Thursday, August 10, 2006

Life Insurance Racket

     Now that we live in a 2-income house (as opposed to a house that either my wife or I could afford on a single salary), we're investigating life insurance options so that in the case of the untimely demise of one of us, the other does not have to move.
     So far, I'm fairly disgusted by the industry. I mean, insurance is a scummy business as a whole, but life insurance has more obfuscations and fear-mongering than I'd expect outside a Republican election platform. When you buy car insurance, it's pretty straightforward. If you pay $X per month, the insurance company will fix your car, pay off anyone you damaged, and possibly pay for your own injuries in the case of an accident. Different policies cover different things, but it's not complex. I thought property insurance was as straightforward, but since reports came out from Katrina of insurance companies playing games and not paying for destroyed homes, it turns out that that sector is about as trustworthy as Mel Gibson producing a Holocaust movie. (The whole "wind" vs "water" debate is crap. People clearly believed they were buying hurricane insurance, and the insurance companies were happy to let them think so.)
     When I bought my first house, I purchased a "home warranty". That was probably the most worthless thing I've ever spent money on. It was supposed to cover anything that broke in the house, with a few small print items that were excluded. So when a pipe burst in my crawl space, I called the insurance company. "Not covered." Why? Well, the part of the pipe that broke is excluded in the small print. My A/C died. "Not covered." Why? The way it broke was excluded in the small print. After 2 years of having Every. Single. Claim. denied, I cancelled the stupid policy. I started getting warning letters. "This is your last chance!" I read. A month later, I got a letter saying, "This is your final chance to cover your house!" I got phone calls weeks after that offering discounts. I'd rather send my money to a deposed Nigerian prince.
     Which brings me back to life insurance. There are 2 types of life insurance. They're called "Term Life" and "Cash Cow". The insurance companies usually give prettier names to the second, calling it "Whole Life", "Universal Life", "Premium Guaranteed Life". And they talk down the first, calling it "Rental Insurance". Term Life is insurance. You pay the company $X, and if you die, they pay your beneficiary $Y. Permanent Life (Perm), what textbooks will call the Cash Cow, is actually a hybrid product. It's a mix of Term Life and investment account. Perm Life premiums usually stay constant over your entire lifetime, while Term Life premiums go up. But this is misleading. Term Life payments stay constant, while the insurance payments in Perm Life go down. They don't tell you this, because the dollar amount on the check will be the same. What they don't clarify is that part of the money comes from your own investment account. If you wanted to buy Term Life with a declining payout, your premiums could stay constant too. Think of your mortgage. Your payments stay the same, but behind the scenes, more of your money goes to pay down principal instead of interest, as time goes on.
     So where's the scam? After all, what's wrong with saving money? Nothing, if your retirement plan is to buy 40 year CD's that you can only cash after you die. Life Insurance companies pay really crappy returns. If all you're interested in earning on your savings is 6% annually, a CD will take care of that for you. Better yet, you can actually use a CD before you die.
     Now, I do have to mention that there is one huge benefit to Life Insurance - payments after death are tax-free. It's like a Roth IRA that pays out when you're dead. This is a good way to avoid estate taxes if you want to pass down money to your children. Since there are no estate taxes on spouses, however, nobody gains anything if your spouse is the beneficiary. Except for the insurance company, who's been making tons of interest on your money for 30, 40, or 50 years. Anyway, that's estate planning, and unless your estate is worth millions of dollars, you don't have to worry about it. (If it is worth millions of dollars, there are other ways to shelter the money before dealing with life insurance.)
     On the New York Life webpage, the insurance company tries to help you with the confusion. It's heard the saying "Buy Term and Invest the Difference", so it wants to give you a Fair & Balanced analysis on which is right for you. The page has headlines like "Do You Prefer Renting or Owning?" and "Invest the Difference in What?". Translations: "You prefer owning to renting, and we say Term is like renting", and "Do you really want to go through the hassle of planning for your future?"
     Maybe some of you who are older and wiser than me can cut through the bull that the insurance companies are feeding us. Explain to me a good reason why Perm is not a ripoff. If I'm disciplined and responsible with my savings, I figure I'm always better off buying Term, until the day comes when I no longer need Life Insurance (house is paid off, kids are through college). Why is someone always trying to steal my money?

19 comments:

sideshow bob said...

