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.

 

 

 

The Advantage of Using a Multi-company Insurance Brokerage Firm; of Backdating; of Paying Premiums Annually Case Study # 13

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I just finished a case that illustrates the advantage of using an insurance brokerage firm representing many companies versus a single company, even a good one such as Northwestern Mutual, State Farm, or USAA.

The best offer my normal go-to company would provide this client was Preferred rather than Preferred Best, because she uses anti-anxiety medication. However the insurance brokerage firm which I suggest for many clients (but from which I receive no commissions, in case you’re wondering) uses a generic application, so without her having to sign additional paperwork they automatically switched her to Metropolitan who issued her Preferred Elite. Met had no problem with her mild medication and the premium difference was 21% less for 15 years. This brokerage firm routinely uses over 30 companies and shuffles risks around based on health conditions, medications, avocations, and occupational hazards, for optimum offers. Insurance underwriting departments have personalities too, and some are more tolerant of certain risks.

We also backdated the policy to be issued at a younger age for a lower premium. Backdating is a common practice allowing the policy to be issued up to six months earlier to gain a younger issue age, for lower lifetime premiums. The downside is you pay premiums for a period when you had no coverage, so you have to weigh the savings against the waste. After careful calculations, even if this insured backdated the maximum allowable time of six months the future savings represented a 16% after-tax return on the “wasted” premium. However she only needed to backdate for three months meaning the future savings represented a 36% tax-free return. It makes me wonder why it’s not automatically done, however agent commissions are a percentage of premium and an older issue age means higher premium, so there is a disincentive to do so.

The final piece of advice which I’ve devoted an entire blog to in the past is the advantage of paying annually versus quarterly or monthly. Sometimes this is a budget issue (can’t afford to pay annually) but the financing charge inherent in a monthly payment is typically 10%. If you take the money out a savings to pay annually, you save a lot more interest than you would earn leaving your savings account intact.

All of these improvements are small nuances compared to the big picture (right-sizing the policy, a competitive company, the right type, etc.) but collectively they are weighty. Once a policy is launched it’s usually carried for decades if not a lifetime, so trimming the premium down upfront is certainly worth the effort

Which Insurer Will Treat You Best?

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I finished two cases in December that each took over half a year to wrap up. Very unusual. They had other similarities too: minor health issues, over insured by major insurers, with young children yet oblivious to Social Security survivorship benefits, and best of all, their improvements were outstanding. These type of improvements motivate me.

The first client was a pharmacist with a State Farm $750,000 20 year term, issued nine years ago, costing 140/month, and rated table 2. His health condition had improved so we asked State Farm if they might reduce the rating, but they would not. I have my auto and homeowners insurance with State Farm, but they are no leader in life insurance. We first right sized his policy since he had young children with substantial Social Security survivorship benefits he did not know about. His assets had increased and debt reduced since he purchased the policy and he and his wife felt comfortable reducing it to $500,000. The new 15 year level premium policy (four years longer than the current one) was issued at Standard Plus for $505/year. He’ll save nearly $1200/year.

The second client was a young engineer whose pharmacist wife had a Northwestern whole life policy with a large loan. A Lincoln life agent was encouraging her to roll this into an annuity. The agent had sold each of them a $1.5 million term policy, and after carefully evaluating their survivorship goals and how they were already self-insured through current assets we reduced her coverage to $500,000 and his to $750,000. We also reduced the Northwestern to shrink the policy loan. Its cash value was earning an attractive dividend interest rate, and putting it through the commission ringer for the annuity unnecessarily whittled down its value.

Lincoln would not permit her to reduce her current policy which was excessive as per their goals. The engineer’s weight was a tad above the guidelines for the best risk category, so over several months he dieted to get below the threshold and ended up getting Preferred Best rates. I directed him to an insurance brokerage company representing many companies. The best risk category with a super competitive term specialist, along with rightsizing the policy, saves them $1440/year on term premiums, while reducing loan interest to Northwestern, and avoiding annuity commissions.

Periodically ask yourself– how did you came up with the amount of your policy? do you understand Social Security survivorship benefit? and have things changed? One last similarity: they will each save my fee back 1.4 times per year for many years, likely totaling 18K for one and 30K for the other. That’s a 140% annual after-tax return on their fee.

Neither the “Good Neighbor” company nor the one named after America’s favorite president served these clients as well as a specialist whose name you wouldn’t recognize. Knowing which insurer will treat your risk factors best and how to put your best foot forward is why there’s no such thing as a “good” company for all insureds. The risk category you are assigned can make a “good” company not so good after all.