increasing costs of coverage as the insured ages. Similarly, cash value policies do not inherently constitute unattractive investment vehicles (the historical investment-related performance in Table 3, where the whole life policy’s average annual rate of return over the recent 20-year period was 8.43%, certainly shows much conventional disparagement can be erroneous and misguided). This presentation can be useful in confronting the misinformation that has been promoted by advocates on both sides of the dispute between whole life and term. As is so often the case with contentious issues, they can be readily resolved and dispelled with facts.

The fundamental advantages of traditional cash value life insurance arise from the product’s tax advantages. These advantages are free, non-proprietary inputs, which, in a properly functioning marketplace, cannot be used to extract value from an informed consumer. While whole life was created long before our current tax system, and while some of its sales agents prefer to pretend that it is not composed of term insurance, such pretensions in light of the above analysis will be futile. Whole life’s components and operational aspects are subject to mathematical analysis just like all other financial products. This analysis strongly suggests the industry’s practices of paying large commissions for the sale of whole life and other cash value policies cannot be sustained in a marketplace of informed consumers. It also shows that assessing the competitiveness of any recommended life insurance policy, even a term policy, requires taking into account the tax advantages of a competitively priced cash value policy. The lowest-cost term policy over 20 or 30 years may not actually be the most competitive product on an after-tax cost basis—the most important basis on which to assess costs.

The costs of life insurance products comprise the following very basic components: sales-related costs, premium-related taxes and claim costs—which include all non-sales and non-tax costs, such as underwriting expenses, administration and profits. Of these component costs, some are subject to greater competitive pressures than others. For instance, while premium taxes are set by statute, and claims are largely a function of underwriting standards and policyholder persistency, sales-related costs are potentially much more subject to market forces. The whole life policy shown in Table 3 actually had total cost over 20 years of $20,195, or $83.70 per thousand dollars of coverage (costs measured on a present value basis using a 5% discount rate). Of these costs, approximately 11% were for taxes paid by the insurer, 42% were for claims, administrative costs, etc., and 47% were sales-related. Clearly, when the transparency provided by the informative illustration becomes pervasive, cash value policies with lower-than-traditional sales loads become increasingly attractive.

Summary

Current policy illustrations do not facilitate comprehension of a policy’s financial mechanics. Problems have been identified with widely used policy analysis approaches (the NAIC’s, the Linton yield, Belth’s and others). An informative illustration was created from a commonly used illustration, transforming it by revealing its inherent cost and rate assumptions. From such understanding, consumers’ demand for relevant additional information naturally rises.

Disclosure of life insurance, like that of virtually any financial product, has fundamentally been a two-step process: (1) provide a description of how the product or illustration works, and (2) provide performance information so one can assess and search for competitive performance. The informative illustration shown in Table 2 achieves the first step. Tables 3 and 4 provide examples of some of the necessary performance information to complete the second step.

Using the analytical framework of a policy’s financial mechanics—as a system with a stream of annual costs and annual rates of return—a comparison of whole life with the alternative of buying term and investing the difference brings meaningful insight to this age-old controversy. No one should buy a financial product they do not understand.

For clients’ in-force cash value policies, planners can transform any insurer-provided illustration into an informative illustration and should certainly do so for any contemplated new purchase. Then, planners can engage in financial analysis of life insurers’ operations to assess the likely competitiveness of the insurer’s future performance and that of its policies. These steps enable financial planners and agents to provide better advice to their clients and help clients better understand life insurance matters.

Practitioners usually do not assess the financial performance of life insurers’ policies with anything similar to the sophistication of financial analysis routinely applied to equities, bonds, mutual funds or other important financial products. Now, however, financial planners and agents who understand the vital role risk management plays in financial planning but have been unsatisfied by non-transparent insurance products can apply the analytical structure of an informative illustration to motivate and facilitate their work.

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The State of Workers’ Comp in 2016

Over the last two years, employers and groups that self-insure their workers’ compensation exposures have enjoyed reasonably favorable terms on their excess insurance policies. Both premiums and self-insured retentions (SIRs) have remained relatively stable since 2014. This trend is likely to continue through 2016, but the long-term outlook for this line of coverage is less promising. Changing loss trends, stagnant interest rates, deteriorating reinsurance results and challenging regulatory issues are likely to have a negative impact on excess workers’ compensation insurance in the near future.

