An Open Letter to Federal Regulators

I welcome and applaud the federal government’s interest in the regulation of our nation’s insurance industries and markets. In response to the Federal Insurance Office’s request for comments on the “gaps” in state regulation, I appreciate this opportunity to present my views. Indeed, your request, Director McRaith, for comments upon such “gaps” seems to reveal what a keen, yet heretofore unpublicized, good sense of humor you must have. To very briefly introduce myself, I am an economist, a CFA and a life insurance agent of more than 20 years who has worked with scores of life insurers. My views have been published by the Journal of Insurance Regulation, the American Council on Consumer Interests and various other industry trade publications. My positions are based on my extensive experiences with our nation’s profoundly problematic state-based insurance regulatory system, problems that those who have not been intimately involved with in the marketplace might find inconceivable. State insurance regulators have never required the proper disclosure of cash value life insurance policies. Markets do not work properly without adequately informed consumers. While life insurance is, conceptually, a simple product, without the proper conceptual understanding of and the necessary relevant information, consumers cannot effectively search for good value. “The Life Insurance Buyer’s Guide,” published by regulators and mandatorily distributed with policies by insurers and their agents, is not just a little deficient—it is misleading, seriously incomplete and defective. And, it, in all of its various state editions, has been that way for almost 40 years. Professor Joseph Belth has written about this national problem for more than 40 years. In 1979, the Federal Trade Commission issued a scathing report on the life insurance industry’s cash value products. Cash value policies are composed of insurance and savings components, and consumers need appropriate information about both. This specifically requires appropriate disclosure of these policies’ annual compounding rates on consumers' savings element as well as annual costs regarding their insurance element. Both Professor Belth and I have separately developed very similar disclosure approaches. (More information about my approach and its comparative conceptual and marketplace tested-advantages is available on my website or upon request.) The exceptional nature of this regulatory failure can be grasped by specifically contrasting the states’ regulatory track record on cash value policy disclosures with those of other financial regulators’ actions. Investment product disclosures have been mandated since the 1930s. Truth in Lending was enacted in 1969. And yet, while a consumer’s potential risks in making a poor life insurance purchase can arguably be shown to be greater than those in purchasing a poor investment or obtaining an unattractive loan, Truth in Insurance or Truth in Life Insurance legislation has never been promulgated by any state. A second insightful perspective, and one with much more tangible consequences on its harmful impacts on consumers, can be grasped by reviewing a few basic facts about the current life insurance marketplace. Three Facts Fact No. 1: The life insurance marketplace is awash with misinformation; this should hardly be surprising. Life insurers actually run misleading advertisements and conduct training in deceptive sales practices. Evidence of such has been repeatedly submitted to state regulators. Moreover, given the industry’s commission-driven sales practices (commissions that can make those of mortgage brokers, now notorious for their own misrepresentations, look tiny), sales misconduct is pervasive. The harmful consequences of such agent misrepresentations are manifested every day, both directly and indirectly, in unwise purchases or other costly life insurance mistakes by American families. These misrepresentations go unrecognized because of consumers’ inadequate financial grasp of a product’s true conceptual framework, and these go unpunished because, as a past president of the national largest agent organization has written in widely quoted published articles, state laws prohibiting deceptive life insurance sales practices have virtually never been enforced. Fact No. 2: Cash value life insurance policies that are sold to be lifelong products have extraordinary high lapse rates. Data shows that over an eight-year period, approximately 40% of all the cash value policies of many life insurers are discontinued. It is true there are many possible causes for consumers to discontinue coverage, but age-old evidence of consumer dissatisfaction has been a virtual five-alarm that state regulators have ignored for more than 40 years. Such lapses are especially financially painful to consumers, as the typically sold cash value policy has huge front-end sales loads (sales loads regarding which agents are trained to make misrepresentations). It is very important that all readers fully understand that, contrary to pervasive misconceptions and misrepresentations, cash value policies do not avoid the increasing costs of annual mortality charges as a policyholder ages. The fundamental advantages of cash value life insurance products come from the product’s tax privileges. Tax privileges, however, are essentially a free, non-proprietary input. In a competitive marketplace, firms cannot charge consumers or extract value for a free, non-proprietary input. No one pays thousands of dollars in sales costs to set up an IRA. Cost disclosure will enable consumers to evaluate cash value policies by the policies’ price competitiveness and, as such, will drive the excessive sales loads out of cash value policies. The heart of the battle over disclosure is that disclosure threatens to—and, in fact, will—undermine the industry’s traditional sales compensation practices. For example, over the past five years, Northwestern Mutual, the nation’s largest insurer, with $1.2 trillion of individual coverage in force, paid $4.5 billion in agent life insurance commissions and other agent compensation, while its mortality costs for its death claims were only $3.5 billion. (Northwestern paid more than $12 billion to policyholders surrendering their coverage during the same five years.) Agents, naturally, do not like the idea of reduced compensation, but their arguments are not compelling. Insurers