Your Life Insurance Policy on the Stock Market

Today's rant is about a post in the NY Times - none other than Jenny Anderson. But while I normally take this spot to rant about the journalist's lack of understanding or misleading language that seems so pervasive in the financial media, she does a pretty good job. Maybe if you are thinking about subscribing to a paper, you should consider them.

Let's get two things straight first:
1. I'm sort of a fan of life settlements. It gives policyholders an extra way to access the value they have in the policy and the value of their own insurability without relying solely on the insurance company. Life settlements are sort of a creative way to stick it to the man. More power to the individuals who can sell their policies for more than the cash value.

2. The slippery slope argument is one of the great argumentative fallacies - meaning while many people might believe it or use it in an argument, it is not always true.

However, in this case, the slippery slope seems to becoming a reality.

Life settlements can be very good things for policy owners, but they should be careful who they sell their policies to. The best choices are usually institutional investors like pension funds and so on. So what would happen if those investors wanted to bundle them and sell them off to other investors?

Well, they would have to create the groups or tranches of the different policies, buy bonds as a way of supporting the value or lowering the risk to those investors and so on. If this sounds like what happened in the mortgage industry a couple years back, you would be correct.

Not only are there questionable moral problems with this type of strategy and the real value of securitization is questionable, but the long term affect for you and me is higher life insurance premiums for everyone down the road. See, when life insurance companies issue policies, they expect a certain number of them will be canceled before the policy owner dies. But if more life policy owners held on to the policies, the life insurance companies would have to set aside more money to pay off those future claims. That extra money comes from the future life insurance premiums you and I pay.

There just isn't a way for that system to work. Eventually, it will be over valued, future premiums will increase, requiring more and more capital to make the machine go, which will cause the bubble to pop. Granted, I think the bubble would take a long time to pop because of the nature of our life expectancy. But this is not a sustainable model. More importantly, it does not offer any real attainable value. It only shifts the value temporarily with a long term negative affect.

My solution would be to let policy owners sell their policies back to the life insurance companies themselves. If life insurance companies competed for old policies the same way new investors do, many people would take a low-ball offer from them over another source any day - solving our problem. What do you think?

Life insurance advice gone wrong

I was cruising the headlines recently to see which reporters are most in need of a little life insurance education and came by this fine piece written for the Sun Sentinel. The worst part of it is that the author has an email address on Kiplinger's domain, ugh. I could write her a long email, but that wouldn't be as much fun as parading it around in public. Besides, financial writers who don't know enough about their topics is a sickness that needs to stop. I write as a public service. You're welcome.

The first problem I see with this life insurance article is that the author splits it up into divisions by product categories. This is a pretty basic way to do it that enhances misconceptions about the "types of life insurance". Most life insurance experts will be able to tell you that all types of life insurance are variations on each other, share many similarities, and often you can use one type of life insurance to solve the problems that another is designed to do better. Life insurance is not a world of neat categories. It is all arbitrary nonsense that only serves to confuse the public about the reality.

This is a nit-pick, but when she says, "tax-free death benefits," she ought to say "potentially tax-free death benefits". For a little more on taxes and life insurance, I suggest the author read up a bit. It is usually tax free, but not always.

I'll skip a few more picky points to get to the juice. "Cash-value policies, such as whole and universal life, don't expire." Wrong. They do expire. Even old-school insurance agents will tell you there is a contractual expiration period for most policies, especially whole life. A permanent life policy would certainly expire if it did not have enough value to sustain the death benefit. In fact, I have seen this particular scenario over and over.

Permanent life policies (the all encompassing term for whole life, universal life, etc) can expire for a number of reasons - even if you make the planned premium on time every month. The dividend from the company may go down or disappear. The interest rate you expected to get wasn't reality. The internal charges of mortality costs and administration may have gone up. Or any combination of these.

