What’s Your Opinion on Insurance Products?

Let me level with you up front: I don’t have a lot of experience with insurance products — especially the type that mirror investments. Prior to my experience related in the below story; the only other time I dealt with insurance investments was successfully extracting Mrs. Grumpus from one of the two products she invested in as a young worker in her home country. Up to now, I really hadn’t given them a lot of thought. As a result, I never held strong opinions about them in either direction. Maybe the most I ever felt was lucky for not getting involved with them — which I suppose is better than the regret I routinely express from other investment choices!

Of course, I’m not completely unaware of the arguments for and against such products. I hear them routinely denounced on several podcasts I listen to. Jill Schlesinger from “Jill on Money” is probably the most vocal, but certainly not the only one. The costs associated with such insurance “investment” products are often what draws the most negativity. Insurance sales people who push insurance products as a panacea to all money problems, is another issue that stirs emotion the wrong way.

That said, I also agree with much of what Darrow Kirkpatrick and Wade Pfau have to say when it comes to the usefulness of annuities later in life. Thus, I don’t dismiss the role that some insurance products can play in sustaining a person’s Financial Independence (FI). However, the story below is certainly an example of all that is wrong with the industry. It is fuel to the fire for anyone, like Jill Schlesinger, who dislikes insurance products that attempt to act as investments. This story is tragically real — which is unfortunate for the person involved. While it happened to a service member, it could have happened to anyone. Buyer beware.

With Friends Like These …

One of the E-5s at my command came into our office the other day and asked me to review a life insurance investment that a “friend” had sold him prior to one of his overseas deployments. For those of you unfamiliar with the pay structure in the U.S. military, I’ve linked it here. However, all you really need to know is that an E-5 doesn’t earn a lot of money. It’s only the 5th pay rung on the ladder and pays as little as $2330 a month. Although, I suspect this guy has about five to six years in the service, so his pay probably ranges anywhere between a whopping $2700 to $3000 a month — prior to any special pays, housing assistance, or taxes. Which is a fact that makes the next part of this story all the more upsetting.

This particular service member attended a financial education brief that my senior non-commissioned officer and I ran prior to the holidays. He said it got him thinking about the fees he was paying for this insurance investment, and he wanted a second opinion. I talked to him about his concerns, how he got into the investment, and what the agent had told him about the investment. When we looked at one of his statements it quickly became apparent that he was contributing roughly $700 a month to this plan — about 25% of his monthly base pay.

In and of itself, a 25% savings rate is not a bad thing. However, if fees eat up that monthly contribution, that’s not good. It’s also an inefficient use of money for someone who doesn’t make a lot. He printed his most recent annual statement so I could analyze it for a few days. I let him know that while I was no expert in insurance policies, I had some experience in extracting Mrs. Grumpus from one of the two insurance products she’d bought in her home country (prior to marriage). Thus, I could at least provide him some recommendations.

Indexed What?

It turns out our young service member had bought himself an Indexed Universal Life (IUL) insurance policy. What’s an IUL? I’m glad you asked. Investopedia pleasantly describes it as:

A permanent life insurance policy that allows policyholders to tie accumulation values to a stock market index. Indexed universal life insurance policies typically contain a minimum guaranteed fixed interest rate component along with the indexed account option. Indexed policies give policyholders the security of fixed universal life insurance with the growth potential of a variable policy linked to indexed returns.

In this instant, our E-5 insured himself for $400K. The index he chose for the policy was a Global Index Account — based on the S&P500, EURO STOXX 50, and the Hang Seng Index. Conceptually, that means our E-5’s $700 a month is split between his monthly insurance coverage, and an indexed insurance product. Supposedly that indexed product grows over time and provides some sort of return on investment. Life insurance and investments all in one; what’s not to love?

