‘Stop The World; I Want To Get Off!’

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For 12 years and 150 articles, Richard Weber wrote a monthly series on 'Due Care' for Life Insurance Selling magazine. Because of his love for the theatre, he identified his articles with show tunes or show titles. This is the first of four 'swan song' articles in which Weber summarizes and integrates what he learned during those 12 years.

 

In the spring of 1990, then Publisher Larry Albright asked me to write 'a few articles' for Life Insurance Selling on some of the issues plaguing the industry, including the notoriety of Executive Life and the problems of traditional agents fending off the Whole Life replacement artists. Suddenly it’s 12 years and 140+ articles later — and during all that time there hasn’t been a lack of subject matter. Consistent with the clich' that all good things must end, we’re concluding this long-running series.

This, and the following three articles, will review some of the highlights and changes I’ve written about during those 12 years, as well as providing some guesses about the future.

In the spring of 1979, the Federal Trade Commission published a report about Life insurance. Although it was a considerable public relations annoyance at the time, the FTC’s analysis had an extraordinarily far-reaching effect on the Life insurance industry. Paraphrasing slightly, one of the report’s conclusions was that '… cash value Life insurance is an extremely poor investment, yielding barely a 1%-2% return on the premium.' Notwithstanding the industry’s immediate response, the seeds of change were sown. Remember that interest rates were already high at the beginning of 1979, and by the end of the year, the FTC turned out to be right — if only in the context of broader economic events.

By the end of 1979, inflation and interest rates spiked to unprecedented levels. And non-par policies, which had been quite popular up until then, suddenly became the whipping boy of the industry. After all, who’d buy a policy with a guaranteed return on reserves of 4% (which in the early years might’ve represented a negative return on invested premiums) when money market accounts were yielding 12% and more? Although ironic today, given the industry’s difficulties with illustrations, the non-par products had a clear virtue: what you saw was what you got. Because premiums, death benefit, and cash values were all guaranteed, the policy was the illustration. But disintermediation decimated the demand for these products virtually overnight. The only saving grace was that Universal Life had recently come on the market, and UL, together with Current Assumption Whole Life, became the popular product design to help the stock companies survive.

The other part of non-par’s attempt to survive and keep at least a portion of the consumer’s savings dollars in Life policies was highlighted by the difference between 'portfolio money' and 'new money' (recently invested funds). With interest rates suddenly spiking, a portfolio consisting of mostly 'new money' would perform better than money simply blended into an existing portfolio with lower average earnings from investments made in calmer times. The difference can be dramatic. Imagine having $10 million of premium income to invest with two possibilities: a new portfolio of policies and no existing investment pool backing those new policies, and an existing block of business with an average return of bonds (some dating back to the 1940s) of 6%. With U.S. Treasury Bonds yielding 14% in the early 80s, that $10 million would generate a pure 14% return each year for the next 30 years. True, the older portfolio of bonds would have an incremental increase in yield due to the new $10 million receiving 'new money' returns, but the portfolio rate couldn’t jump immediately to the 14% level.

In this environment, Universal Life with its by-definition 'new money' approach, commanded a 40% market share of Cash Value Life sales by 1984. Compared with traditional Whole Life policies (and certainly compared with non-par policies), illustrations for 'new money' policies were indicating 12% to 14% returns. And those returns were captured by another recent innovation for the Life insurance industry: the computerized policy illustration. There was an almost mystical chemistry that synergized the flexibility of Universal Life, the high interest crediting rates of the early 80s, and the Personal Computer — introduced by IBM in October 1981. Voila! With just a few keystrokes, an agent could 'customize a policy' for their client and print out an illustration on a dot-matrix printer as proof of their efforts.

As most agents who worked in that era will recall, one common policy illustration suggested clients could 'pay just seven premiums' for lifetime coverage. The applicable term — since banned — was 'vanishing premium.' Ultimately, it wasn’t the premium that vanished; it was the agent (and occasionally the insurance company; more on that later). Such illustration techniques as vanishing premium were just computer-aided variations on 'minimum deposit' and other approaches to make the purchase of Life insurance as painless as possible. The underlying math was impeccable: take the present value of all future costs and benefits, and with an appropriately high interest crediting rate, find the number of years to pay a given premium to put it all in balance. The imbalance, it turned out, came from the fact that interest rates started to fall. And although the alarm bells were initially muted, the decline of interest rates that began in earnest in 1986 foretold the class-action policyholder lawsuits of the 1990s.

Interest rates began to drop from their historic highs in late 1980, but remained high through the end of 1985. Not willing to surrender a 200+ year history of policy design, the traditional carriers began to fight back. Although portfolio rate accounting initially held down their investment returns, these portfolio investment returns continued to rise as current rates fell. Seemingly, mutual companies had performed a magical feat that positioned them to recapture the marketplace with ever increasing dividend scales.