Predictions for 2016

Little direct information is available on the excess workers’ compensation marketplace even though written premiums well exceed $1 billion nationwide. Accurately forecasting changes in the marketplace is largely a function of the prevalent conditions of the workers’ compensation, reinsurance and financial marketplaces. But, based on available information, premium rates, retentions and policy limits should remain relatively flat on excess workers’ compensation policies for the balance of the 2016 calendar year. This projected stability is because of four main factors: positive results in the workers’ compensation industry over the last two years, availability of favorable terms in the reinsurance marketplace, an increase in the interest rate by the Federal Reserve at the end of 2015 and continued investment in value-added cost-containment services by excess carriers.

For calendar year 2014, the National Council on Compensation Insurance (NCCI) reported a 98% combined ratio for the workers’ compensation industry nationwide. In 2015, the combined ratio is projected to have improved slightly to 96%. This equates to a 2% underwriting profit for 2014 and a projected 4% underwriting profit for 2015. This is the first time since 2006 that the industry has posted positive results. The results were further bolstered by a downward trend in lost-time claims across the country and improved investment returns.

Reinsurance costs and availability play a significant role in the overall cost of excess workers’ compensation coverage. On an individual policy, reinsurance can make up 25% or more of the total cost. Excess workers’ compensation carriers, like most insurance carriers, purchase reinsurance coverages to spread risk and minimize volatility generated by catastrophic claims and adverse loss development. Reinsurers have benefited from underwriting gains and improved investment returns over the last three years. These results have helped to stabilize their costs and terms, which have directly benefited the excess workers’ compensation carriers and, ultimately, the policyholders that purchase excess coverage.

According to NCCI, the workers’ compensation industry has only posted underwriting profits in four of the last 25 years. This includes the two most recent calendar years. To generate an ultimate net profit and for the industry to remain viable on a long-term basis, workers’ compensation carriers rely heavily on investment income to offset the losses in most policy years. For the first time since 2006, the Federal Reserve increased target fund rates at the end of 2015. Although the increase was marginal, it has a measurable impact on the long-term investment portfolios held by workers’ compensation and excess workers’ compensation carriers. Workers’ compensation has a very long lag between the time a claim occurs and the date it is ultimately closed. This lag time is known as a “tail.” The tail on an excess workers’ compensation policy year can be 15, 20 and even as much as 30 years. An additional 0.25% investment return on funds held in reserve over a 20-plus-year period can translate into significant additional revenue for a carrier.

Excess workers’ compensation carriers have moved away from the traditional model of providing only commodity-based insurance coverage over the last 10 years. Most have instead developed various value-added cost-containment services that are provided within the cost of the excess policies they issue. Initially, these services were used to differentiate individual carriers from their competitors but have since evolved to have a meaningful impact on the cost of claims for both the policyholder and the carrier. These services include safety and loss control consultation to prevent claims from occurring, predictive analytics to help identify problematic claims for early intervention and benchmarking tools that help employers target specific areas for improvement. These value-added services not only reduce the frequency and severity of the claims experience for the policyholder, but excess carriers, as well.

Long Term Challenges

The results over the last two years have been relatively favorable for the workers’ compensation industry, but there are a number of long-term challenges and issues. These factors will likely lead to increasing premiums or increases in the self-insured retentions (SIRs) available under excess workers’ compensation policies.

Loss Trends: Workers’ compensation claims frequency, especially lost-time frequency, has steadily declined on a national level over the last 10 years, but the average cost of lost-time claims is increasing. These two diverging trends could ultimately result in a general increase in lost-time (indemnity) costs. Further, advances in medical technology, treatments and medications (especially opioids) are pushing the medical cost component of workers’ compensation claims higher, and, on average, medical costs make up 60% to 70% of most workers’ compensation claims.

Interest Rates: While the Federal Reserve did increase interest rates by 0.25 percentage point in late December, many financial analysts say that further increases are unlikely in the foreseeable future. Ten- year T-bill rates have been steadily declining over the last 25 years, and the current 10-year Treasury rate remains at a historically low level. A lack of meaningful returns on long-term investments will necessitate future premium increases, likely coupled with increases in policy retentions to offset increasing losses in future years.

