Life Insurance Tips

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Tips For Smart Consumers

In an increasingly competitive insurance market, some companies-and their agents or salespeople-will press the limits of legal and ethical sales practices. It's up to each insurance consumer to proceed carefully. In this chapter, we will conclude our study of the life insurance business with a review of tips for smart consumers.

The first and most common-sense tactic of the smart consumer is to read the insurance policy he or she is buying carefully. In fact, most polides incorporate this advice into their standard form.

For example:

This contract is a legal contract between the contract owner and the insurance company. Read your contract carefully. It sets forth, in detail, the rights and obligations of both you and your insurance company. It is therefore important that you read your contract carefully.

Evaluating Financial Strength

The most rigorous and easiest rating service for consumers to understand is The Weiss Report. If a company is rated A +, A, or A-by Weiss, you can safely conclude that the company is finandally strong.

However, there are many rating services where an A rating doesn't mean much. In fact, most companies can claim an A rating by some service. In the months prior to its bankruptcy, Executive Life was rated A by several major rating services.

If a company has a weak Weiss rating, an agent or salesperson will typically refer to Duff & Phelps, A.M. Best, Standard and Poor's or Moody's ratings report.

Insurance agents and salespeople are subject to a number of laws and regulations which shape their behavior during sales presentations.

Example: Agents are prohibited from misrepresenting policy terms (specifically, this usually applies to exaggerating projected benefits).

In addition, agents are often required to disclose facts about information practices and the products they are proposing for sale. In many jurisdictions, agents must provide prospective policy owners with a policy summary and. a buyers guide at the time of application.

A policy summary is a document that summarizes the coverages, benefits, limitations, exclusions, and terms of the policy proposed for sale.

A buyers guide is a consumer publication that describes the type of coverage being offered, and provides general information to help the applicant compare different policies and reach a decision about whether the proposed coverage is appropriate.

Tricks and Pitfalls To Avoid

The basic sales presentations which insurance salespeople and agents use are called sales illustrations. They can be very misleading. Problems crop up especially because some companies:

• make overly aggressive return projections
• arbitrarily assume future mortality improvements
• compound mortality improvements into the future
• assume future lapses to dramatically improve projections
• fabricate future earnings that have no historical basis
• mistreat existing policyholders to improve future projections for new policyholders

Example: A dollar invested at 5 percent eyery year for 40 years grows to $126; the same dollar invested at 10 percent every year becomes $486 in forty years. That's a difference of nearly four-fold caused by a 5 percent change in performance assumption.

Remember, insurance companies are not required to meet the projections included in sales illustrations. In the end, you simply cannot rely on illustrations for comparison.

Actual histories are available. If a company cannot or will not provide its investment performance and financial histories for comparison, look for a company that will. If your agent cannot provide this information, find an agent who can.

It's far better to rely on the company's actual historical performance than a particular policy or illustration. Compare histories, not projections.

The Four Key Deceptions

One: Premium Deception

The lowest premium may be the lowest. premium only because the company made unrealistically aggressive assumptions. Suppose you are a male 45, and have told the agent you want $500,000 of coverage and want to pay premiums for only 10 years-then the premium will vanish (that is, the policy will become self-financing). The agent shows you two different companies:

Company A Company B $4,772 lO-year vanish $7,285 lO-year vanish This appears to be an easy decision...right? Same amount of insurance, same payment period, but dramatically different premiums. Actually, Company B may be a better choice.

What happens when a company arbitrarily decides to assume policyholders will live longer? Premiums will drop dramatically. Let's look at the effect on the premium for a male 45, based on improved mortality.

How can insurance companies do this? Imagine that an insurance company can show a one percent mortality decrease in the past five years. It can assume one percent decrease compounded for 80 years and say the new mortality is supportable based on historic trend.

Two: Cash Value Deception

The highest cash value projected for 5, 10 or 40 years in the future may be the result of manipulating mortality; lapse ratios, interest assumptions, expense projections, persistency bonuses, ete.

You are looking at two illustrations. The premium is the same for both. The face insurance amount is the same for both. After 20 years, the cash values are as follows:

COMPANY A $69,300 COMPANY B $92,298

You might assume that company B is a better value. But there's very little reason to make that assumption. Whole life premiums typically assume a guaranteed 4 percent interest. They may perform substantially better, but the premium is calculated on a worst case scenario of 4 percent. This is why whole life premiums are higher than universal life. They're also guaranteed, so they are safe assumptions.

Universal life premiums typically assume a nonguaranteed current rate. Obviously, if you assume a 6 or 8 percent interest income rate, the premium seems lower than if you accept a guaranteed 4 percent rate. But the premium may increase in the future if current interest rates fall.

Fast-growing projected cash value doesn't mean lower cost. It may simply mean aggressive assumptions on the insurance company's part.

