The Era of Life Insurance Disillusionment
Universal Life Insurance and Vanishing Premiums
THE RHA REVIEW
Volume 2, No. 4, Third Quarter 1996
By Robert Puelz, Ph.D.
In the early 1980s I had the opportunity to learn about the sale of life insurance from reputable marketing people at a respected mutual life insurance company. After a few years, however, I chose to follow my academic yearnings, leaving the sale of life insurance to others. In hindsight, I now realize that I was witness to significant change within the life insurance marketplace, notably the widespread sale of universal life insurance under implausible long-term interest-rate assumptions, and the sales tactic of vanishing premium life insurance.
Problems raised by life insurance products not easily understood by the consuming public have surfaced in a series of lawsuits pertaining to deceptive sales practices by insurance representatives. Recent major cases have alleged wrongdoing by the representatives of some significant life insurers, including the Prudential and New York Life. In Texas, Crown Life recently agreed to an out-of-court settlement associated with the sales of vanishing premium policies during 1987. Some policyholders who bought the vanishing premium concept are having their premiums reappear. Moreover, some life insurance consumers have begun to experience actual cash value accumulations and death benefits lower in comparison to the original projections. Indeed, the forecast by Joseph Belth, associated with the sale of interest-sensitive products, predicting a "backlash when consumers eventually discover — the hard way — the magnitude of interest-rate risk they assumed," has come to fruition.1
So what types of disclosures should be made by a life insurance agent and a life insurance company that are selling a policy of life insurance? Disclosing information to prospective customers so that they can make informed purchasing decisions is important and has been the subject of considerable attention in the life insurance trade press over the past 20 years. I have a few suggestions for the industry which are in addition to the required reporting of the surrender cost and net payment indices mandated by the National Association of Insurance Commissioners’ Life Insurance Disclosure Model Regulation.
First, an agent and the company should report the yearly price of insurance per $1,000 of protection across a reasonable range of dividend crediting rates. The yearly price calculation is simple and provides a useful benchmark by which both term and cash value products can be compared in terms of their protection costs.2
Second, for cash value policies, the yearly rate of return on the savings component of the policy should be reported across a reasonable range of dividend crediting rates. As stated, both the yearly price and return calculations are impacted by projected dividends. Reasonable disclosure about prospective dividend performance entails projections at current payout levels, and projections above and below current levels. In this respect "reasonableness" ought to be company-specific and related to feasible ranges of the company’s projected mortality, projected expenses and net investment income.
Third, typical cases involving a life insurance need should include a discussion about buying term insurance. It is well known among life agents and the industry in general that this purchasing strategy is a viable alternative. It is equally well known, however, that there is a larger financial incentive for agents and companies to sell a product with a cash value component rather than to sell term insurance.
Fourth, sales proposals stating that premiums will vanish are misleading. When a non-expert insurance consumer is told that premiums will vanish, despite standard bottom-of-the-page caveats such as "The dividends illustrated are neither guaranteed nor estimates of future dividends," the customer will expect to pay premiums for only the period of years illustrated until the premium "vanishes." Moreover, even if current and reserved dividends are sufficient to pay premiums during the later policy periods under this method of premium payment, there is a true economic opportunity cost to the policyholder who uses these dividends for this purpose. It is my view that vanishing premium sales illustrations imply to the prospective customer a "get something for nothing" sales approach as an inducement to buy the policy.
Finally, cross all appropriate policy comparisons, the agent should reveal his or her compensation to the prospective customer. The commission an agent is paid will have a direct impact on the ability of the policy to perform, since the commission is an important expense component of the premium structure. Prospective customers need to know the amount an agent is compensated so as to properly value his or her service.
If life insurance agents clearly place importance upon client needs and maintain up-to-date knowledge of the industry and its products, then agents will go a long way in showing the due care owed to their customers.
1Insurance Forum, October 1985.
2See Joseph M. Belth, Life Insurance: A Consumer’s Handbook, 2nd ed. (Bloomington, IN: Indiana University Press, 1985).