Don’t You Want To Protect Your Family?

November 8, 2013
"This is the accelerated benefits rider, this is the waiver of premium clause, and over here we have OH GOD JUST KILL ME NOW"

“This is the accelerated benefits rider, this is the waiver of premium clause, and over here we have OH GOD JUST KILL ME NOW”

 

Now that we’ve gotten Wednesday’s cash grab out of the way, a question that’s puzzled us for years:

How the hell do life insurance agents make money? This ties into one of our Supreme Commandments of Personal Finance (we can’t say “10” because the number changes, and besides it’s probably closer to 3):

Always look at each transaction from the other party’s perspective.

If you’re buying, what does the seller stand to gain from this? Is he (it’s a guy in this example) making enough on the sale to vacation in the Bahamas for a month? Or is he working for The Man, and merely avoiding getting fired for another pay period by getting you to buy a country club membership? In other words, how much wiggle room does he have?

Conversely, how much will the buyer benefit from what you’re selling? Obviously, you’re not going to keep a tally for every single transaction in your life, or you’d never do anything else. Your purchase of a 99¢ Big Gulp® at the 7-Eleven is not a staring contest between Southland Corporation’s predatory pricing and your hard bargaining. But be pragmatic. A) Don’t leave money on the table, and 2) Know when to walk away from a deal, because there will almost always be another one.

Back to our mystery. With no bipedal dependents, we at CYC Headquarters are long past anyone trying to convince us that life insurance is a good investment. But tens of millions of other people do spend money on life insurance, and are convinced that doing so is the only thing preventing their offspring from ending up in an orphanage, in a poorhouse, as a stowaway on a merchant ship, or as part of some other Dickensian relic.

We went to MetLife’s website, plugging in the numbers for a 40-year old male in “great” health (the level between “excellent” and “good”) who doesn’t suck on those filthy disgusting cancer darts. The site prompted us to select a state of residnecy, so we chose the nation’s most populous. A million-dollar, 20-year term policy for a Californian costs $106 a month. The agent gets, say, 15% of that. So, $16. For maybe a couple of hours’ work. Of course, selling life insurance policies isn’t quite like selling Girl Scout (or for our Canadian friends, Girl Guide) cookies: the standard inclination is not to buy, and to avoid the salesperson if possible. Assume a generous lead conversion rate of 10%, and your typical life insurance agent appears to be working for far less than minimum wage. At least recyclable soda can collectors can show up to their daily grind in something significantly more casual than Western business attire.

Except our commission estimates were miles off. A professional connection of ours explains that the scale is anything but uniform. In fact, it goes more like this: 75% in the 1st year, 10% in the 2nd, then 0. Clearly, the agency can afford to be so generous to the agent on the front end because at any given time, only 5% of 20-year policies are in their 1st year. (We used math for that.) Still, average it out over the life of the policy, and the commission structure still seems pretty skinflinty. On the other hand, front-loading it saves all but the lowest-performing rookie agents from starving to death.

A declining commission schedule means that the pressure to sell is never not there. Residuals and royalties are for musicians, not for insurance agents. The idea of selling a policy and enjoying its commission in perpetuity, or at least for the life of the policy, doesn’t exist. While other industries (Wall Street, the military) can afford to bring as many unproven recruits in as possible, allowing for plenty of attrition while a small fraction of those recruits make a long career out of it, life insurance don’t play that way. Hiring fresh college graduates no longer makes economic sense. Rather, the trend is toward hiring established, middle-aged financial professionals with impressive client lists and a penchant for estate planning. Which is probably better for all concerned.

All in all, hawking life insurance still sounds to us like a stupendously difficult way to make a living. Add that to the list of real jobs that we’d rather die than do. Not that anyone reading this was necessarily contemplating becoming an insurance salesperson, but at least we have a better grasp of how an occupation that seemingly makes no financial sense, does. To some extent. Our formula for building wealth remains unaltered: the more sources of passive income you have, the less you’ll have to rely on your own ability to perform the mundane. Monthly rent checks and quarterly dividends beat monthly pittance commissions, at least in our admittedly biased world.

Filed Under: Insurance Tagged With:

Whole Life Insurance, a/k/a Actuarial Rustproofing

April 11, 2012

"Those few inches of air between your underbody and the road can MURDER a car, lemme tell ya..."

