2011 Statement to the Federal Insurance Office
Statement of R. Brian Fechtel, CFA and Founder of BreadwinnersInsurance.com
Submitted in response to the Federal Insurance Office’s October 2011 Request for Public Input
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” seem to reveal 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 for 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 industry trade publications. My positions are based on my extensive experiences with our nation’s profoundly problematic state-based insurance regulatory system, problems which those who have not been intimately involved in the marketplace might well find inconceivable.
State insurance regulators have never required proper disclosure of cash value life insurance policies. Markets do not work properly without adequately informed consumers. While life insurance is truly a conceptually simple product, without a proper conceptual understanding of it and the necessary appropriate relevant information, consumers cannot effectively search for good value. “The Life Insurance Buyer’s Guide” published by the 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 over 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 comprised of insurance and savings components, and consumers need appropriate information about both. This specifically requires appropriate disclosure of these policies’ annual compounding rates on their savings element and 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 are 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 the 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 in its harmful impacts upon consumers, can be grasped by reviewing a few basic facts about the current life insurance marketplace. Fact One: The life insurance marketplace is awash with misinformation. Without good disclosure, 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 - which 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, misrepresentations that go unrecognized because of consumers’ inadequate financial grasp of the product’s true conceptual framework, and that 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 Two: 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 values policies of many life insurers are discontinued. It is true that there are many possible causes for consumers to discontinue coverage, but age-old evidence of consumer dissatisfaction has been a virtual 5 alarm fire alarm 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 about 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 arise from the product’s tax privileges. Tax privileges, though, 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 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 insurer with $1.2 trillion, the largest amount, 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. (And, regarding Fact 2 above, Northwestern paid over $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 that little life insurance would be sold without such agent compensation; that is, that the large and undisclosed agent compensation that 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 of life insurance will drive the excessive and unjustified sales loads out of cash value policies, making them price competitive with pure term policies, and thereby enabling consumers to at last truly benefit from the product’s tax privileges. Also, and not insignificantly, 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 Three: It is obviously an empirical question how much life insurance would be sold without the industry’s traditional compensation practices. Sadly though, it is undeniable that the industry’s sales approaches are not effective. Unbiased experts have for decades demonstrated that Americans have insufficient life insurance. Fairly recently, The Wall Street Journal (Leslie Scism, August 2010) reported that levels of coverage have plummeted to all-time lows. And yet, in contrast, data showing consumers’ ever increasing voluntary purchases of additional coverage via their employers’ group life insurance plans ought to cause all to view askance the industry’s assertions regarding the dire societal consequences of a change in the industry’s compensation practices. Moreover, marketing research documents that fear of making a mistake is the primary reason consumers avoid and/or postpone purchases and financial decisions. Inadequate life insurance policy disclosure not only prevents consumers from being appropriately informed, it also is a main factor in their avoidance of the very product they so often need.
I predict that publicity of appropriate disclosure will lead to unprecedented: 1) sales growth, 2) policyholder persistency, 3) levels of coverage, 4) positive impacts upon all other measurements of satisfaction regarding consumers’ future life insurance purchases, and 5) life insurance agents will finally be perceived, having in fact broadly become, trusted and truly esteemed professionals. Admittedly, regarding their past purchases, disclosure could now well 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” virtually the size and age of an intergalactic asteroid.
Below, I very briefly summarize a few other “gaps” in state insurance regulation.
As it is presently marketed, Long Term Care Insurance 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: 1) insurers retain an option to increase the premiums entire “classes of insureds,” and yet 2) consumers must confront such post-purchase price risks without knowing the information necessary to conduct a due diligence assessment of alternative policies (for instance, they are told nothing about the investment activities and assumptions inherent in the pricing of the LTCI policies, or product lapse assumptions which almost all insurers originally misestimated and thereby drastically underpriced their LTCI policies’ initial years’ premiums). Furthermore, 3) consumers cannot transfer their coverage to a new insurer without forfeiting the value they’ve previously paid. A simple example can demonstrate the extraordinary problems with almost all currently marketed LTCI policies. Consumers can face premium increases because the insurer realizes it has or will have inadequate reserves. The cause of the inadequate reserves, however, can be anything from unacceptably high but undisclosed agent compensation, poor investment performance, or any other material factors in building the product about which the consumer was not at all informed. Defective LTCI policies have let consumers be shot like fish in a barrel; their inherent unfairness makes loan sharks envious. In contrast, appropriate disclosure of LTCI will bring consumer drastically superior value and understanding.
The state guaranty system’s levels of coverage for resident policyholders whose insurers become insolvent not only vary from state to state quite significantly, but are woefully inadequate and antiquated. Furthermore, these unfunded systems are not properly built. While there have not been hundreds of failures of life insurance companies, life insurers do not face the same demands as banks where consumers can withdraw their money in a moment. Nonetheless, during the past 20 years, there have been some huge life insurer insolvencies or near insolvencies (Executive Life, Mutual Benefit, General American, Confederation Life, Kentucky Central, American Skandia, Allmerica). The harms suffered by such policyholders have been much greater that those suffered by customers of insolvent banks post 1933. State guaranty system resolutions typically involve protracted “settlements” where policyholders are locked-in so that the time value of money is used to superficially maintain some of the policies’ contractual guarantees, but not others. New York State’s Department of Insurance just “celebrated” wrapping-up its resolution of Executive Life’s New York subsidiary, 20 years after the insolvency.