Fees

Well, fees for one. After examining the statement, it appeared to me that the annual fees amounted to roughly 20% of the total of his annual payments!!! Yes, you read that right. In fact, I posted a sanitized copy of his statement’s front page (below) so everyone can check my math. This is how I read it:

• $8,355.12 in “Premiums” paid for the year
  • Minus $1664.17 in total charges
    • $501.36 for “Premium Expense Charges”
    • $1098.68 for “Total Monthly Deductions”
    • $64.13 for “Other Charges”
  • Equals $6690.95 (80%) remaining

I understand that some of those charges are for the insurance coverage and that unlike term insurance, this is a lifelong policy and therefore more expensive. However, even when I found the agent’s guide for this particular product on the internet, I couldn’t decipher what part of the charges or deductions covered the life insurance policy compared to the investments. I thought I found it under the section titled “Base Annual Minimum Premium Rates (per $1,000)”. The stated rate for a male his age is $4.36 per $1000 covered. However, when I did the math, that came to $1744 for $400K in coverage — which is more than the charges I just categorized above. So who knows?

For argument’s sake, let’s say the $501 annual charge covers the life insurance policy. As a means of comparison, since he’s active duty military member, our E-5 could’ve obtained up to $400K in Servicemember’s Group Life Insurance (SGLI) for $348 annually. That doesn’t even take into consideration whether or not our service member needs that amount of insurance since he’s a young single guy without dependents. Now the insurance defenders out there might say something like, “This is an investment as well! SGLI doesn’t do that.” True, but our E-5 has other investment options that charge way less and can potentially deliver way more.

According to the Thrift Savings Program (TSP) website, the government’s version of the 401K, their average fees are only $0.46 per $1000 invested. Let’s run the math on that assuming our E-5 would have set aside the same amount ($8355) between SGLI and TSP, that he did on this insurance product in one year. Subtracting the $348 for SGLI, that leaves $8007 left for TSP. $8007 invested into TSP at $.46 per $1000 managed is a total of $3.68. annually. Thus, we got a $1158.32 difference between $1162 in the remaining fees on the insurance product and $3.68 for TSP. Let’s be honest that $3.68 is akin to a rounding error in comparison to $1162. Expressed mathematically it’s .32% .

More Fees

Now, let’s see what kind of awesome rate of return this product got our young service member. Once I deduct all the fees, it essentially means our E-5 invested $557.58 a month ($6690.95 / 12 = $557.58). If you refer back to the front page I scanned in, you’ll see that the money he invested monthly (as well as the $5105.47 invested from the previous year) earned $270.04 of interest from March 2016 – March 2017. Weighted that means the 43% ($116) came from interest earned on the $5105.47. The total of the monthly contributions ($6690.95) earned the remaining 57% ($154). After running those values through a recurring investment calculator at Buyupside.com, and then averaging their decimal equivalents; I calculated a combined annual rate of return of 3.5%.

Unfortunately, there is no exact match within TSP for an investment with the S&P500, EURO STOXX 50, and the Hang Seng Index. The Life Cycle (L) Funds are probably as close as our E-5 could get in a product with major domestic and international exposure. Unlike his insurance investment though, the L funds also contain bonds — which makes the L fund somewhat more conservative of an investment. However, I’m willing to spot the insurance product the advantage, in this case, just to prove a point.

Let’s assume our fearless E-5, instead of investing in the insurance product, invested his $8007 TSP instead. Assuming he’d invested the $8007 in the 2050 L fund for all of 2016 (the nearest 12-month equivalent I can find to his insurance statement) he would have earned an 8.65% annual rate of return. According to the recurring investment calculator at Buyupside.com that would have yielded $385.26 in returns for the year. That’s just on contributions from 2016! That doesn’t even include the return he would have made from the previously invested $5105.47 (which of course would have been more due to lower fees and higher returns of a TSP/SGLI combo).

And More F-ing Fees!

At the expense of whipping this dead horse, let’s quickly discuss the commission. Commission? Yes, the whole reason our E-5’s “friend” pushed this completely inefficient and inappropriate product on him in the first place. I happened to find the section in the agent guide which showed the current “Base Commission Target Rates (per $1,000)” of this product. The current commission is $5.81 per $1000 covered based on age. $5.81 multiplied by 400 equals $2324! It also equals a fairly nice payday for the agent who sold our E-5 this product.

