Worst Case in a Long Time Why Consumers Need Impartial Advice

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I recently got a call from a mom and adult daughter, neither married, who had had equity no-load mutual funds within IRA’s.  They got spooked during the volatile first quarter of 2016, heard a fellow on the radio promoting a strategy “safe from the stock market”, and jumped out of the frying pan into the fire.

Commission-driven Recommendations:

Asserting he wants to do what’s best for the client, this financial “expert” encouraged Mom, age 70, to roll her IRA to an Athene annuity to fund an IRA, which some liken to wearing a raincoat indoors.  A tax shelter within a tax shelter is redundant and carries unnecessary fees. It’s an equity indexed annuity guaranteed to not lose in stock market decline and participate in the market up to 3% per year.  If the S&P goes up 10%, she gets 3%, and if it goes down 10% she loses nothing. There are better ways to address risk, but it is emotionally appealing.

The commission creates enormous surrender fees, 10% declining by 1% per year over 10 years. She avoids possible stock market loss but pays sure transaction costs while limiting growth dramatically.  The agent argues that the surrender fees vanish if she keeps it long enough (true), but all that while she is missing equity opportunity which has also historically been surer when one commits to the market for 10 years (the time it takes to avoid annuity surrender penalties).

His recommendations were worse for the 40-year old daughter: a $450k Minnesota Mutual Flexible Premium Universal Life Insurance plan for which she pays $50/month and has made two additional $11,000 payments and is scheduled to make two more.  It has some long-term care benefits which confuses comparison.

The daughter has no kids, makes less than 25k/yr, and lives with her mom who is 30 years older– hardly a case that warrants that size policy.  Daughter can’t afford (out of her salary) those premiums anyway.

Understanding what you have:

Rarely do consumers comprehend the inner workings of such a policy, so we conference-called Minnesota Mutual to find she’s charged $152/mo within the policy.  The cost above her $50/mo payment is coming from her surrender value (which came from the two $11,000 payments).  So she’s got an $1800/yr subtraction to what’s (already) inferior investment growth within the policy.

Minnesota Mutual sales literature says this:

The primary purpose of life insurance is to give you a means of support after the death of a provider…

Another aspect of permanent life insurance is that it can grow cash value …

Minnesota Mutual publishes proper advice, but the agent promotes it improperly, and consumers listen better to a persuasive agent than they read a sales brochure.

The agent does not recommend what’s usually appropriate, a Roth IRA.  But that’s not the worst of it.

Using life insurance policy as an investment is rarely a good idea.  Aside from that, how will she come up with two more 11k annual payments making 25k per year?  By tapping assets… but all she has is her IRA.  The agent had her make an early IRA withdrawal two years!  The client didn’t know it was taxable until she got a bill from the IRS for $3267: $1687 for federal tax @ 15%, $1125 early withdrawal penalty @ 10%, $118 of interest, and a $337 “substantial tax understatement penalty”.  I asked the agent how she’s supposed to pay that, to which he replied, “a policy loan” (from the policy she did not need).

At this point she has paid $50/mo for 28 months or $1400 + two payments totalling $22,550 equals $23,950 lifetime premiums.  The $152/month charges and surrender penalties reduced her cash surrender value to $9,946 less the $3267 due the IRS, nets a 70% loss from this “investment” designed to protect against stock market loss.  The Subprime Mortgage crisis wasn’t that bad.  The agent defends it saying if she keeps it for decades she can avoid surrender fees. However, considering the $1800/yr internal costs and missed earnings opportunity, that’s smoke and mirrors.

Noncommission-driven recommendations:

Here’s the new plan: The daughter is getting a $100k 10-year level term policy for about $150/yr.  (I do not get a commission.)  She and her mom have $8k of credit card debts, some as high as 8% and 14% which they’ll pay off with the cash value, then focus on their house mortgage @ 4.25%, to be debt free in 18 months.  A dollar saved is a dollar earned, and those tax-free earnings also avoid stock market risk.  Then they will dollar cost average into Roths, what they should have been doing all along.