I can't help you navigate the policies, but I rmember when Sy and I were looking at insurance policies, I was especially amused by the Accidental Death and Dismemberment stuff. The policy offered $X if you lost one limb, and two times as much if you lost two limbs...but that was only if those limbs were both on the same side of your body. For example, if you lost your right leg and your right arm, you'd get two times $X, but if you lost your right arm and left leg, that didn't count as two limbs.

Who comes up with this morbid crap?

Alisa said...

I just recently spearheaded a massive overhaul of our companies offered benefits, and we decided to add the additional benefit of Life Insurance to our employees.

Our Broker (a very lovely and honest man) told us that he wouldn't sell Whole life insurance to his worst enemy and to only go with Term life insurance policies. In his view, whole life is nothing but a giant consumer rip off.

ORF said...

Scott,
My father purchased my life insurance policy for me several years ago and turned its oversight over to me a couple of years ago. I have it through Northwestern Mutual and as far as I'm concerned, it's doing a fine job. I suspect it's a term life insurance policy as my dad is fairly sage about these things and knows how not to get ripped off. I don't really have a clue about payout and since I am currently spouse-less, my beneficiary is my younger brother. Incidentally, he also gets all my CDs (the musical kind, not the fiscal kind) according to my will. And yes, I also have a will. My dad likes paperwork, what can I say?

On the whole, insurance of any kind of another is a scam for the risk-averse. sux

Ben said...

Whole life policies had a lot more utility before the advent of low tax penalty investment vehicles like 401ks and Roth IRAs.

Joe said...

Life Insurance Companies are in business to make money. However, monies placed with them can produce excellent results if done right. The biggest problem is finding someone who A) wants to do what’s in his customer’s best interest as opposed to his (fiduciary responsibility) and more importantly B) someone who knows enough to lead you in the right direction.

Term Insurance may be the best product for someone but what if twenty years down the road you still need insurance, in that case you’ll find that it’ll cost you a whole lot more, while someone who takes out permanent life insurance out early, will never be priced out.
Additionally, there are ways to structure your policies that will set you for life. Missed Fortune 101 by Douglas Andrews goes in depth on how to do that. I highly recommend that book and I have a blog that has more information on this topic.

Scott said...

Joe, It's true that if you don't consider your needs down the road, you could find yourself priced out or uninsurable. But if you plan correctly, you can get a Term poliy that lasts 20 or 30 years.
A Perm policy is nothing but a declining Term policy with a savings account attached. Your blog talks about taking an active role in investing and about leveraging the relatively low mortgage rates to make higher-yield investments. Why would you promote the low-paying cash accounts of Perm policies when someone could simply buy a declining Term policy and put money into a savings account?

Anonymous said...

Scott

You can get 96 - 98% of the average annual return of the S&P500 index (maybe more if there's several down years) with NONE of the associated risk of loss of principal with an Eqyity Indexed Universal Life (EIUL) Insurance policy.

I understand your hesitation to view Permanent Life ins. as an investment vehicle, but that mostly applies to Whole Life and Fixed Universal Life.

EIULs are reshaping the Life Insurance landscape.

When you do buy-term-and-invest the difference cost analysis, you factor in the opportunity cost of the mostly cost of term and an annual growth rate of lets say, 8%. It is a statistical fact that only 1% of term policies pay a death benefit according to the Life Insurance Marketing Research Association.

So, lets say you spend $50 p/month for term ins., and you're alive at the end of 30 yrs. $50 p/month for 30 yrs. at an 8% return = $67,969 LOST.

Stop buying the media baloney. After all, brokers/investment advisors get paid throughout the life of the investor, insurance agents do not.

Anonymous said...

Buy term if you can't afford a permanent policy. If you can afford a permanent policy, do it.
The living benefits you can can be wonderful. The public is misinformed by the media. If you buy term life when you're young for 20 or 30 years, you have a .05% chance of having the claim paid to you before the age of 65. Therefore, it is a waste of money if you can afford permanent policy. After age 65, you have a 100% chance of dying. The only question is when. While you're alive you experience the living benefit of permanent life policies.

Anonymous said...

continued from above...

A UL policy that is paying 5% annually is a tax equivalent of 7-8% of a CD or mutual fund. Within limits, you don't have to pay the taxes when you withdraw your money. I see it being one of many good vehicles to place your money in.

Scott said...