Reinsurance: According to a recent study published by Ernst & Young, the property/casualty reinsurance marketplace has enjoyed three consecutive years of positive underwriting results, but each successive year since 2013 has produced a smaller underwriting profit than the last. In 2013, reinsurers generated a 3% underwriting profit followed by a 2% profit in 2014 and finally an underwriting profit of less than 1% in 2015. Like most insurance carriers, reinsurers utilize investment income to offset underwriting losses. As the long-term outlook for investments languishes, reinsurance carriers are likely to move their premiums and retentions upward to generate additional revenue, thus increasing the cost of underlying policies, including excess insurance.

Regulatory Matters: Workers’ compensation rules and regulations are fairly well-established in most states, but a number of recent developments at the federal and state levels may hurt workers’ compensation programs nationwide. The federal government continues to seek cost-shifting options under the Affordable Care Act (ACA) to state workers’ compensation programs. Later this year, state Medicaid programs will be permitted to recover entire liability settlements from state workers’ compensation plans – as opposed to just the amount related to the medical portion of the settlement. At the state level, there are an increasing number of challenges to the “exclusive remedy” provision of most workers’ compensation systems. Florida’s Supreme Court is currently deliberating such a challenge. Should the court rule in favor of the plaintiffs, Florida employers could be exposed to increased litigation from injured workers. A ruling against exclusive remedy could possibly set precedent for plaintiff attorneys to bring similar litigation in other states. Lastly, allowing injured workers to seek remedies outside of the workers’ compensation system would strip carriers and employers of many cost-containment options.

An Open Letter to Federal Regulators

I welcome and applaud the federal government’s interest in the regulation of our nation’s insurance industries and markets. In response to the Federal Insurance Office’s request for comments on the “gaps” in state regulation, I appreciate this opportunity to present my views. Indeed, your request, Director McRaith, for comments upon such “gaps” seems to reveal what a keen, yet heretofore unpublicized, good sense of humor you must have.

To very briefly introduce myself, I am an economist, a CFA and a life insurance agent of more than 20 years who has worked with scores of life insurers. My views have been published by the Journal of Insurance Regulation, the American Council on Consumer Interests and various other industry trade publications. My positions are based on my extensive experiences with our nation’s profoundly problematic state-based insurance regulatory system, problems that those who have not been intimately involved with in the marketplace might find inconceivable.

State insurance regulators have never required the proper disclosure of cash value life insurance policies. Markets do not work properly without adequately informed consumers. While life insurance is, conceptually, a simple product, without the proper conceptual understanding of and the necessary relevant information, consumers cannot effectively search for good value. “The Life Insurance Buyer’s Guide,” published by regulators and mandatorily distributed with policies by insurers and their agents, is not just a little deficient—it is misleading, seriously incomplete and defective. And, it, in all of its various state editions, has been that way for almost 40 years.

Professor Joseph Belth has written about this national problem for more than 40 years. In 1979, the Federal Trade Commission issued a scathing report on the life insurance industry’s cash value products. Cash value policies are composed of insurance and savings components, and consumers need appropriate information about both. This specifically requires appropriate disclosure of these policies’ annual compounding rates on consumers’ savings element as well as annual costs regarding their insurance element. Both Professor Belth and I have separately developed very similar disclosure approaches. (More information about my approach and its comparative conceptual and marketplace tested-advantages is available on my website or upon request.)

The exceptional nature of this regulatory failure can be grasped by specifically contrasting the states’ regulatory track record on cash value policy disclosures with those of other financial regulators’ actions. Investment product disclosures have been mandated since the 1930s. Truth in Lending was enacted in 1969. And yet, while a consumer’s potential risks in making a poor life insurance purchase can arguably be shown to be greater than those in purchasing a poor investment or obtaining an unattractive loan, Truth in Insurance or Truth in Life Insurance legislation has never been promulgated by any state.

A second insightful perspective, and one with much more tangible consequences on its harmful impacts on consumers, can be grasped by reviewing a few basic facts about the current life insurance marketplace.