After reviewing this with the agent, he paid the daughter $3000, about what she owed the IRS. This was a gesture of good faith, but nowhere near what she would have saved with objective advice upfront to avoid the mess altogether.

 

Collecting Multiple Life Insurance Policies Leads to Redundancy and Waste

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Do you own several life insurance policies? People tend to buy policies piecemeal in response to life events like the birth of a child or an agent’s sales pitch. Collecting life insurance policies is often uncoordinated and inefficient. Just having multiple policies, each with an annual policy fee, and missing volume discounts of larger policies is costly. How do I know if I have too much life insurance and am wasting resources?

Most consumers think this way:
• My agent recommended it; it seems reasonable.
• We are expecting our first child! It seems time to buy.

A proactive consumer thinks this way:
• I’ll get objective opinion from someone who does not sell policies.
• I’ll engage someone familiar with the entire insurance market, rather than primarily representing one company.
• I won’t allow my worst recallable memory to become my baseline (e.g. an uncle who died young), but I’ll think in terms of probabilities.
• I’ll consider the opportunity cost of premiums if invested elsewhere.

Case Studies: The Pastor and the Doctor

I just finished two cases, one for a 65-year-old doctor with no dependent children and the other for a 32-year-old pastor expecting their first child. Despite having good companies (USAA, State Farm, and Northwestern Mutual), they both improved a lot. Insurance consumers can profit from a gatekeeper. Instead, most rock along leaking significant resources month after month, year after year, unaware of how much they could save.

The young pastor had a $100,000 20-year level premium State Farm policy that was 8 years old (12 years left of level premiums) costing $24/month (not a good buy), a 100k term life policy provided by his church, and had just been sold a $750k Northwestern term policy.

I directed him to socialsecurity.gov/myaccount to see what survivorship benefits his child and wife would get at his death: about $2400/month. He was ignorant of this, which is a shame that something so relevant to an insurance purchaser is rarely addressed by an agent. Social security survivorship benefits for him are essentially equivalent to a $500,000 term policy.

He replaced the State Farm’s 100k and NML’s 750k term, with a 500k personal policy. 500k with the 100k through work buys a nice house near family, a 100k education fund, and a 100k emergency fund. With no mortgage and liberal savings to replace a car, etc., Social Security will pay the bills. She’s a teacher who could work once their child is school age.

We talked about the low probability of death within 20 years, which makes for better choices than a fear-inducing (What if…?) sale’s pitch. This improbability translates into a high probability of “wasting” those premiums. We considered the opportunity cost compared to putting more of it into a Roth or accelerating the mortgage. The insurance amount respects the wife’s emotional temperament.

The Northwestern term cost $407 first year, growing to $1200/yr by the 20th year. The new policy costs $316/yr guaranteed level for 20 years. He dropped the State Farm and Northwestern, the doctor dropped the USAA, big name companies that are strong in property and casualty and cash value policies, but not term insurance.

The Potential Savings

This 32-year old initially saves $32/month, which may not seem like much. However, in a Roth using a Sector strategy, it could grow to $25,000 by their baby’s first college year, or over $1 million in 50 years, his normal life expectancy. Rather than buying excessive insurance paying only in the unlikely event of death within 20 years, savings are redirected towards life events that normally occur.

The doctor had collected a hodge-podge of life policies over his career. We started with an income goal for his wife and saw he was over insured. I evaluated each policy (NML and USAA cash value and AMA term), and he began dropping the poorest and keeping the best. This will save $400/month from the first three, plus more from the one Northwestern he kept but modified. His health is good.

I guarantee clients save my fee back within 18 months, a 60+% return. This doctor saves it back in less than three months. Please see Testimonials. I’ll give an initial interview free. Call me at 706-722-5665, or email to talk about your situation.

Is Whole Life Viable for Anyone? New Policies- Rarely; Old Policies- Sometimes Case Study #14

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I’m wrapping up a case that illustrates some guidelines applicable to many.  This client is smart, financially gifted, well managed, mature, but he made a decision five years ago regarding a whole life policy which he is reconsidering and sought my advice.