This kind of interest rate assumption has been a big problem and a big surprise to people who bought universal life insurance in the late 1980s. At that time, interest rates were much higher, so premiums were low; When rates fell, policies collapsed.

Three: Vanishing Premium Illustration Deception

Many smart consumers These are usually associated with whole life or related policies that build enough cash value in 10 or 15 years that their dividends and interest income pay the premiums. Buying vanishing premiums is expensive in the short run but can make a lot of sense in the long run-look for vanishing premiums.

The caveat: The lowest premium or shortest nllmber of years to vanish in a sales illustration may be the result of aggressiveand baselessassumptions.

Four: Highest Retirement Income Deception

An agent or salesperson can falsely illustrate significant retirement income improvements in a cash value policy by only running the illustration to ages 85, 90 or 95-rather than the usual 100.

The insurance industry has been soundly criticized for making projections look-and sound-like reality. On the bottom of every sales illustration, the law requires a paragraph of disclaimers which say effectively: Everything you see is a projection, no! a promise. These are not estimates or guarantees of future results. Actual results may be better or worse in the future.

Knowing the Players Involved

It is important to clearly understand all of the parties who might be involved and the parts they play in the life insurance process. These might include the applicant, the insured, the policy owner, and the beneficiary. Although these are four separate roles, they may all be played by one person or several people.

Example: A husband applying for insurance on his own life that benefits his wife is the applicant, insured and policy owner. His wife is the beneficiary.

Example: A company might apply fur insurance on the lire of a key employee. In this case, the company is the applicant, policy owner and benefidary.The key employee is the insured.

The term third-party ownership refers to a situation where the policy is owned by someone other than the insured.

Purchasing Strategies

As with many other products, consumers have a wide range of options when considering which life insurance policy to buy. To make cost-effective selections, there are two basic methods an applicant can follow: the traditional net cost method and the interest-adjusted cost method. There are advantages and disadvantages to both.

The traditional net cost method adds premiums expected to be paid over 10 years (or the maximum number if the term is less than 10 years), then subtracts the cash value expected to be accumulated and dividends tQ be paid by the end of the lO-year period. This number is averaged (divided by 10, in this case) for a final number referred to as the average annual surrendered net cost.

To do this calculation-or any like it-you should get premium, dividend, and cash value numbers from each of the insurance companies you're considering. Calculations should be compared on a per $1,000 of insurance basis.

There are three main problems with this calculation. One, it assumes that the policy owner will have the policy for exactly 10 years. The averages would be different for a 20-year period. Two, dividends are only assumptions. If dividends are higher or lower than predicted, cost averages are affected. Three, this comparison does not take into account when premiums and benefits are paid-the time value of money. The interest-adjusted cost method is similar to the traditional net cost method, with the exception that it accounts for an interest rate. After the selection of a time period for analysis (such as 10 years) and the selection of an interest rate (such as 5 percent), the calculation proceeds as follows:

• add annual dividends at interest to the cash value at the end of the peri divide this amount by an interest factor which converts it to a level annual amount
• subtract this result from the annual premium

Riders and Other Modifications

One mechanism that smart consumers use to tailor insurance policies to their needs is. through the use of riders and other modifications to standard policies. Riders take their name from the concept that they have no independent existence. They have force and effect only when they are attached to a policy. A rider is a special provision or arrangement not in the basic policy contract but that has been attached to and made a part of the contract, sometimes for an extra premium. Riders can be used to enhance or add benefits to the policy or they can be used to take benefits away from the policy.

Among the most common types of riders:

• Accidental Death (Double Indemnity). This provides an additional death benefit and a dismemberment benefit for loss of certain cbody members, if the death or the loss is due to an accident. The accidental death benefit, usually referred to as the principal sum (the rider's face amount), pays an additional death benefit if the cause of death is due to an accident as defined by the policy. Usually, death must occur within 90 days of the accident for the benefit to be paid. Example: John has a $10,000 whole life policy which contains the accidental death rider (double indemnity). If he is killed accidentally as defined by the policy, the total death benefit will be $20,000. However, it should be noted that the value of the accidental death rider is $10,000. It is an amount equal to the face amount of the policy. The basic whole life amount of $10,000 is increased by another $10,000 due to the rider.
• Waiver of Premium. This provides that, in the event of total disability as deftned by the policy; premiums for the policy will be waived for the duration of the disability. The rider is temporary in that it usually expires at the insured's age 65. However, if a total disability occurred prior to the expiration of the rider, the premiums are waived for the duration of the disability. There is usually a six-month waiting period before the rider's beneftts are payable. This means that the insured must be totally disabled for six months (a few insurers only require three months) and then future premiums will be waived for the duration of the total disability. Once the six-month waiting period has been satisfted, any premiums paid during the waiting period will also be refunded to the policy owner. A variation of this rider is Waiver of Premium with Disability Income. The same concept applies as with waiver of premium, but this rider will pay a weekly or monthly disability income beneftt to the insured in addition to the life insurance premiums being waived.
• Guaranteed Insurability; This guarantees that, at specifted dates in the future (or at specifted ages or upon the event of specifted occurrences such as marriage or birth of a child), the policy owner may purchase additional insurance without evidence of insurability. The rate for this additional coverage will be that for the insured person's attained age, not the age at which the policy was issued. The amount of insuranc~ which can be purchased on the option dates is usually limited to the amount and type of tfie base policy. If the policy owner had a $10,000 whole life policy with the guaranteed insurability rider, he or she could purchase up to an additional $10,000 of whole life coverage on the option dates. The biggest advantage offered by this rider is the opportunity to buy additional amounts of insurance as one's responsibilities and needs change, without proof of insurability. The option dates are usually the policy anniversary nearest the insured's birthdays at ages 25, 28, 31, 34, 37, and 40. In addition, marriage and the birth of children between the ages of 25 and 40 also
• Return of Premium. TWs was developed primarily as a sales tool to enable the agent to say, "In addition to the face amount payable at your death, we will return all premiums paid if you die within the first 20 years." The rider is simply an increasing amount of term insurance that always equals the total of premiums paid at any point during the effective years. Technically, the rider does not return premiums but pays an additional amount equal to premiums paid to date of death. The policy owner who purchases the rider is simply buying additional term insurance. . Return of Cash Value. This seldom-used rider was designed to offset the common-though invalidcomplaint, "When I die, the company confiscates the cash value." This complaint is based on lack of understanding of the mathematics involved in a level face value life insurance policy. However, if the agent can say, "We can attach a rider returning the cash value in addition to the face amount," the objection is more easily answered than if it is necessary to explain the mathematics involved. The return of cash value rider is similar to the return of premium in that it is merely an additional amount of term insurance that is equal to the cash value at any point while effective. Buying it, the policy owner is simply getting additional term insurance.
• Cost of Living Adjustment. This rider is important to people who are in a position to be impacted strongly by inflation. Because of the high inflation years of the 1970s, many policy owners were concerned that the face amounts of policiespurchased would not be adequate to cover expenses by the time the death benefit was paid. The cost of living rider changes the face amount of the policy each year by a stated percentage, such as 5 percent. This amount is compounded annually. The cost of living rider can be used to both increase and decrease the face amount of the policy; 'depending on that year's cost of living. There are limits on the amotlnt,theface amount can be decreased, however.
• Additional Insureds. These riders are commonly attached to life insurance policies to provide coverage on the lives of one or more additional insured people. Usually these are term insurance riders covering a spouse, one or more children, or all family members in addition to the named insured. Many companies will issue additional insured riders on request. Some companies actively market combination coverage policies for family members as a family protection policy.
• Living Need. This rider is a recent development in life insurance. It allows a terminally ill individual to obtain part of the insurance proceeds prior to death. To be eligible for this benefit the individual must present medical proof of the terminal illness. Most companies offering this benefit will limit the amount of the insurance proceeds which may be paid in this manner. Most companies do not charge additional premium for this rider because it is an advance against the death proceeds for which the policy owner is already paying premiums.

A caveat: Sometimes companies offer a wide variety of riders and options as sales tools to allow the sales person to focus on the riders and disguise the poor quality of the basic company and product.

Beware of agents pushing the unique benefits and riders as compelling reasons to buy the product.

Once the underwriting process is complete and you have been approved, the life insurance policy will be issued by the insurance company. The coverage is not effective until the policy is delivered and the initial premium has been paid. Smart consumers proceed carefully through this stage of the process.

Often, you will pay the initial premium with the application. When this occurs, the agent will provide you with a receipt for the initial premium and the effective date of coverage will depend on the type of receipt issued.

A few companies use an unconditional or binding receipt that makes the company liable for the risk from the date of application. This coverage lasts for a specified time or until the insurer either issues a policy or declines the application, if earlier. The specified time limit is usually 30 to 60 days.

With a binding receipt, regardless of your insurability, you are covered for a specific period of tjrne following completion of the application and the payment of th'e initial premium. Use of this type of receipt is rare.

A temporary insurance agreement is a type of receipt that provides you with immediate life insurance coverage while the underwriting process is taking place whether or not the individual is insurable.

Example: You submit the initial premium and application and are provided with a temporary insurance agreement which states that coverage is effective immediately and will continue during the underwriting process. If you should die during this period, the coverage is in force regardless of your insurability or risk classification as a result of the underwriting process.