Three Facts

Fact No. 1: The life insurance marketplace is awash with misinformation; this should hardly be surprising. Life insurers actually run misleading advertisements and conduct training in deceptive sales practices. Evidence of such has been repeatedly submitted to state regulators. Moreover, given the industry’s commission-driven sales practices (commissions that can make those of mortgage brokers, now notorious for their own misrepresentations, look tiny), sales misconduct is pervasive. The harmful consequences of such agent misrepresentations are manifested every day, both directly and indirectly, in unwise purchases or other costly life insurance mistakes by American families. These misrepresentations go unrecognized because of consumers’ inadequate financial grasp of a product’s true conceptual framework, and these go unpunished because, as a past president of the national largest agent organization has written in widely quoted published articles, state laws prohibiting deceptive life insurance sales practices have virtually never been enforced.

Fact No. 2: Cash value life insurance policies that are sold to be lifelong products have extraordinary high lapse rates. Data shows that over an eight-year period, approximately 40% of all the cash value policies of many life insurers are discontinued. It is true there are many possible causes for consumers to discontinue coverage, but age-old evidence of consumer dissatisfaction has been a virtual five-alarm that state regulators have ignored for more than 40 years. Such lapses are especially financially painful to consumers, as the typically sold cash value policy has huge front-end sales loads (sales loads regarding which agents are trained to make misrepresentations).

It is very important that all readers fully understand that, contrary to pervasive misconceptions and misrepresentations, cash value policies do not avoid the increasing costs of annual mortality charges as a policyholder ages. The fundamental advantages of cash value life insurance products come from the product’s tax privileges. Tax privileges, however, are essentially a free, non-proprietary input. In a competitive marketplace, firms cannot charge consumers or extract value for a free, non-proprietary input. No one pays thousands of dollars in sales costs to set up an IRA. Cost disclosure will enable consumers to evaluate cash value policies by the policies’ price competitiveness and, as such, will drive the excessive sales loads out of cash value policies.

The heart of the battle over disclosure is that disclosure threatens to—and, in fact, will—undermine the industry’s traditional sales compensation practices. For example, over the past five years, Northwestern Mutual, the nation’s largest insurer, with $1.2 trillion of individual coverage in force, paid $4.5 billion in agent life insurance commissions and other agent compensation, while its mortality costs for its death claims were only $3.5 billion. (Northwestern paid more than $12 billion to policyholders surrendering their coverage during the same five years.)

Agents, naturally, do not like the idea of reduced compensation, but their arguments are not compelling. Insurers believe little life insurance would be sold without such agent compensation; that is, that the large and undisclosed agent compensation cash value policies typically provide is, 1) necessary to compensate agents for their sales efforts and yet, 2) could not be obtained from an informed consumer.

My position is that good disclosure on life insurance will drive the excessive and unjustified sales loads out of cash value policies, making them price competitive with pure-term policies, thereby enabling consumers to truly benefit from the product’s tax privileges. Also, product cost disclosure is an essential component of any fair business transaction (and, as all readers properly educated about life insurance know, a cash value policy’s premium and annual cost are different.)

Fact No. 3: It is undeniable that the sales approaches used today are not effective. Unbiased experts have, for decades, demonstrated that Americans have insufficient life insurance. In August 2010, the Wall Street Journal’s Leslie Scism reported that levels of coverage have plummeted to all-time lows. Contrast that with data showing consumers’ ever-increasing voluntary purchases of additional coverage via their employers’ group life insurance plans. Marketing research shows that fear making a mistake is the primary reason consumers avoid or postpone purchases and financial decisions. Inadequate disclosure on life insurance policies not only prevents consumers from being appropriately informed; it is also a main factor in their avoidance of the very product they so often need.

I predict publicity of appropriate disclosure will lead to: unprecedented sales growth, policyholder persistency, different levels of coverage, positive impacts on all other measurements of satisfaction regarding consumers’ future life insurance purchases and life insurance agents becoming trusted and esteemed professionals. Admittedly, appropriate disclosure could lead to litigation over agents’ and insurers’ prior misrepresentations.