The issue of “whole vs. term and invest the difference” is something I cut my teeth on 40 years ago when entering this business as a full-time life insurance agent with Northwestern Mutual, and I became adept at promoting whole life’s virtues.

The debate is done best when refined: the best cash value insurance vs the most competitive term with the difference invested most effectively.  This client had a whole life policy that is superlative for two reasons:

  • Northwestern provides probably the best whole life value in the marketplace. (That’s why I spent 15 years selling them.)
  • The heavy front-end load has been paid on this one, so it’s elite.

Jim is a 56-year-old electrical engineer, with a homemaker wife, grown kids, 1.25 million in 401k/IRA’s, healthy emergency fund, and no debt.  He’s healthy and thinks he’ll live to late 80’s (though stats say mid 80’s), but either way is 30 years.

Keeping an old policy, where the onerous initiation fee (commissions) have already been paid, is very different than the question of buying a new one.

As I typically do, I got an in-force ledger, and NML shows the rate of return on the premiums with respect to the death benefit with insured dying at various ages.

Ruminate on these a bit.  Early death yields the greater return (but the odds are low), death at normal life expectancy is mediocre, and at older ages is even lower.  Whether the normal life expectancy’s 5% is “good” or “bad” all depends on alternatives.  After all it’s likely a 30-year investment for Jim.

This puts before us, on a silver platter, the essence of the decision.  “Insurance” is a misnomer for the inevitable, since as my favorite line from Brave Heart goes, “All men die.”  For Jim 95% of the premium goes into investment and 5% for insurance.  The investment portion goes mainly into bonds and mortgages with inherently lower returns.  The mortality aspect costs more than a term policy.  Expenses are exorbitant.

What if Jim redirected the NML cash value and premiums into other investments?  What would they grow to by normal life expectancy of age 85?

Such a 30-year (long-term) investment lends itself to equities with higher returns, albeit higher volatility too, for three reasons:

  • Life insurance is a longer-term investment than even retirement funding.
  • The dollar-cost-averaging nature of how premiums are paid in over decades.
  • The high expense load of a whole life policy hits your net worth far worse than dollar-cost-averaging into the worst possible equity investing scenario, e.g. starting off at top of market bubbles like Dec. 1999 or fall 2007.

Let’s see what’s at stake.  The Northwestern policy would have a death benefit at age 85 of $500k based on the current dividend scale with dividends buying paid up additional insurance.

If its current cash surrender value, along with scheduled premiums were redirected to alternative investments over the same time, it would accrue to these:

Qualifications:  I assumed with “Same cash flow” scenarios that Jim bought a comparable amount of term insurance to replicate the NML death benefit in event of an early death, reducing the cash flow into the alternative investment.  Jim is self-insured through other assets so won’t buy a term policy, making his investing alternative numbers a tad better than what’s shown here.

In a sense, this is a definitive comparison, bending over backwards to help whole life win, because I’ve cherry picked an elite commission-already-been-paid policy.  You can’t go out and buy something this good.

The engine that drives this comparison is equity investing at 8-12%.  I have monitored returns from various investment strategies and these are realistic, even the 12% that may seem like a stretch, if greater volatility is acceptable, as it should be when dollar-cost-averaging into an investment over many years.

The difference is invested in Roth IRA’s because it mimics the tax-free nature of life insurance death proceeds.  (Roth’s are tax superior overall.)  In my early years there was no comparable tax rival and even today NML’s ledger shows total insurance rate of returns assuming a 28% tax bracket, inflating the actual rate of return.  This is irrelevant when using the Roth, a nail in the coffin of whole life.  The other nails are higher equity returns, lower expenses via no-load mutual funds and ETF’s, and cheaper mortality cost through level term policies, which can be tailored to degree needed, rather than yoked to the investment, as in whole life.

In Jim’s case, since he already maxes his and his wife’s Roth’s each year, he will begin to fund Roth’s for his adult kids.  This is vulnerable to being unraveled, so must be done carefully.  But it also offers the opportunity to educate your kids about beneficial investing principles, rather than passively paying money to an insurance company for decades, probably worth the risk for the future generation.

