RISCARIO INSIDER

March 30, 2014

WHEN CAN INSURERS CHARGE MORE FOR THE INSURANCE YOU ALREADY OWN?

Insurance companies make mistakes which cut into their profits. This is called underpricing and happens more often than you might expect. Sometimes assumptions prove wrong and other times matching the competition causes the trouble.

Can the insurer charge you more for the insurance you already bought?

When Prices Can Increase

Some products have premiums which adjust annually (usually upward). You’ve probably noticed that with your car insurance and home insurance. The premiums for employee benefits (e.g., hospitalization, prescriptions, dental care, disability) also change but you may not know. Since that’s one of the two types of insurance you can’t own, your employer can cut back on benefits to save money.

If you’re not happy with your insurer, you’re free to switch companies with no penalties and little effort. When prices go up, you can also reduce or cancel your coverage, which exposes you to more risk.

Where You Have More Protection

You face problems when you buy insurance with premiums based on your health. If your health deteriorates, switching to a new company will cost more — if you can even get coverage. Put differently, you’re stuck with your insurer. You have no recourse against their premium increases.

Guarantees reduce the insurer’s flexibility to make changes. Since you’re protected from surprises, you pay more. You also get much more. The level of guarantees depends on competition and regulation.

Example: Long-Term Care Insurance

Imagine buying a Lexus for $5,000 down plus $500 a month under a contract that allows the dealer to raise the monthly payment if he wants to. Six months in, it goes to $800, and you have a free choice between paying up or handing in the car and losing your down payment. That would be a ridiculous contract to sign. LTC [Long-Term Care insurance] buyers sign contracts like that.
— Forbes (Aug 2013)

Here’s a sad example from the world of Long-Term Care Insurance in the United States. By 2012, half the top 20 insurers stopped selling new policies (though you can likely keep coverage you already have). Premiums keep going up.

John Hancock is boosting premiums by an average of 40%. Some clients are paying much, much more. Would you believe 90%? That’s what a couple in their 60s faces as their annual premiums jump by $3,958.74 from $4,398.61 to $8,357.35.

"We bought these policies because this [long-term care] is the only insurance you really need. Long-term care will eat up all your assets. We were told when we first bought the policies that the rates could go up, but 90% seems outrageous." — John Holtzman, age 67

To offset the increases, this couple is planning to reduce their protection. That puts them at greater financial risk. Cancelling coverage would be worse.

What Went Wrong?

“… the industry over all made incorrect assumptions when it set premiums for older policies — particularly, those issued before 2002 — and didn’t set rates high enough. For instance, far fewer people than anticipated let their policies lapse. And interest rates in recent years have been much lower than expected, making it difficult for companies to earn adequate returns on invested premiums.” — Thomas J McIrney, Genworth CEO

Long-Term Care insurance usually pays a daily benefit if you’re unable to perform two or more activities of daily living such as bathing or eating. The money can go towards help at home or a nursing facility.

The Problems

Problems arises when

you think you have guarantees but don’t
you don’t explore the guarantees you have
you know premiums can increase but don’t examine the “worst case scenarios”

The best time to find out is when you have the most options: before you buy.

March 23, 2014

WHY BILLIONAIRES BUY LIFE INSURANCE

If I had a million dollars, well, I’d buy you an exotic pet. Yep, like a llama or an emu. — Barenaked Ladies

If you had a billion dollars, you could buy a whole zoo. Or $201 million of life insurance. That record-breaking purchase happened in California. The premium is about $2 million a year but cost-effective — perhaps even a bargain.

Self-insure?

Billionaires have the money to insure themselves to

pay medical expenses: no need for medical expense insurance
offset the costs of life-changing diseases: no need for critical illness insurance
replace income if unable to work: no need for disability insurance
provide lifelong income: no need for life annuities

Some afflictions have no cure at any price (and hence no insurance). RIP Steve Jobs (pancreatic cancer) and Warren Buffett’s wife Susie (oral cancer).