Payment Schedules

Most life insurance companies base their premium payment schedule on a yearly cycle. Although they use a calendar year to figure the base for your premium, it is possible to pay your premium on a semi-annual, quarterly or monthly basis. You may however owe an increased service charge to offset the added expense of processing payments more than once a year.

An insurance company will usually ask at the. time of the application how you are going to pay. Most companies will allow you to change the frequency of your payments at your discretion.

Some companies require a pre-authorized check (PAC) method of payment if you choose to pay on a monthly basis. This assures the insurance company that your payment will be received on a timely basis and cuts down on additional paperwork costs.

Direct withdrawal of funds from your checking account has become a standard feature within the life insurance industry. Don't be surprised if your company has this requirement tied to its monthly premium arrangement.

Other Policy Changes

At any point during the life of a life insurance policy; the policy owner has the right to change certain provisions. These include:

• the face amount downward
• the beneficiary/contingent beneficiary
• the type of plan (if allowed)
• the payer
• the owner (by sale or gift, transfer or assign the policy)
• the billing cycle

• a provision that states you have less than one year from the time of incident to bring a lawsuit upon an insurance company you are entitled to at least one year
• a contract provision that permits cashing out the policy at time of maturity for less than the face amount of the policy, including any dividend .additions, (the company may subtract any policy loans and overdue premiums.)
• a provision which would allow the company to forfeit the policy due to outstanding loans or loan interest, if the total owed is less than the loan value of the policy
• a provision stating that the agent represents anyone but the insurance company, i.e., a provision stating that the writing agent may act or represent the insured person or applicant

If You're Uninsurable

What should you do if you have health problems that make you uninsurable? If your life insurance application is rejected because of information in an investigative report, you must be notified and given the name and address of the reporting company.

If your health problems are so severe that you are classified as uninsurable, or even if a new life insurance policy is just too expensive for you, it's good to know that some companies offer guaranteed issue life insurance. This insurance is available in smaller face amounts-like $10,000.

The full face amount is payable in the event of accidental death, but for death from natural causes the benefit is limited to the total of premiums, plus interest, at least for the first few years of the policy. After that, the benefit equals the face amount. Guaranteed issue life insurance is a good solution for covering expenses such as funeral costs for otherwise uninsurable people.

A life insurance policy may be issued as applied for, modified, or even amended if the applicant does meet the underwriting standards of the insurance company. While uncommon, an insurance company may issue a waiver with the policy which states that death by a particular event will not be covered. This might be done if the insured person has a particularly hazardous occupation or hobby. More commonly, an insurer might issue a more limited form of policy or at lower limits than that which was applied for.

In the 1980s, to gain a competitive edge in illustrations, some companies began to use inflated interest rates for universal life and unrealistically high dividend scales for mutual company illustrations. Illustrations of future performance did not reflect actual history of performance.

If you are rated a substandard risk, there are a number of things you can do to get at least some life insurance ...coverage.

Economic Pressures Are Intense

A last caveat: As actual interest rates fell below projections during the late 1980s and early 1990s, consumers became wary of interest sensitive policies like universal life. As aggressive assumptions were proved wrong, consumersJound their vanishing premiums didn't vanish and their level premium poliCies required more money.

Some insurance companies concluded that they had to carry out the illustration war in the arcane invisible world of undisclosed assumptions. They began to manipulate mortality assumptions and lapse ratios. These changes can have a big impact on pricing and projected cash values-yet are virtually impossible to debunk because they're undisclosed in compliance documents.

A small reduction in mortality can create a major lowering of premium. Suddenly, companies that have no history of extraordinary performance are able to out-illustrate everyone.

One trick some insurance companies use to appear more competitive than they are is called segmentation. The companies classify their policies by age and change their portfolio management to credit newer policies with higher dividends, lower expenses, and lower mortality assumptions.

This punishes existing policy owners in order to seduce new ones. Eventually-three or four years later-the new policy owners will become subject to the same treatment that other older customers get.

Some larger mutual companies have acknowledged that they use segmentation. The justification some stock companies offer for withholding actual historical performance-which would reveal segmentation-is that the old policies don't reflect the current plans offered.

Conclusion

The way life insurance is sold is changing. It's becoming a price-driven, commodity market. Long-time professionals in the industry aren't sure where the business will ultimately land. A lot of people are getting out of insurance-a lot of those staying are, frankly, scared. More than ever, buyers have to beware.

It's increasingly likely that you'll buy your next life insurance policy over the phone, via computer or through the mail. You'll likely be dealing directly with .the insurance company (and even if you use an agent or broker, that person's increasingly likely to be working for a single company). You'll need all the critical tools you can find.

This book has given you the basic tools you need for understanding life insurance-the honest and the slippery. If you following the guidelines and ask the questions we've discussed, you should be able to satisfy your needs and the needs of the people who depend on your judgment and money.