Why do consumers miss out on the better opportunity?

  • Consumers are responders rather than initiators. The industry has an army of agents promoting cash value insurance, whereas alternative better uses of money has few advocates and depends on consumer initiative.
  • It’s easy to miss the dramatic advantage of 8-12% vs 5%. Consumers don’t know how to carefully evaluate; they may not comprehend opportunity cost.

In summary, when I look at least doubling the result for heirs compared to a five-year-old whole life policy with a premier company like NML, I can categorically say whole life policyowners ought to do like Jim and rethink.

So, what’s Jim going to do?  Cash out his NML policy and fund Roths?  Not so fast.  There’s often some salvage value in an old policy.  Many advisors make sweeping disparagements leading clients to throw the baby out with the bathwater.

Whole life is a poor long-term investment, but an old NML policy cash value earns an attractive dividend interest rate.  It’s cash value of about 50k is about the same as Jim’s emergency fund currently earning 1.2%.  If he takes a paid-up policy, then without future premiums, the cash value grows by 3.5% each year (aside from a little extra death benefit).  Earnings are tax-free until he recovers the loss he has in the policy.  This liberates his current emergency fund for equity funds for those higher long-term returns.

Buying a new whole life policy is rarely a good idea.  What to do with an old one is best decided with experienced counsel.  Your current need for coverage, your health, knowing the real dividend interest rate on your current policy, taxable gain at surrender, possibly consolidating it with another life policy or annuity to not waste a loss, Roth eligibility, investing strategies… all influence this “rarely” and “sometimes” decision.

 

 

 

Should I Drop My Whole Life Policy? Case Study #11

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This is a common question from clients unsure about what they have and a common recommendation from agents seeking to earn a new commission. Yesterday I talked to a Virginia client considering dropping a Lafayette whole life policy which he had purchased eight years ago when an agent recommended he replace a 20 year old Northwestern policy. Earlier this month a local client’s Edward Jones advisor recommended he replace a 30 year old Northwestern whole life policy with a new John Hancock policy. All of these were bad ideas.

At least three things drive these costly mistakes:

  1. it’s difficult for the consumer to understand the value of a cash value policy, since it’s a mixture of insurance and investment.
  2. the entire industry moves on agents pursuing commissions which only happens when new policies are sold.
  3. some respected financial advisors, e.g. Dave Ramsey, make generalizations disparaging whole life insurance.

I am not a fan of whole life insurance and rarely recommend a new purchase. (Though some companies and specific policies are much better than others and there’s a small niche for these.) However there’s a dramatic difference in purchasing a new policy and continuing an old policy that’s beyond the high early year transaction costs. Just because I don’t recommend new purchases doesn’t mean that I endorse casually dropping old policies. This decision is influenced by your age, health, investing alternatives, and largely the caliber of your policy.

Yesterday’s client should keep the Lafayette policy. An in force ledger revealed cash value earning 4%, and he already had a lot of cash earning next to zero. His immediate priority is putting his low earning cash to better use. He should have never bought the Lafayette policy to replace a Northwestern Mutual whole life policy, but that’s water over the dam now, and at least this time he’s getting advice before acting.

My local client averted a mistake by asking for an unbiased opinion first. Replacing a 30-year-old Northwestern policy with a new John Hancock policy would have only profited the agent.

Consumers don’t recognize commissions on a whole life policy are one to two year’s premiums (!), a flagrant violation of John Bogle’s eternal triangle principle of minimizing cost. It’s usually impossible for improved nuances of a new whole life policy to overcome such a blow. Adding insult to injury, switching from Northwestern Mutual to Lafayette or John Hancock were steps down in quality, only underscoring the lack of discernment and/or self-interest of the agent.

There’s another valid perspective on whether to keep a whole life policy. Whereas the Lafayette cash value was earning a net 4%, and that’s very favorable compared to a savings account, it’s unfavorable compared to long-term stock market returns averaging around 10%. And make no mistake, a life policy is a long-term investment if kept until death.