     OK, see, this is the bullshit I'm talking about. First of all, I'm sick of hearing about "The media". WTF? Unless *I'm* the media, you're full of shit. I did my research in financial textbooks and on insurance company websites.
     Second, it's a lie that you can withdraw the money tax-free. It's true that your heirs get the money tax-free, but that's hardly planning for your own future. You can take a loan tax free (name one loan that isn't), but it costs you double - a) you have to pay the insurance company interest and b) your returns on your "investment" drop to near zero since you have taken out the principal.

Anonymous said...

Sorry Scott

Your lack of knowledge on life insurance is showing

Some of the ULs have CONTRACTUALLY guaranteed zero-cost loans

The word LOAN in a life insurance policy means borrowing from the cash value, which is a combination of principal PLUS gains, IF IT'S A DECENT POLICY. You may or may not ever deplete the principal depending on how its performed.

Withdrawing the cash value above the corpus (principal) triggers a taxable event, so the loan protects the additional cash value from taxation.

Do you know of any other loan that has a zero-cost feature ?

Based on a 30-year lookback on the S&P 500 index, one EIUL would've credited almost 10% annual average.

So, you have life insurance when you need it, a nice pile of cash when you don't.

Perfect retirement vehicle !

You're are making a general statement on how poorly the returns are on insufficient facts to ALL types of permanent insurance.

WL & Fixed UL are based on the bond markets, so they willl traditionally underperform other types of policies.

I never recommend Whole Life, but more often recommend an EIUL.

Anonymous said...

Hey Scott,

I sell life insurance so I have to agree with that last comment about Equity-Indexed Universal Life. And I could make the same argument for Variable Universal Life. The thing is, you and I both have to be careful when pontificating about whether a specific product makes sense. All products make sense for some person, at some point in his/her life, according to situation and goals. Generalizations have limited merit, but especially with financial vehicles. As the last commentator stated, cash values built up in a permanent life insurance contract may be borrowed at a zero cost, or in retirement, withdrawn as an income stream with no income tax to pay... and the build ups are also tax deferred. You cannot say that about your 401K, which will be fully taxable as income. Life insurance nest eggs also do not count as sources of tuition when parents and students are applying for financial aid. Perhaps best of all, these cash value contracts are excellent for business owners in numerous situations. If you have a cash business, where best to set aside money? You can complain about 6%, but over time, many people would have been thrilled with 6% tax-dererred and tax-free distributions. Especially all the folks who are only now seeing their investments re-attain their pre-dotcom bubble bursting levels.

Anonymous said...

I think all insurance salesmen are scam artists,, and i think Northwestern mutual is the KING of CHURNING...

Joey said...

Doesn't anyone ever wonder why the rich get richer and get away from more and more taxes? It's because of investments like the EIUL. Don't get me wrong the EIUL is not an end all be all solution but it is the one of the best ways to slowly build money towards your retirement without having to pay extreme taxes on the back end (401k, do some research, here is your real "Cash Cow). The EIUL is not just a benefit if you die. The way it actually works is that the life insurance is actually just an "Umbrella" if you will, to protect you from outrageous taxes. Second, Scott if you wish to pull your money out of an EIUL you can. There are penalties in the first 10 years but that's better that being penalized at 40% by your 401k if you pull before your 59 and a half!! and after 10 years you can pull up to 90% completely tax and penalty free. By that time 90% will be more than what you have invested in to it including your annual premium. My father in law is a CEO of a financial marketing firm and I am now starting to work with him as a financial consultant. I know that the "CEO" would not put the man that is going to support his daughter the rest of her life in to a dead end investment or a "Cash Cow". It is now an end all be all but it is a very good product for a lot people. Also, just a cool fact, did anyone know that the second biggest lobbying group on capital hill if for life insurance? Why? Because it is one of the very few ways that people can make there "money work for them" tax free. instead of what we have all been taught to do and "Work for our money". 1st largest group is the war (Obviously). Scott this may or may not be the best for you but it definitely is worth and look not only for you but your family. Anyway I really could talk about this stuff all day and if anyone would like to talk about it feel free to reply to me, but I wish everyone the best of luck.

Scott said...

Joey, I totally agree. If you're wealthy, this is a great dodge for estate taxes. But for the average Joe who wouldn't be paying estate taxes, it's not such a great deal.

I did mention in my column the caveat that "This is a good way to avoid estate taxes if you want to pass down money to your children." But it really only applies to the very wealthy. (FYI - anyone in the "middle class" getting hit by estate taxes is probably paying them on a family business, which can't be put into a life insurance premium anyway)

Anonymous said...