As I think you may now understand, inadequate life insurance policy disclosure is a regulatory “gap” that is virtually the size and age of an intergalactic asteroid.

Other Gaps

As it is currently marketed, long-term care insurance (LTCI) constitutes another serious problem. While, theoretically, LTCI can make sense, the devil is in the details. Essentially, LTCI is a contingent deferred annuity, yet one where insurers retain an option to increase the premiums for entire “classes of insureds” and where consumers must confront post-purchase price risks without the information necessary to assess alternatives. Furthermore, consumers cannot transfer their coverage to a new insurer without forfeiting the value they’ve previously paid. Defective LTCI policies have let consumers be shot like fish in a barrel; in fact, the policies’ inherent unfairness makes loan sharks envious. Appropriate disclosure on LTCI would bring consumers drastically superior value and understanding.

Regulation of life insurance agent licensing is incredibly deficient. Agents should truly be financial doctors. However, states’ agent licensing requirements fail to make sure consumers are served by financially knowledgeable professionals; licensing exams are a joke. While there are many competent agents, it is quite possible that the overwhelming majority of agents—many of whom are new and inexperienced, as more than four out of five recruits fail in the commission-based environment within the first few years—do not possess the basic knowledge necessary to accurately assess a consumer’s needs or to properly evaluate different companies’ policies.

There is virtually no state regulation of fee-only advisers who charge for providing advice about life insurance industry products. Such individuals can cause harm to consumers in multiple ways: improperly assessing needs and evaluating policies and recommending policy terminations or other actions (beneficiary or ownership changes, inappropriate policy loans, etc.) that lead to policies being mismanaged. To my knowledge, the only state that actually requires licensing for fee-only advisers is New Hampshire. A cursory review of public records, however, reveals shocking omissions in New Hampshire’s enforcement of such rules. One of the state’s former insurance commissioners, who for years has operated a prominent website providing and charging for advice on life insurance, has never been licensed.

Agent continuing education (CE) requirements are problematic. Outdated courses are still deemed acceptable, similar courses can be submitted virtually indefinitely to fulfill bi-annual CE requirements, and many courses are so devoid of meaningful information that they are vacuous. While the potential merits of CE are undeniable, only serious testing and recordings provide the means of monitoring the true effectiveness of instruction and learning.

Another area for improved regulation concerns the insurer-agent relationship. This is not to suggest draconian involvement by the government, rather to recognize the legitimate public interests in properly structuring such relationships—just as is done in relationships between pilots and airlines, construction workers and contractors, nurses and hospitals. The contracts between insurers and agents show unequal bargaining power. Insurers have not only exercised their power unfairly but have—possibly illegally—prohibited certain agent conduct, while requiring other, on matters clearly outside the boundaries of the contract. Attorneys specializing in franchise law have stated that the typical agent’s contract is the most one-sided arrangement they have ever seen.

Over the past 20 years, I have written many articles and submitted extensive documentation of sales and managerial fraud in the life insurance marketplace, yet no one with any marketplace authority or power has ever taken any effective action. Nonetheless, my commitment to reform the life insurance industry and marketplace remains. In fact, while federal regulatory action and any other private assistance would be greatly appreciated, all that is needed for the transformation of the age-old, dysfunctional life insurance industry is the dissemination—the genuine and effective mass market dissemination—of the type of life insurance policy disclosure information that is available on my web site, BreadwinnersInsurance.com. [The full version of this letter is available on the site.]

What Happens if U.K. Exits the E.U.?

On June 23, 2016, the U.K. population will vote on whether to stay a part of the E.U.’s 28 countries or to leave. It’s a once-in-a-generation decision, and it is likely to dominate U.K. press for the next six months. But what impact would a British exit, or “Brexit.” have on the insurance industry?

A report by Euler Hermes, a consultancy backed by Allianz, indicates this exit would include:

  • Massive loss of U.K. exports, which could take 10 years to recover
  • A heavy hit to financial services
  • London’s loss of its supremacy as a financial center
  • The likelihood that trade barriers would be imposed by continental Europe

Global insurers would inevitably be affected. Zurich Financial Services says it is “monitoring developments carefully.” The AXA chief executive described the situation as the U.K. “playing Russian roulette” and predicted a severe negative impact on London. Moody’s says the U.K.’s credit rating would be hurt.