Another possible reason why whole life and universal life insurance can lapse is because of a bad combination of misinformation. The policy owner reads one article in their local newspaper that says these policies are great because they can't expire. Then they read another one by an against-the-grain financial muckety muck who says these policies are great because you can borrow the cash value from them. Upon calling customer service (because we all know chances are their agent has probably left the business or gone to another company), they are told the truth - that they don't really have to pay back any of the loan. Of course, the policy holder does have to pay back the loan with interest - if they want the policy to continue. But that was just a detail.

Scratch that part about reading another article. In the same Sun Sentinel article, the author speaking about life insurance loans, clearly states, "but you don't have to pay it back." If it weren't for her journalistic exemption, she would be liable for putting this bad combination of advice in print.

So in case I haven't made it abundantly clear, yes, permanent life insurance policies can expire. Making your life policy as permanent as you once thought it was after messing it up with bad advice like this can often be expensive.

Life Insurance and Media Bad Combination

The first thing I want you to do when you hear news about life insurance is to consider the source. I know you may have seen a video floating around that showed up on some late night spot of a 24-hour news network talking about Life insurance as a great investment, but how credible is it? It's just some B-roll footage a bunch of biased life insurance salespeople put together that made it on the news because it was A) free to the network and B) just controversial enough to be interesting.

See, the point of our media is to sell advertising. Yes, there are still some very brave and very dutiful journalists out there digging up the real story. I saw A Mighty Heart. But the media companies that control what stays in and what stays out is all about making money - especially as the thumb screws get tightened on them. That's why a 'cancer-fighting hot dog' would make the front page but 'exercise and eat right to live healthy' never would.

All the articles, white papers, press releases, videos and other content I've seen about life insurance as a great investment had the smell of an insurance company or an insurance agent behind it. Even if they duped one of the good journalists, I bet that biased fellow got a big shout out.

Here is an article from the Wall Street Journal that talks a big game about how great New York Life (NYLIC) is without mentioning part of what makes it such a great company and why its competitors tanked so quickly in the past. Let me start off by saying I am not denigrating any company or supporting any other. I really just want the best to float to the top.

The thing is that not only does NYLIC have a lot of cash that the article reported, but it can also decide to stop paying such a high dividend at any point in time and simultaneously drop its liabilities and increase cash flow. That is a huge advantage that any mutual company has. But before you go running out to buy life insurance from mutual companies just because they are more financially stable, let's take a look at why that might not be so good to the policy holder.

Remember that I said they could achieve this financial double-whammy by reducing the dividend. A dividend in life insurance is not the same thing it is on the stock market. It is a return of over paid premiums by policyholders. They express this return of premium as a percentage rate to make it look more impressive than it might otherwise be. But the thing is that dividends are not guaranteed and can go up, down, or become non-existent year to year.

So if you collect more money than you need for your long-term contracts and pay the rest back to your customers, but you don't have to. And if you have built up some of your following because of how much money you give back to them, when times get tough, you can keep more of that money. You increase your cash flow and those customers who aren't happy leave, reducing your liability to them. Boom. This is great if you own a business, but not so great if you are a patron of that business. I'd rather buy from a place that tells me exactly how much it is and sticks to it.

The other thing the Wall Street Journal articles doesn't point out is that the three competitors mentioned in the piece, AIG, Hartford, and Lincoln National, were pulling in some decent-sized cases on borrowed money but not anymore. What? People were borrowing money to buy life insurance policies? Yes, and how!

These were typically multi-million dollar life insurance policies that were paid for with money the super-wealthy borrowed at lower interest rates than the rest of their capital performed. Very often, they would have to buy even more life insurance than they planned, so that when they died, the death benefit was enough to cover the cost of the loan and leave some money to their heirs.

But as capital was tight (aka it was hard to get a loan) a while back, that has an effect of trickling up into higher markets as things progress. Loan money for mega-million life policies dried up and so did a chunk of the business these three companies were doing. They were certainly doing other types of business at the time, but missing out on these big hits takes a toll on your bottom line.

So an article that covered the story a little fuller would have taken into account these industry nuances and the different ways life insurance companies have to turn a buck. Instead, the story turned out to be flat with an uninspired quote. The meat of the story could have been this industry marketing no-no "The company gave agents a document ticking off rivals' woes." So sad.