Participating Life insurance — the domain of mutual Life insurance companies — had prospered in the post-World War II economy. Interest rates were calm and relatively low, largely unaffected by inflation or interest rate hikes. Dividend-paying policies do best in this type of economy. It’s relatively easy to suggest that a client include cash value Life insurance in their 'portfolio' of fixed returns, since Life insurance paid as much or more than passbook savings accounts. Many Life agents who entered the business in the 1950s through the 70s came to believe in the sanctity of the ever-increasing dividend scale. The longer you kept the policy, the better it got; dividend scales in general never went down, rarely leveled out, but just kept going up.

So it’s understandable that long-standing traditional agents didn’t question the continued rise in dividend scales as interest rates in the economy began to decline. Although mathematically legitimate (a composite portfolio rate will continue to rise until the current rates fall below the portfolio rate), the other side of the equation was that the more current rates fell, the more certain it was the dividend scales would have to retreat in the near future.

That’s exactly what happened. Although mutual companies could take advantage of the favorable 'math' between rising long-term portfolios and falling short term rates from 1979 through 1986, one or two brave mutual companies began to announce dividend decreases in 1986 and 1987 (to the derision of their agents). Industry-wide dividend scale decreases began in earnest in 1988.

As interest rates and dividend scales began to move in the same direction, the Life insurance industry felt intense economic pressure. Older bonds with 4%-6% yields were worth a fraction of their purchase price, but were 'carried on the books' at their original value. Companies could borrow money and add it to their capital account, but not count it as a liability (surplus relief). These and other accounting traditions from calmer days were working against the health of the Life industry of the late 1980s. The rating agencies began wholesale downgrades of their proprietary solvency ratings, adding more fuel to the fire.

Perhaps the most notorious Life company in the 'modern' era was Executive Life. Resurrected from a previously unknown and almost defunct carrier by CEO Fred Carr, Executive Life rose to stardom with its 14% crediting rates, 'Irreplaceable Life' guaranteed issue replacement products, and admittedly some long-needed product innovation in the form of current assumption Whole Life products sold with extremely low annual premiums, or higher premiums projected to 'vanish' in just a few years.

Although not well documented, it’s clear the policyholders surrendered and exchanged a significant number of 'traditional' policies to Executive Life for most of the 1980s. It wasn’t until late 1989 that the financial and popular press began to question the financial shell game that appeared to be behind the spectacular growth of the company. Yet only months before the ultimate demise of the company, policyholders and agents seemed to maintain their belief in Fred Carr.

At the company’s August 1990 annual meeting, Carr made a brief presentation with convincing arguments as to why the company would remain healthy. There were several questions from the audience — mostly friendly — and the meeting adjourned in less than an hour. Barely seven months later, on April 13, 1991, the California Commissioner of Insurance seized the assets of Executive Life and forced the company into a seven-year rehabilitation that severely reduced benefits for millions of Life and annuity policyholders. Executive Life was the largest insurance company failure in U.S. history.

Despite the financial harm to so many policyholders, many people in the Life insurance industry privately cheered the demise of the company that had caused them such distress. But when the New Jersey Commissioner of Insurance seized Mutual Benefit just three months later in July 1991, few were laughing. The collapse of Mutual Benefit, a 146-year 'Old Line Eastern Mutual,' was an economic and public relations disaster for the industry. The financial and popular press had focused on the Life insurance industry, and if the Russian coup in August 1991 hadn’t deflected the media’s attention, more carriers would’ve probably gone insolvent. Until August of that year, many of us feared for the very survival of the industry.

In spite of this close call, the Life industry proved its fundamental ability to survive. Even with a few more significant failures (Kentucky Central, Fidelity Mutual, and Confederation Life as the most notable examples), a combination of regulatory changes, carrier rehabilitations, and the continued drop in interest rates allowed the industry to recover.

The 1980s were the turning point in what had been a conservative and — dare we say it — dull industry that began in the early 1700s. But by 1991, there was nothing dull about Life insurance! For all the pain, disappointment, and economic loss, policyholders were still covered by trillions of dollars of death benefits, and cash values totaled in the hundreds of billions. And new products were emerging: Universal Life, Current Assumption Whole Life, equity indexed products, and the current winner among consumers: Variable Universal Life.

The next article will continue the saga of how the Life insurance industry has changed since the 1980s — and suggest some benefits and perils that our fast-paced and competitive global economy will probably experience.

Richard M. Weber, MBA, CLU is president of The Ethical Edge, Inc., a consulting firm that advises Life insurance professionals on due care and ethical practices to help them grow their volume and income. For more information, phone or fax (760) 652-0408, e-mail[email protected] or visit www.ethicaledge.biz.
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