Despite the recent challenges of Solvency 2, the argument that there will be less regulation if the U.K. leaves the E.U. doesn’t hold weight with Lloyd’s of London, whose Chief Risk Officer Sean McGovern recently said, “None of the alternatives will be as beneficial for the London market as the current relationship.”

Companies are already indicating they will need to make stockholders aware of the consequences of leaving—if only to avoid directors and officers (D&O) claims down the line. Because most annual reports are published only months before the vote, there’s likely to be a swell of activity; social media analytics measuring citizen sentiment will have a field day.

In October 2015, U.S. administrator Michael Froman ruled out a separate trade deal with the U.K. in the event that it leaves the European Union. He said, “We have no free trade agreement with the U.K., so it would be subject to the same tariffs—and other trade-related measures—as China, or Brazil or India.”

At face value, staying in the E.U. seems like an obvious choice, especially as the U.K. population—like the insurance industry—is risk averse and often reluctant to change. But there are other issues at play here, especially those regarding the emotional response.

Some are suggesting that London would be at greater risk of terrorism if the U.K. remains part of the E.U. Others are concerned about the immigration issue and the effect of the Euro crisis. Others simply argue that that the U.K—which has the fifth-largest economy in the world, is the fourth-greatest military power, is a leading member of the G7, has more Nobel Prizes than any other European country and is one of only five permanent members on the U.N. Security Council—is entitled to greater autonomy to make its own decisions and should not be constrained by politicians who are not elected by U.K. citizens.

“After all,” say those in favor of an “out” vote, “isn’t the current safety and prosperity enjoyed by the U.S., Australia, India, Canada and others founded on the principles of democratic self-government created by those who were once prepared to take matters into their own hands?”

Luckily, even with an “out” vote, the exiting process won’t happen overnight. There will be processes to follow, some of which could take years. It’ll give plenty of time for insurers and intermediaries, (not just those in the U.K. or Europe) to think carefully about the consequences on their businesses, the economy and their customers.

Here are some issues that would have to be considered:

  • As London reduces its influence and there is a brain drain, where might the power shift to, physically, and will some of the big broking houses move house (again)? Where will the new powerhouse occur? Singapore or Shanghai?
  • If there are new trade tariffs, how will this affect the flow of global business? According to U.K. government data, in 2011, the U.S. exported $3.5 billion of insurance services to the E.U.—that’s nearly $1 in every $4 in global insurance services exports.
  • How might an economic squeeze in the U.K. over the next decade affect consumer behavior in terms of buying both property and life insurance, and will this lead to further consolidation of an already saturated marketplace?

There is a basic insurance principle used to establish negligence that dates back more than 100 years. It refers to the “man on the Clapham Omnibus,” a hypothetical character epitomizing the “common man,” who is described as reasonably educated and intelligent but nondescript and against which a defendant’s conduct is measured.

So, on June 23, 2016, everyone in the U.K. over the age of 18 will get to vote regardless of their expertise on the topic. On that day. it will not just be a matter for the entire U.K. population but for the “man on the Clapham Omnibus.” At this moment, we can only speculate whether his head will rule his heart, or vice versa.

Leveraging the Power of Data Insights

The vast majority of insurance companies lack the infrastructure to mobilize around a true prescriptive analytics capability, and small- and medium-sized insurers are especially at risk, in terms of leveraging data insights into a competitive advantage. Small- and medium-sized insurers are constrained by the following key resource categories:

    • Access and ability to manage experienced data scientists
    • Ability to acquire or develop data visualization, machine learning and artificial intelligence capability
    • Experience and staff to manage extensive and complex data partnerships
    • Access to modern core insurance systems and data and analytics technology to leverage product innovation insights and new customer interactions

Changing customer behaviors, non-traditional competition and internal operational constraints are putting many traditional insurance companies—especially the smaller ones—at risk from a retention and growth perspective. The marketplace drivers create several pain points or constraints for small and medium size insurers, such as can be seen in the following graphic:

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This is excerpted from a research report from Majesco. To read the full report, click here.