Why would anyone want to bundle their savings with life insurance?
Life insurance is for your death.
I pay you this, you pay my beneficiary that when I die.End of story.
Savings is for when you are living.
As far as I know, you can't live & die at the same time.Also, how do you know how much of your premium every month buys the actual insurance and how much goes to savings? I like to have control over my money as much as possible.
Also,I can make more money investing in mutual funds rather than the insurance co. doing it for me with my so-called savings. That really is what it all boils down to. People don't know what or how to invest their money on their own, so they throw it into a life insurance policy and get screwed in the end by letting the insurance co. handle it. They handle it all right, they will gladly pay you peanuts for letting them control & invest your money and making a larger percent off of it than you know how to. My father who is 90 years old, had 2 whole life policies 1 for 2.5M face value
and 1 for 3M face value. You talk about getting screwed. He paid in $8,240.00 on the 3m policy and $4,400 on the 2.5m policy and was still paying when I discovered it.
I had him cash them in & cut his losses.He had no idea what he had. WHAT A JOKE!!!

Anonymous said...

My sister in law has been looking for a job and her aunt referred her to a friend that sells "401K" and that she could join as an agent after getting her license. I don't think she even knew he was selling insurance, just some kind of retirement plans. The "advisor" told her to get her family together for "support" to all meet with him and her. I said "support for what?! Whether or not she should take the job? This makes no sense." Anyway the guy met with the family and his little speech just made me sick. Everything sounded too good to be true, he only mentioned how this product (never mentioning the actual name of the product) is a perfect investment for retirement, tax free and better than a 401K (the money is insured!). He said he would go through the details at another time with anyone interested. Funny how this went from supporting our family member to get a job to a direct sales pitch. The guy works for FFS First Financial Security and according to their website the more people you "recruit" to sell these policies the higher up the pyramid you go, thus making higher commissions. I had to find out on my own that these are called Equity Index Universal life policies and luckily I can warn the family before any of them meet with this guy alone and sign anything. So much for trusting a "friend of the family".

Anonymous said...

I worked at Northwestern Mutual for 5 years and Life Insurance is one (if not the best) long term investments you can do.
First of all. All Universal products are s***. The best way to save money for retirement is a Whole life (or Perm Life) insurance.
You will get two huge benefits: One. If you start early (in your 20's) you could potentially triple your money by the time you are 60 years old just by paying $100 dollars/month and you can actually stop paying after approximately 15 years depending on the policy and company. Then it pays it self off.
Two. Your death benefit keeps increasing and you can change the beneficiary as many times as you want. So you can leave some pretty good chunk of money to someone you care about in case something happens to you.

RipOFFcity said...

I sell life insurance too, and have for 20 years. Anyone reading this, listen and listen good: I WOULD NEVER EVER PUT A DIME INTO A RIP OFF WHOLE LIFE/UNIVERSAL POLICY OR ANY OTHER FANCY NAME YOU CAN COME UP WITH. These policies are the biggest 'legalized' fraud in the entire country if you ask me. I've owned them myself and i've seen hundreds of policies from all different companies over the years, and have seen what happens to them over time. The contracts are seriously so complicated that there is no one in the world including us agents who can explain everything about them. If you say you can, then you are lying. For those of you who are commenting about the low interest or even 'zero interest' loan, you forgot to mention one thing: ITS YOUR MONEY!!!! Every policy I have seen over 20 years goes something like this: policyholder premium was a certain amount, let's say $100/mo. for a face amount of $150,000. After 20 years, said policyholder has paid in approx $24,000 but the 'cash surrender value' or amount you would receive if you cashed in policy would be, say around $22,000---yes, not only did you not make ANY interest but the value is almost always less than even what you've paid in due to underperformance of policy AND increasing cost of insurance that eats away any interest earning potential as you get older (which they never even tell you about). But, WOW, you tell me I can take a LOAN for zero percent!!!?? Well, aren't they so gracious since its MY MONEY in the first place...actually LESS than my money since i don't even have what i paid into it. So, why wouldn't you buy a 20 year term for $750K for just $30/mo since $150K won't even put you in the ground, and you just actually LOST money anyway, never mind ever actually making any. This is real life story i see over and over and over again, no matter what company, no matter what age. The only policies that have ever worked are the ones that have been seriously overfunded and who wants to do that. STEER CLEAR and if anyone wants to come to your house to review life insurance, kick them out. You can buy term right over the phone....it's black and white.