However for both these clients the cash values were a minor portion of their assets much of which were already invested in equities. Also each had a lot of low-earning cash which became the most-likely-to-improve candidate. Had this not been the case, replacement was more of a possibility, but for the sake of putting proceeds in equity returns and certainly not to buy another whole life policy. Client context can swing the decision either way.

If you’re tempted to cash in an old whole life policy:

  1. Understand what rate of return is being earned on its cash value. (Not the published rate, but the real rate.) It’s usually higher than alternatives of similar risk.
  2. Agents recommending replacing old cash value policies with new ones are often the fox guarding the hen house. Rarely can improvements overcome new commissions.
  3. If a financial guru categorically suggests replacing any whole life insurance he is often throwing out the baby with the bathwater.

What’s the take-away from these cases? ASK before you ACT. The Virginia client’s mistake eight years ago was an uninformed response to an uninformed agent. This time he’s ASKING. The local client averted a similar mistake by ASKING upfront. It grieves me to see such waste so easily avoidable. Calculating the true rate of return on your current policy is child’s play for me and my charge is small potatoes compared to what’s at stake. Proverbs 20:18.

Corollary: ASK an IMPARTIAL source. Ironically the supposed authority, the licensed insurance agent, precipitated these mistakes.

Qualification: We’ve been talking about old policies. If a whole life policy is less than three or four years old (before transaction costs have been paid) it may be best to discontinue ASAP, after replacing with cheaper coverage first, dependent on several considerations.

“I am an Insurance Salesman”: The Necessity of a Second Opinion Case Study # 9

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I just finished a case that started as a call to the radio show, Money Wise. This listener’s agent encouraged him to replace a whole life cash with a new term policy and put the $45k cash value in an annuity. “Term is cheaper and the cash value will earn more”, sounded plausible. Mark Biller of Sound Mind Investing was the guest and recommended he call me.

First I evaluated the whole life policy to see if it needed replacing and then assessed his overall need for life insurance. The cash value was earning 3.87%, much higher than money in the bank, but lower than long-term equity investments. This wasn’t bad, but it was an inordinate amount of his net worth tied up in a relatively low long-term return.

He was no longer married, and had a 22 year old independent working son and 19 year old student daughter. He already had two good life policies: the 150k whole life and a 200k term policy costing only 342/yr with level premiums for another nine years, more than long enough to see his daughter to independence. The agent recommended a new $400k 20 year term policy costing 1492/year. He didn’t need insurance for 20 more years and he didn’t need that payment.

…there comes a time when emphasis needs to shift from the what-if-I-die scenario to the what-if-I-live scenario…

He had a Roth IRA which he hadn’t been able to fund in recent years. He also had 200k of debt. He’s in his young fifties and dedicated to his children, however there comes a time when emphasis needs to shift from the what-if-I-die scenario to the what-if-I-live scenario. Also, one should never fund an annuity (tax-deferred) when eligible but not funding a Roth (tax-free).

We returned the annuity and rejected the new term policy. The dividends on the whole life policy had bought paid up additional insurance which we surrendered for 13k of the 45k cash value. He will use that to fund his Roth for 2013 and 2014. We’ll keep the whole life at least until Roth funding is due for 2015, then maybe whittle it down further or discontinue it altogether if his daughter becomes independent. He’ll apply that extra $1492 to his mortgage.

I explained the rationale behind these decisions to the agent. He acknowledged it made sense, but then added, “I am an insurance salesman”. That code language meant, “My responsibility is to sell policies; besides I’ll forgo a $1k commission if I don’t place the life policy, aside from the $1500 commission I lost not placing the annuity.” I respected his candor and expected him to try to place this term policy. Indeed he did, but my client had a balanced understanding of the risks of both rejecting the policy (premature death) and accepting the policy (opportunity costs) and stood firm.

It’s not a matter of understanding, but of motivation. What saved this client was reaching outside the traditional box of advice exclusively from a salesman, and getting input from someone who understood insurance nuances and the marketplace, investment alternatives, and had the proper motivation. His retirement should be larger, his debt and taxes smaller, while he saves his fee back three times per year for two decades. It started with a phone call.