believe little life insurance would be sold without such agent compensation; that is, that the large and undisclosed agent compensation cash value policies typically provide is, 1) necessary to compensate agents for their sales efforts and yet, 2) could not be obtained from an informed consumer. My position is that good disclosure on life insurance will drive the excessive and unjustified sales loads out of cash value policies, making them price competitive with pure-term policies, thereby enabling consumers to truly benefit from the product’s tax privileges. Also, product cost disclosure is an essential component of any fair business transaction (and, as all readers properly educated about life insurance know, a cash value policy’s premium and annual cost are different.) Fact No. 3: It is undeniable that the sales approaches used today are not effective. Unbiased experts have, for decades, demonstrated that Americans have insufficient life insurance. In August 2010, the Wall Street Journal's Leslie Scism reported that levels of coverage have plummeted to all-time lows. Contrast that with data showing consumers’ ever-increasing voluntary purchases of additional coverage via their employers’ group life insurance plans. Marketing research shows that fear making a mistake is the primary reason consumers avoid or postpone purchases and financial decisions. Inadequate disclosure on life insurance policies not only prevents consumers from being appropriately informed; it is also a main factor in their avoidance of the very product they so often need. I predict publicity of appropriate disclosure will lead to: unprecedented sales growth, policyholder persistency, different levels of coverage, positive impacts on all other measurements of satisfaction regarding consumers’ future life insurance purchases and life insurance agents becoming trusted and esteemed professionals. Admittedly, appropriate disclosure could lead to litigation over agents’ and insurers’ prior misrepresentations. As I think you may now understand, inadequate life insurance policy disclosure is a regulatory "gap" that is virtually the size and age of an intergalactic asteroid. Other Gaps As it is currently marketed, long-term care insurance (LTCI) constitutes another serious problem. While, theoretically, LTCI can make sense, the devil is in the details. Essentially, LTCI is a contingent deferred annuity, yet one where insurers retain an option to increase the premiums for entire “classes of insureds” and where consumers must confront post-purchase price risks without the information necessary to assess alternatives. Furthermore, consumers cannot transfer their coverage to a new insurer without forfeiting the value they’ve previously paid. Defective LTCI policies have let consumers be shot like fish in a barrel; in fact, the policies' inherent unfairness makes loan sharks envious. Appropriate disclosure on LTCI would bring consumers drastically superior value and understanding. Regulation of life insurance agent licensing is incredibly deficient. Agents should truly be financial doctors. However, states' agent licensing requirements fail to make sure consumers are served by financially knowledgeable professionals; licensing exams are a joke. While there are many competent agents, it is quite possible that the overwhelming majority of agents—many of whom are new and inexperienced, as more than four out of five recruits fail in the commission-based environment within the first few years—do not possess the basic knowledge necessary to accurately assess a consumer’s needs or to properly evaluate different companies’ policies. There is virtually no state regulation of fee-only advisers who charge for providing advice about life insurance industry products. Such individuals can cause harm to consumers in multiple ways: improperly assessing needs and evaluating policies and recommending policy terminations or other actions (beneficiary or ownership changes, inappropriate policy loans, etc.) that lead to policies being mismanaged. To my knowledge, the only state that actually requires licensing for fee-only advisers is New Hampshire. A cursory review of public records, however, reveals shocking omissions in New Hampshire’s enforcement of such rules. One of the state’s former insurance commissioners, who for years has operated a prominent website providing and charging for advice on life insurance, has never been licensed. Agent continuing education (CE) requirements are problematic. Outdated courses are still deemed acceptable, similar courses can be submitted virtually indefinitely to fulfill bi-annual CE requirements, and many courses are so devoid of meaningful information that they are vacuous. While the potential merits of CE are undeniable, only serious testing and recordings provide the means of monitoring the true effectiveness of instruction and learning. Another area for improved regulation concerns the insurer-agent relationship. This is not to suggest draconian involvement by the government, rather to recognize the legitimate public interests in properly structuring such relationships—just as is done in relationships between pilots and airlines, construction workers and contractors, nurses and hospitals. The contracts between insurers and agents show unequal bargaining power. Insurers have not only exercised their power unfairly but have—possibly illegally—prohibited certain agent conduct, while requiring other, on matters clearly outside the boundaries of the contract. Attorneys specializing in franchise law have stated that the typical agent’s contract is the most one-sided arrangement they have ever seen. Over the past 20 years, I have written many articles and submitted extensive documentation of sales and managerial fraud in the life insurance marketplace, yet no one with any marketplace authority or power has ever taken any effective action. Nonetheless, my commitment to reform the life insurance industry and marketplace remains. In fact, while federal regulatory action and any other private assistance would be greatly appreciated, all that is needed for the transformation of the age-old, dysfunctional life insurance industry is the dissemination—the genuine and effective mass market dissemination—of the type of life insurance policy disclosure information that is available on my web site, BreadwinnersInsurance.com. [The full version of this letter is available on the site.]