RISCARIO INSIDER

March 24, 2012

THE PERILS OF WHOLE LIFE INSURANCE

Opinions on whole life insurance get fiery. Advisors who sell it tend to be older. Whole life was probably the first product they sold. They've learned how to position it and deal with objections. They've convinced themselves of the merits. Criticize whole life and you're in for an argument.

Over the years, advisors have said that whole life pays higher compensation than any other life insurance product. Let’s ignore that. Let’s get to the core question: why do you buy insurance? To transfer risk to the insurer.

Whole life transfers risk back to you. Is that what you want?

Rejoice?

Tax refunds feel nice but why do you get them? Because you overpaid. Insurance dividends feel nice but why do you get them? Because you overpaid.

With participating whole life insurance, you pay more than the insurer needs. The insurer conservatively projects mortality claims, expenses and investment earnings. If actual mortality claims are lower, you get a dividend. If expenses are lower than projected, you get a dividend. If investment earnings are higher than expected, you get a dividend. That's nice but there's the other side.

Your dividends could be lower than you expect. Here are three examples.

AIDS: in the 1980s, AIDS became a concern for insurers who sold guaranteed products. There was no problem with par whole life since higher mortality claims simply meant lower dividends. If Hollywood is to be believed, there are epidemics and scourges waiting for us. With whole life, you get to share in the cost.
Y2K: upgrading computer systems was pricey. With whole life, higher expenses simply mean lower dividends. Who knows what might lead to higher expenses in the future?
Investments: with whole life, you're stuck with the returns on the investments the insurer selected. Maybe you wouldn't have done better but you would have had choices. If you’re not good at deciding, your advisor is there to help you.

Rather than return your premium overpayments to you, your advisor may encourage you to spend on more insurance. If you'd like to cancel your coverage, you'll be offered "nonforfeiture options", which are other ways spend your money the insurer instead of getting it back.

The Evolution

Whole life is an expensive black box. Clients and their accountants were looking for products which were transparent and cheaper. The solution was universal life, a combination of life insurance and investments. In essence, you're "buying term and investing the difference". You're also getting guarantees. Typically, you know the mortality rates and expense charges. As with whole life, the investment returns are unknown but now you and your advisor get to choose from the choices available. Premium tax rates may not be guaranteed.

With universal life, you win if actual mortality rates or expenses are higher than projected. The insurer wins if mortality rates or expenses are lower. Doesn't this give insurers an incentive to guarantee inflated rates?

They can try, but there's competition with other insurers, whole life and "buy term and invest the difference". Also, mortality has been improving and technology reduces costs. The projected savings can be factored into the guarantees.

In Canada, most insurers have stopped selling whole life insurance. Instead, the market has shifted to term life and universal life.

Trust

With tax, you or your accountant can calculate the costs. You're cannot verify or calculate a dividend. You're trusting the insurer, possibly for decades. Do you? The financial sector is the least trusted in the world … again.

Some insurers selling whole life rank low in corporate governance, a measure of keeping promises. I have a fondness for London Life because their coveted London Life Actuarial Scholarship helped pay my way through university. However, 1.8 million policyowners have not fared as well. In a class action, Great-West Life and London Life were ordered to pay $455.7 million for violating the Insurance Company Act and general accounting principles. An appeal court confirmed the decision but reduced the settlement to $220 million.

Companies change their behaviour. This week, RBC and TD announced they are ending free bank accounts for their older clients --- even if they’re been clients for decades. It's easy to change banks accounts. Right now, BMO, CIBC and Scotiabank still have free ones.

With insurance, you can’t easily switch. You undergo new underwriting and may face tax on the cancelation of your old plan. All that assumes you’re still insurable.

Stay Away?

Whole life insurance may may sense in some situations. If guarantees are important to you, ask an advisor you trust for other options before you decide

Podcast 161

direct download | Internet Archive page | iTunes

PS What are your thoughts on whole life?

March 17, 2012

THE PERILS OF PYRAMIDS AND MULTILEVEL MARKETING (MLM)

Pyramids look wonderful … as you get to the top. But

there’s not much room at the top
the journey isn’t easy
not everyone likes heights

The masses at the bottom do the work and hold up the structure. Why? Perhaps they’re drawn by the lure of riches. Perhaps they’re forced as in Orwell’s 1984.

If you’re a slave, you may wish to be the master. That won’t end slavery or the plight of the slaves. You might not enjoy the riches unless you ignore the source.

Something For Nothing

A high civilization is a pyramid: it can stand only on a broad base; its primary prerequisite is a strong and soundly consolidated mediocrity.
--- Friedrich Nietzsche

We know of people who are much more financially successful than we are. They seem to enjoy pleasant lives and probably do. Their rewards look outsized. Why can’t we make a fortune … without the risk and hard work?

CHAIN LETTERS

They say the Pharaohs built the pyramids. Do you think one Pharaoh dropped one bead of sweat? --- Anna Louise Strong (1885-1970)

Did you ever get caught up in a chain letter? You send a dollar to someone higher up, add your name to the letter and send copies to your connections immediately. Eventually your rank in the pyramid grows and you start receiving dollars too. At least that’s the promise. Those who don’t participate get bad, bad luck. The chain has both carrot and stick. Did you earn enough to cover the cost of postage?

Pyramids are based on false expectations of rewards. The risks get downplayed. The work looks trivial. Besides, you’ll get trained. Success seems guaranteed. We look like fools if we don’t participate (and perhaps like fools if we do). All we need is a credit card. We’ll earn the money back in no time.

Even big institutions get fooled. TD Bank has set aside $255 million for the pyramid-like Rothstein scam.

Multilevel Marketing

The current legal version of pyramid structures is often called multilevel marketing (or less descriptively as network marketing or referral marketing).

“MLM companies have been a frequent subject of criticism as well as the target of lawsuits. Criticism has focused on their similarity to illegal pyramid schemes, price fixing of products, high initial start-up costs, emphasis on recruitment of lower-tiered salespeople over actual sales, encouraging if not requiring salespeople to purchase and use the company's products, potential exploitation of personal relationships which are used as new sales and recruiting targets, complex and sometimes exaggerated compensation schemes, and cult-like techniques which some groups use to enhance their members' enthusiasm and devotion.” --- Wikipedia

Does any of that sound familiar?

The real rewards often come from recruiting. That takes real work and is difficult to sustain. Yet we want to believe we have a reserved spot on an express escalator to the top of the pyramid. That makes us vulnerable and later less trusting. And less trusted.

Podcast 160

direct download | Internet Archive page | iTunes

PS You may have better luck with a franchise or lottery tickets.