Life insurance is different. Large amounts are available and there is no substitute. Even so, why would a billionaire buy coverage?

Maintain Privacy

Life insurance protects the privacy of the buyer. Despite the media scrutiny, the owner of the $201 million of coverage remains anonymous. We know the gender (male) but not the age. The seller is ‘not legally permitted to disclose the name of the billionaire buyer but said it was a well-known Californian tech investor’ (Forbes). The insurers can’t say either. We wouldn’t have known about the purchase if the buyer hadn’t given permission for limited disclosure.

Since death benefits rarely through an estate, the beneficiaries need not be identified.

Have Flexibility

The beneficiaries are not notified until the time of a claim. This allows the buyer to change the beneficiaries and how much each receives.

The buyer can cancel or adjust the amount of coverage. In the case of the $201 million of coverage, the owner says that "he wants his next of kin to keep working hard" rather than waiting for a payoff.

The owner can reduce flexibility by making the beneficiaries irrevocable. This may be required upon divorce.

Save Or Grow A Business

A growing business may need outside money from lenders or investors. Those supporters want some assurances. The business might collapse upon the death of a key person like the owner, especially in the early years.

Ted Rogers is an excellent example. His dad died when Ted was only five: "He didn't have a lot of life insurance at that age, so the businesses were sold or shut or stolen."

In building Rogers, Ted borrowed from banks many times. They required he
have life insurance payable to them as protection. Term life insurance is ideal here --- the most coverage for the lowest price. Later, the temporary coverage can be made permanent for tax planning and estate planning.

DiversifY

You can put all your eggs in one basket and have that basket watched 24 hours a day. That doesn't mean problems won't arise. That basket may not be diversified. Billionaires have lost their fortunes (e.g., Allen Stanford, Sean Quinn, Patricia Kluge). Celebrities have gone broke too (e.g., Abraham Lincoln, Mike Tyson, Michael Jackson).

A solution is to invest in different classes of assets. Permanent life insurance allows, tax sheltered growth, tax-free access via leveraging and a tax-free death benefit. The payout is a predetermined amount at an unpredictable time (death). No other asset offers these characteristics.

Investments inside insurance may fluctuate and lack guarantees. That's true of investments outside life insurance too. However, permanent life insurance keeps growing in value because the date of death keeps getting closer. Can other investments make that claim?

What if an insurer goes bankrupt? There may be protection in those cases (e.g., by Assuris in Canada or a state government in the US). The risks are reduced by spreading coverage over multiple companies. The $201 million of coverage is spread over 19 insurers, each at risk for less than $20 million.

Pay Estate Liabilities

At death, large sums may be required to pay taxes and other obligations such as loans. Permanent life insurance is often the cheapest, fastest way to get cash for those liabilities. Also, there’s no need to have a rush sale on assets at an inopportune time. As a result, more of the estate gets preserved.

Caveats

Life insurance is only available to the healthy. The unhealthy pay more (e.g., smokers). Sometimes the risks are so high that no coverage is available at any price.

There are limits to how much coverage is available on one life. Maybe $201 million is less than the buyer wanted. Insurers want to prevent incentives for

murder (example the ‘professional hit’ on Claude Dray)
suicide (George Bailey in It's A Wonderful Life?)

If the coverage gets cancelled before death, there won't be a payout. It helps to earmark money to pay future premiums.
If affording the life insurance becomes a problem, some jurisdictions allow the sale of the policy to an investor. These life settlements get icky because the buyer gets a higher return the sooner the death.

Surprises

Apparently, the advisor behind the $201 million of insurance (Dovi Frances) didn’t get paid a commission. The firm (SG LLC) “charges clients a flat (and one can assume, steep) annual fee for advisory services ranging from asset management to alternative investments.”

The advisor got the client 4-5 years ago through a direct mail campaign.

Smart

Billionaires have access to excellent advice from top advisors. They do buy life insurance. How about you?

Links

PS There may be larger life insurance coverage on billionaires who value their privacy more than a Guinness World Record.