 

Life insurance is supposed to keep your survivors’ financial lives operating without interruption should you buy the farm. If you’re rational enough to acknowledge that you might die and leave dependents, but not so rational as to compare the likelihood of you leaving your family destitute with the price of insurance, then perhaps a term policy is for you. You pay fixed amounts on a regular schedule, and if you fulfill your part of the covenant by dying, your family is covered.

With a term policy in effect for a fixed number of years (hence its name), the term expires and you buy another policy. If you survive the term, you spend thousands of dollars and receive nothing of value except the intangible quality of “protection”, which it turns out you never needed. Incredibly, it’s easy to make the argument that this type of policy, the one that gives you a -100% return, is the best type of life insurance. Beyond term insurance, sometimes people looking for coverage kid themselves into seeing life insurance as an investment, rather than a financial fire extinguisher that will probably spend its entire existence mounted in a bracket in your kitchen.

Over time, financial instruments always increase in complexity proportional to their profit margins (a recently discovered economic law, temporarily dubbed “McFarlane’s Shift”.) In that spirit, the insurance industry created classes of “investment” policies that went beyond term life insurance. These (in chronological order of invention; whole life, universal life and its variants) claim to foster your money’s growth, something term policies don’t do.

“Whole life” policies aren’t in effect for a fixed term, but rather – appropriately enough – the holder’s whole life. They carry a cash value that’s accrued throughout the duration of the policy. Not that there’s anything wrong with cash values in and of themselves, but investing and insuring are different objectives. To confirm that, if you die while your whole life policy is in effect, your beneficiary doesn’t get the cash value. Just the death benefit.

It’s sound financial advice to look at each transaction from the other party’s perspective. Is this exchange value-for-value, or is someone getting the short end? An insurer who moves you from a term policy to a more expensive whole life one incurs zero additional risk. That excess is pure loss for one party, pure profit for the other. Most mutual funds will almost certainly offer a better 30-year return than the modest percentage points you can expect from a whole life policy.

Understand opportunity cost. The money you invest in a whole life policy is money you now can’t spend elsewhere. Investing is one thing, protecting your family is another. If it’s protection you want, then it’s protection you should pay for.

A universal life policy is similarly pricey, one major difference from a whole life policy being that with the latter, you can modify the death benefit (and thus the premia) through the policy’s duration. If you increase the premium, the surplus goes into investments that aren’t subject to income tax, but that must be approved by your insurer. And the holdings are protected from creditors. In other words, only use this if you’re a rich person looking for a tax shelter. When you die, your polo-playing granddaughters can settle the tax bill with universal life proceeds.

But even with a basic term policy, the young father who thinks he’s prudent by “taking care of” his stay-at-home wife and bevy of offspring can easily forget that time progresses. Your kids aren’t always going to be financial drains. (Hard to believe, but it’s true.) Your earning power will likely increase throughout your career. And your investments, if you choose wisely and start early, will increase too. If life goes like that, according to something resembling a plan, then any money you’ve spent on life insurance has been wasted. This despite what any insurer might tell you.

If you’re retired, or getting there, life insurance is likely a losing proposition regardless of your net worth. Your family should depend less and less on your income as the years progress. Which is a cause to rejoice, not to buy insurance. And of course the older you get, the greater your monthly payments. Your cardiologist might care that you’re running 30 miles a week. Your insurer, less so.

There are even people who buy life insurance policies for their children, which is the equivalent of issuing a formal declaration of war on your money. The rationale among some parents who buy such policies is that were the child to die, the parent would be so distraught that she couldn’t bring herself to ever again function at a job. Tabling the ethical question of why suffering a tragedy would disqualify someone from being productive, why would you spend disposable income on something that pays a return only if your child dies? There are cheaper ways to tempt fate.

It’s hard to win with life insurance, especially the investment class of life insurance. If you want to leave a legacy for the succeeding generations, there are Dow stocks, index funds, blue-chip stocks…even the most conservative investments give you less risk of loss (if you buy term) and far less overhead (if you buy an investment policy.)

This article is featured in:

**Baby Boomers Blog Carnival One Hundred Thirty-eight Edition**

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Request of the Week

April 11, 2010

"You want to hear 'Freebird'? Yeah, we'll get right on that."

We’d never solicited requests at Control Your Cash, but then Twitter follower @JSmisko sent us the following tweet:

@CYCash If u have done a blog on life ins, plz repost for me. Thx.