I only discovered the agent guide as I was writing this article. I’ve yet to ask this particular service member if he paid a commission. I sure hope not. I cringe at the thought of someone who’s paid so little, turning around and paying a “friend” for the privilege of that friend’s insurance company emptying his pocket each month.

Finally, I refer you to the scanned front page of the policy one final time. Look for the “Surrender Charge” line and you’ll see the value of $8796. That’s how much of the E-5’s “invested” money the insurance company would keep if he chose to cancel the policy. According to this statement, he’d only get $3270 of his $12,066 — or 27% — if he chose to cash out. That money’s not an investment, but a hostage. And this isn’t an insurance policy, but a ransom policy for the unaware.

My Advice

Given everything I just wrote above, some of you might be wondering what I advised this particular service member? Well, you can read it below. Once you do, let me know if you think I missed anything:

I looked at your policy statement a little more closely. I’m afraid to say that your gut instinct appears correct: there are a lot of fees associated with your policy.

• If I’m reading the 2016 – 2017 statement correctly, it looks like you paid roughly $1600 in fees in those 12 months out of your $8355 in “premiums” — which calculates to almost 20%. The rest of that money went into the index investment.
• I see your account earned roughly $270 in interest over the same time period. I can’t determine if the index “investments” within your policy rose in value or not.
• That’s a steep cost for investing no matter which way you cut it though. To compare, TSP charges around .038% for its investments at the moment. Of course, they don’t provide life insurance.
• As another metric, millionaires and billionaires pay hedge fund managers 3% baseline + 20% of the profits to manage their money. You are in wealthy company my friend.

Looks like approximately $500 of the $1600 was spent on the life insurance policy itself, which is fairly expensive for a guy your age. I’m no insurance expert but would think you should be able to find a term life insurance policy for $400K in coverage for half of what you’re paying right now. However, there’s the question of whether or not a single guy like you needs a life insurance policy at all. Do you have dependents? SGLI should be more than enough if you don’t have dependents.

I can’t tell precisely what the other $1100 in annual charges were for. Looks like some of those costs were related to your investment choices. There are a lot of monthly charges in the investment portion of the statement but it’s not easily discernible as to why they are charging you.

It also looks like you may have two “riders” on your policy – which are modifications to a policy – that may be costing you extra money.

• One is for terminal illness, which you don’t need as an active duty service member. I can’t determine what that is costing you.
• The other rider is for the “no lapse guarantee” — I have no idea what that means, but it’s costing you $155 a month.

Recommendations:

1. Call the insurance company and request a “current illustration” of your policy. They are supposed to do it once a year for free. It should provide you a current projection of what your policy would be worth by the time it expires. Directions are in your annual statement on how to request it.
2. When you talk to them ask them the following things as well:
   1. What is your current Cash Surrender Value?
   2. When, if at all, does the surrender charge period end? The best option you can hope for is soon, which would allow you to withdraw all the equity you’ve built up in the investments without penalty.
   3. What happens if you stop payments? Does the policy lapse? Or does the equity you’ve built up through the investments get used to cover the policy until the investment money runs out.
   4. What are the options to decrease payment amounts? Can you get rid of the riders? Can you do something else that allows minimal payments? For instance, can you stop contributing to the investments, but still maintain the insurance policy and investments through some sort of minimal payment?

Not to question your personal life too much, but your friend did you no favors by selling you this product. You may want to re-evaluate your friendship especially if he’s involved in any other financial aspects of your life. The best case scenario I could paint is that your friend didn’t know what he was selling you at the time you bought this policy. It’s my understanding the training thresholds are low for companies like this, and insurance salespeople don’t necessarily need financial backgrounds. The worst case scenario is that your friend knew what he was selling you and took advantage of your friendship to sell you a financial product you didn’t need.

Good on you for starting to ask the questions about whether this insurance policy is a wise use of your money. Unfortunately, it’s not. This is one of those tough money lessons we learn in life. Don’t beat yourself up too bad. As a matter of comparison, I’ve got a running tab of about $750K worth of expensive investing mistakes that I’ve made over the years. It’s one of the reasons I like sharing my knowledge so other people can hopefully avoid the same mistakes I made. Let me know if you have any more questions, and certainly let me know what the company says.