When Walt Mancini and Gloria Fogler-Mancini bought a condo 11 years ago, they became concerned about life insurance. Because the mortgage substantially increased their financial obligations, they recognized that they would be in dire straits if one of them died. So they called their insurance agent and asked about buying an inexpensive term insurance policy.
The agent suggested a cash-value policy instead. Term insurance premiums would certainly be cheaper, the agent said, but if you don’t die while the policy is in force, the premiums go for nothing. With a cash-value policy, you build a nest egg that can be tapped in your old age or be left to your heirs, he said.
Sure, they’d pay a total of $6,240 over eight years ($780 a year), which is about three times as much as they would pay for a comparable term insurance policy over the same period. But by paying that amount, they would be guaranteed insurance for as long as they lived, according to the agent.
There’s only one problem. It’s been 11 years now, and the premiums haven’t vanished. Because the invested portion of their policy hadn’t grown as much as the agent’s illustration showed, the Mancinis have paid nearly 50 percent more than they had expected to keep the policy in force.
The couple is among hundreds of thousands of unhappy consumers who bought the “vanishing premium” life insurance policies that became popular in the early and mid-1980s, only to find that they didn’t get what they thought they were buying.
At the center of the controversy are insurance illustrations–sales tools agents use to sell cash-value life insurance policies.
Thousands of consumers have joined class-action lawsuits against life insurance companies and agents, claiming that these illustrations are purposely misleading. They say that agents showed them pie-in-the-sky presumptions about how the invested portion of their policies would perform and gave them the mistaken impression that their life insurance policies could make them rich. Consumers say that what they didn’t understand was that there was no guarantee of such heady returns. So when these insurance promises didn’t pan out, they were left with policies with significantly less value.
Insurance companies acknowledge that the illustrations are complex, and many have joined an industry effort to make them easier to read. But industry experts maintain that consumers need to be educated about what an insurance illustration does and does not promise.
Just what is an insurance illustration? It’s usually a five- to 10-page report that includes a host of dense charts and aims to predict just how the invested portion of your policy is expected to perform over time.
But making any such prediction is tough because a policy’s performance hinges on a variety of factors, such as what portion of the policy’s premium is used to pay fees and mortality charges and what portion is invested. In addition, the rate of return on the invested dollars will also have a big influence on the long-term value of the policy.
The insurance company can tell you what it will charge in basic fees such as annual account fees and commissions the insurer pays to its agents. But it can’t tell you in advance just how many people will die in any given year, which will affect the amount insurers need to charge in mortality expenses. And the company can’t say just how much it will earn on its investments–and consequently, what you will earn on your insurance investment.
Because of these uncertainties, any prediction about a policy’s future performance is a guess. For the most part, that’s what insurance illustrations are–educated guesses about what the policy might be worth at various points in the future. In fact, one reason these illustrations are so difficult to understand is that the insurer makes several educated guesses in each illustration and shows the results of all of them.
Why? Believe it or not, they’re trying to help. The insurer, like you, isn’t certain that any given guess is right, so it gives you lots of guesses.
It’s important to realize that all of these guesses are likely to be wrong. That’s partly because these calculations all assume that interest rates will remain constant. Mathematically, it’s difficult to do a long-range calculation without assuming a constant rate of return. However, interest rates rarely stay constant for more than a short period.
It may be tempting to use these illustrations to compare the predictions offered by the various insurers when weighing which cash-value policy to buy, experts say. But such comparisons are usually futile.
“To compare the non-guaranteed elements of a policy is a waste of time,” says Byron Udell, president of Accuquote, a Northbrook-based insurance service. “There is no accountability for the accuracy of the non-guaranteed elements.”
In fact, there is just one column on the average insurance illustration that you can bank on: the “guaranteed” column. This column, which also may be called “guaranteed interest and mortality charges” or “guaranteed cash value and death benefit,” provides a worst-case scenario and spells out what the insurer is contractually obligated to do for you.
“The guaranteed rates are like the man behind the curtain. (Agents will) tell you, `Oh, don’t pay any attention to that,’ ” Udell says. “I, on the other hand, am going to point to the man behind the curtain and say: `Pay close attention to that guy. He’s going to tell you the worst-case scenario. And you have to decide whether you can live with it.’ “
Live with it is just what the Mancinis were forced to do. Gloria now says the agent steered their attention to the rosy scenarios without explaining that the policy’s investments might not do anywhere near as well, leaving them with additional costs.
A worst-case scenario will usually tell you that your insurer can pay you as little as 3 to 4 percent on the invested portion of your account. It will tell you the most the company can charge in any given year in fees and expenses. And it will tell you what will happen to your policy’s cash value and death benefits if this worst-case scenario plays out.
What happens? If the worst-case scenario does play out, a vanishing premium won’t vanish; you will have to continue paying to keep your policy in force. If you refuse, the policy usually will lapse (insurance-speak for terminate.)
The good news is that it is rare for a policy to do this poorly. Normally, insurers pay rates of return that are substantially better than the guaranteed rate. When reading an illustration, knowing the fact that the guarantee is the only thing you can contractually count on is important because some companies provide guarantees that are decidedly better than others.
Should you look at the non-guaranteed elements of the illustration at all? Sure. But recognize that the illustration contains only guesses. It is up to you to decide whether you think those guesses are realistic or overly optimistic. Being practical about this analysis upfront can save you a lot of disappointment later.