Rather than ask why he didn’t spell all the words in full with the 66 remaining characters Twitter allotted him, we’re indulging him.

We don’t spend a lot of time on life insurance in the book because life insurance is a waste of money unless you* earn an extraordinarily high income or have expensive dependents (e.g. a blind and retarded daughter with spinal meningitis.)

You pay an insurer a monthly stipend, and if you die your beneficiary gets paid. There are two major classifications of life insurance – term and the less common permanent. “Term” means you buy it for a fixed period, usually 10, 15, 20 or 30 years, and pay similar monthly premia throughout. However, the premia can rise (or less likely, lower) throughout the term. If you contract HIV 4 years into a 30-year policy, your insurer will want to know. And will probably have a right to know via a medical exam, if you read the fine print in your policy (which you won’t be receiving anyway, because as we’re establishing, life insurance is a waste of money.)

If your term policy ends with you still alive, you could argue (as we do) that you wasted 10, 15, 20 or 30 years worth of premium payments. Or you could do like most life insurance customers do, and keep renewing. The older you are when a term starts, the higher your premia; which makes sense, seeing as you’re closer to death. This is why customers who are committed to the concept of term life insurance will usually buy for as long a term as possible.

If you’re a 30-year old man, chances are you’ve got half a century or so before you kick, less if you’re dumb enough to smoke. Of course your income will vary throughout any insurance term, but it’s reasonable for the insurer to assume that your income will rise throughout your work years then decrease once you retire. The insurer calculates the likely existence trajectory of someone in your position, then determines that a typical term policy for someone like you should cost around, say $100 a month. If you die via a cause approved by your insurer (who probably won’t let you, say, jump in front of a train and then have your wife and kids expect a windfall), your beneficiary will get something like $125,000.

But you’re almost certainly not going to die during the term. In any event, your wife can work. (If you don’t have dependents, you must really hate money in order to own life insurance.) Besides, well before your 30-year term elapses, your kids should have stopped relying on you to provide for them anyway. That $1200 a year can go into far better investments, ones that don’t require you to die.

And term is the best kind of life insurance.

In general, permanent coverage is subdivided into whole life insurance and universal life insurance. Whole life insurance remains in effect for…well, your whole life. A long time ago, thousands of term policyholders made it to the end of their terms without dying and wondered why they’d bothered spending all that money. Thus the insurance industry invented whole life insurance, which charges higher premia. The insurer invests the excess, creating a cash value that it offers to you should you ever want to cancel your policy. By the way, if you die while the policy is in effect, your beneficiary doesn’t get the cash value.

The problems with this are plentiful and clear. For the increase in what you pay, the insurer incurs no additional risk. That excess is pure profit to the insurer. If the cash value is the aspect that excites you about whole life, then you aren’t really insuring, you’re investing. If you’re going to invest, there are better ways to do it than with a whole life policy. Pick a mutual fund at random at Yahoo! Finance and it’ll almost certainly offer a better 30-year return than the 2% or so you can expect from a whole life policy.

Universal life insurance is similarly confiscatory for most people, except you have the option of paying more than your monthly premium and having the excess go into investments managed by the life insurance company.
Chew on that. This kind of policy only makes sense if

a) you’re rich enough to overpay for things,
b) yet you’re not rich enough to manage your own investments.

If something appears to be financially illogical, there’s probably a legal reason involved. There is. Universal life insurance investments aren’t subject to income tax, so rich people use them as shelters. When a rich person dies, the IRS will come for its pound of necrotizing flesh, which the estate will then settle using the universal life insurance proceeds. Even though the insurer ostensibly manages the investments in a universal life policy, if a policyholder is rich enough, she’ll tell the insurer what investments to “recommend” to her. And like all insurance policies, universal life policies are protected from creditors, too.

You can’t win with life insurance. Your death, while a foregone conclusion, is hard to predict the date of. In fact the more accurately you can predict the date, the less likely you’ll be to find a company willing to insure you. And the higher the premia you’ll pay. If you want to invest for your descendents, try index funds, blue-chip stocks…even something as conservative as a certificate of deposit offers you a comparable return with way less risk of losing your investment (if you buy a term policy) or way less overhead (if you buy whole life or universal life.)

*As opposed to your investments earning a high income, which your existence shouldn’t have a bearing on.

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