We Have Calculators. Why Not Use them? (part 1)

I might as well start this post by stating unequivocally that I am not inherently against the concept of utilizing life insurance for accumulation purposes.  I am, however, adamantly opposed to mis-posturing how it works and misleading consumers regarding what they are really getting and the actual internal rate of return (IRR) on their money.  I make this statement knowing that by the end of reading what I write today, many will categorically dismiss me as anti-insurance or anti-a-certain-type-of-insurance.  Some may simply call me an idiot and tell everyone they know forevermore that I don’t know what I am talking about.  The problem is… what I am saying is irrefutable.

That comment doesn’t come from arrogance as I am not going to make grand statements about what is right or wrong relative to concepts or what someone is trying to accomplish.  I’m not going to make postulations of any kind.  I am only going to make real world observations and state, as fact, what deliberate key strokes input into a financial calculator relate.  As a simplistic example; 1+1 = 2.  I’m not going to make a judgement as to whether 2 is good or not; it just is.

First of all, I am agnostic regarding numbers.  Who am I to say what numbers are good and what numbers are bad?  As with beauty, that determination should be in the eye of the beholder.  If the actual IRR of a particular transaction is either 2% or 10%, do I really care?  No, I don’t.  What I do care about passionately, however, is that the owner or recipient of that IRR knows exactly what he or she is getting, without spin or manipulation.  Therein lies my beef with too much of what I see in the market.

Most recently, a financial advisor sent me a proposal an agent presented to a client of his.  The basis of the proposed transaction was a traditional whole life policy built specifically for accumulation purposes.  There was no life insurance need in this instance and the transaction was built primarily around tax planning and asset protection.

What I want to focus on is that this was being portrayed as a fantastic investment opportunity with the ancillary benefits of preferential tax treatment and asset protection.  The problem began when I pulled out my HP12C, or more accurately, my HP12C app.  (If you still use an physical HP12C and aren’t aware of the app, do yourself a favor and go to the app store and treat yourself.)  At 5 years, the premium to cash value IRR was about negative 9%, at 10 years it was still negative, at 15 years (age 79) it just broke 2% and it never got close to 3%, even at life expectancy.  By the way, that is IRR on total premium to gross cash value.  If one wanted to access the cash, the policy would either have to be terminated and there would be income taxes due or a meaningful amount of cash value would have to stay in the policy to keep it in force, with either tack reducing the IRR on the transaction.

Those familiar with life insurance won’t be surprised by any of this.  It generally takes a decade or more to break even and the projected numbers in a current whole life policy simply aren’t going to be high.  It may be possible to craft better numbers in another scenario with a different insured individual, another product or funding design but these were the numbers for this situation and they weren’t recognizable relative to what the insinuations were to the consumer.  Remember, I’m not saying they are objectively poor, simply that they bore no resemblance to what the client was led to believe.  Also, relative to the asset protection aspect of the sale, recent case law (here in Michigan) makes it clear the cash value would not necessarily be protected as related to the client.

I guess I shouldn’t be surprised based on an experience I had a number of years ago.  A friend (a financial advisor none-the-less) was being pitched a traditional whole life policy by a career agent and asked us to evaluate it.  All she could focus on was the pot of money in the policy down the road.  A simple observation (no financial calculator needed) showed that at no point would the cash value exceed her premiums but she completely ignored that and kept saying “… but look at that cash value…”  This transaction was solely for accumulation planning.  I was incredulous.  Even after pointing to the accumulated premium and then to the cash value and reminding her that the greater than/less than arrow was pointing the wrong way, she couldn’t internalize that it wasn’t a great deal.

I marvel at the salesmanship required to pull this off.  It’s no secret what is happening in many of these situations.  I’ve witnessed it over and over again and it has a whole lot more to do with what is not said than what is said.  Here is what I mean.  Some years ago I was in a meeting with clients and an advisor reviewing an in-force portfolio.  I thought these people knew better so I was facetiously relating a sales scenario recounting an agent touting the then prevailing 8% dividend being credited to the policy which, in their tax bracket, was like making 12% on their money.  I paused, while grinning, only to realize in horror that no one else in the room was smiling.  The fact of the matter was this story I was intending to mock was precisely the story they had heard and bought on to during the sales process.

What’s the matter with it?  The problem with it is that these clients, and many others I have met with, were led to believe that their premiums were actually going to earn the prevailing dividend rates.  Did the agent actually say they would earn 8% on premiums?  Probably not.  Did the agent specifically say the 8% dividend wasn’t being credited on the entire premium paid?  Probably not.  The point is, a majority of whole life consumers I meet with (as well as UL, VUL & IUL consumers) believe they are earning the touted rates on their cash flow into the policies because they are led to believe such.  But that is not how it works; not even close.  Why do they believe it?  When a salesperson is focusing so strongly on a rate of return for a transaction being sold as an investment, why would one think anything else?

Premium taxes, commissions, policy fees, mortality costs, surrender charges, administration expenses, rider charges,  miscellaneous loads, etc, etc.  Focusing on these things gets in the way of sales so they are often glossed over.  I am not going to say that it is vitally important to line item every fee and charge but if this was a mutual fund or real estate transaction, consumers and their advisors would largely be aware of and understand the various fees and commissions.  However, when the fee structure is such that it can take a decade or more for the accumulation value to climb back up to ground zero, I would think more consumers would be aware of it but I can assure you they are not.  Remember, I’m not criticizing the products but I am critiquing the market which doesn’t make it clear that life insurance accumulation planning doesn’t work like traditional investment planning.  Comparatively, it is a long term transaction.

Likewise, the precise details of how and when one pays premiums affects return unlike traditional investments.  Changes in funding amounts and timing makes a difference.  How one accesses the money down the road matters greatly.  Multiple vagaries of actual funding and withdrawal behavior can meaningfully change the realized return differently than traditional investments.

Finally, there should not be the remotest thought of insurance based accumulation planning until one intimately understand the potential tax consequences of a funding policy falling off the books.  Traditionally, consumers have come to believe that the worst possible investment could result in losing everything invested.  When there is a realization that through life insurance planning, one could lose everything “invested” and end up in hock to the government, maybe it’s time for a second pair of eyes.

Again.  I’m not categorically opposed to insurance based accumulation planning.  I don’t think there is a certain IRR number required for it to be “good”.  I don’t think agents are evil.  However, I cannot recall the last time I took black and white information provided directly from a carrier and calculated an IRR on premium to cash value or cash flow and came up with a number similar to the expectation of the consumer.  Also, it’s only partly because of the 30 plus year decline in the interest rate markets.  The results would be similar, not as bad, but similar in a stable interest rate market where dividends hadn’t fallen by hundreds of basis points over the years.

I can hear the cacophony of voices resolutely stating that my clients understand and my clients get what they expected.  Okay.  Maybe yours do but I can assure readers that way too many do not have that experience because accumulation in life insurance policies, in general, simply does not work like a preponderance of the consuming market understands because I believe a preponderance of the consuming public is mislead regarding how life insurance really works.

There.  I said it.

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