Mutual companies are some of our nation’s largest insurers. Mutuality has admirable characteristics and consequences, especially so with a product intended to be held for years. Unfortunately, many mutual insurers, simply by virtue of the fact that they are not publicly-traded corporations, are not subject to many of the basic and important modern financial regulatory laws, i.e., Sarbanes-Oxley, whistle-blower laws. Perhaps the most critical omissions are effective modern corporate governance rules. Just as public common land was abused in olden years by overgrazing ranchers, the modern insurance mutual can be beset with or succumb to the same types of problems. Governance rules regarding publicly-traded corporations have been drastically modernized during the past 40 years; the governance rules of mutual insurers have been left terribly antiquated.
State laws were enacted long ago to prevent mutual insurers from retaining excessive surplus. These laws have in fact been maintained, despite our nation’s prior financial crises, for centuries. Broaching this subject should not be confused with advocating undercapitalized insurers or imprudence. To my knowledge, these laws have never been enforced during the past 30 or 40 years, obviously shortchanging thousands, if not millions, of policyholders. Furthermore, these laws have been effectively gutted in recent decades by new regulatory accounting classifications that re-label or partition surplus, thereby effectively hiding it from all but the most financially sophisticated. Current regulations also explicitly and mistakenly allow enormous assets to be classified as “non-admitted” or allow viable subsidiaries to be recorded for pennies on the dollar. All such violations of state maximum surplus laws deprive policyholders of receipt, or of timely receipt, of their share of their mutual insurer’s profits.
Some of the all-time greatest shortchanging of mutual policyholders has occurred in financial transactions between companies that are mutual and stock affiliates. For years, Allied, a publicly-traded corporation, looted Allied Mutual, its affiliate that had actually created the larcenous stock company. Essentially, management over years repeatedly backed-up the truck, loaded it with hundreds of millions of the Allied Mutual’s policyholders’ assets, and drove it right past the regulators. The lack of accountability in our contemporary society that underlies much of the grievances of Time’s “Protester” as Person of the Year is, tragically, abundantly rampant in our nation’s state insurance regulatory system.
Regulation of life insurance agent licensing is incredibly deficient. Agents should truly be financial doctors. Yet, state’s agent licensing requirements fail to make sure consumers are served by financially knowledgeable professionals; the 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 4 out of 5 recruits fail in the commission-based environment within the first few years – do not possess the basic knowledge necessary to accurately assess 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, recommending policy terminations or other actions (beneficiary or ownership changes, inappropriate policy loans, etc.) leading 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, most interestingly 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 is not, and 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 – because of regulatory rules prohibiting any discussion during CE classes of actual product competitive information - are so virtually devoid of meaningful information as to be 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. Life insurance CE exams multiple choice tests with two or three obviously defective choices should hardly be acceptable. Given the ease in 2011 with which any and all CE presentations could be recorded, it would seem any regulator serious about having truly meaningful continuing education programs would mandate such.
Another area for improved regulation is effective oversight of the insurer-agent relationship. This is not to suggest draconian involvement by the government in these business relationships, it is only to recognize the legitimate public interests in properly structuring such relationships – just as is done in relationships between pilots and airlines, between construction workers and contractors, between nurses and hospitals. The contracts between insurers and agents is one of unequal bargaining power, and one where the insurers have not only exercised their power unfairly, but also possibly illegally have prohibited certain agent’s conduct, while requiring others, on matters clearly outside the boundaries of the contract. Furthermore, insurers do not always dissemination vital information on material policies events to agents with vested financial interests (not to overlook business reputation and duty to client considerations) in such policies. Attorneys specializing in franchise law have stated that the typical agent’s contract is the most one-sided arrangement they have ever seen.
In closing, let me ask you to consider the following: Who was assumed to know more about, and/or who was officially responsible for preventing problems in the following situations? And yet, who actually solved or led the action to solve society’s serious problem? For instance, in the case of automobile safety, where tens of thousands of Americans were annually being needlessly maimed or killed while riding in cars, who acted best? 1) Executives of the automobile industry, 2) Government officials in the Department of Transportation, or 3) Ralph Nader? In the case of Bernie Madoff’s 15+ year $50 Billion Ponzi scheme, who acted best? 1) FINRA - the self-regulatory body overseeing broker dealers, 2) Bankers who had a duty to know Customer Madoff, or 3) Harry Markopolos – a fellow CFA who despite repeatedly presenting evidence to the SEC failed to ever obtain effective action from those with regulatory authority.
Markopolos’ book on his eight year battle is titled, No One Would Listen. Professor Belth and I both well understand CFA Markopolos’s experience. Personally, over the past 20 years, I have written many published articles, submitted extensive documentation of sales and managerial fraud in the life insurance marketplace, and 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 and or any other private assistance would be welcomed and 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.
Thank you again for this opportunity to present my views and be of service.
R. Brian Fechtel, CFA & Agent