Insurance Pro Blog Podcast | Life Insurance and Annuity Insights

When you start your career in the financial services industry you pretty quickly figure out that you must bow at the altar of the average return on investment in the stock market. Well, that and a couple of other things like… Compliance runs the show–resistance is futile. 8% is the return we assume people will […]

Today is less about the mechanics of life insurance in the aspect of how it applies to you, but more in how it applies to us. We wanted to dive into the fee only vs. commission financial advisor model, essentially to ask the question: is there a better way? Is one way more virtuous than the other?

Does the insurance and investment industry need to change how brokers get paid?

Let’s start off discussing the fee-only model as there seems to be some confusion as to what it really means. When you hear “fee-only,” it really means they are charging you a percentage of the assets that you are putting under their care—which is basically a commission, but for some reason, we've all decided to call it a fee. It's largely a game of semantics.

Now, the fee-only crowd claims that an advisor being paid based on product sales commissions creates a dangerous incentive said advisor to oversell. But when you really look at them…how are fees that different from commissions?

Fees are typically charged quarterly, and the charges are contingent upon the client's account balance. So, the incentive is for the fee-only advisor to have more client money under their control so that they can charge you their fee on a higher balance. None of this is a bad thing mind you, not trying to demonize fees at all, just the way it works.

The incentive here is for the advisor to do a good enough job selling their clients on the idea that having more money parked here is a good thing.

Why have we accepted this as fee-only?

I think when most people someone say they’re a fee-only advisor, there's an image we all conjure up. That is that we imagine the advisor sitting down in the office with their potential clients to talk about services, and at the end of that consultation, the client writes a $2,000 check, and that’s that.

But here’s what happens—that’s typically the last conversation the advisor every has with the prospective client. Why is that? Most people are not willing to write that check for $2k. I believe this probably the purest form of financial advice on the planet, however, most people are not willing to pay the price. Why they aren't is another discussion about psychology and conditioning which is beyond the scope here.

My suspicion is that most fee-only advisors have figured out that there is a lot of friction involved in getting someone to write a check. But if they just take money from their account once a quarter without them having to do anything, it’s far easier.

The fee is on autopilot, similar to that gym membership that just keeps billed to my credit card every month.

I've looked at dozens of statements from accounts that have this sort of “fee arrangement”, and it’s often not very clear what clients are paying. What's worse is that most clients aren't very clear on what they're actually paying for. Which is interesting when the fee-only crowd boasts itself of being the model of full-disclosure. There is no separate invoice mailed out asking the client to write a check for services rendered.

We’re not suggesting that one method of compensation is better than the other, but I am suggesting that basing a discussion of good vs. bad involves a whole lot more than how the financial advisor is compensated. Some people suggest that fee-only is the only way because it removes the ugly incentives and we're disagreeing with that idea.

The real problem with Fee-Only

The problem that we encounter over and over with the fee-only model is that clients go out into the marketplace looking specifically for financial planning. In many cases, they are sitting across teh table from an advisor that has all the right financial planning credentials.

Today is less about the mechanics of life insurance in the aspect of how it applies to you, but more in how it applies to us. We wanted to dive into the fee only vs. commission financial advisor model, essentially to ask the question: is there a better way? Is one way more virtuous than […]

Everybody wants to know what is going to happen with the insurance industry if interest rates go up, go down, stay the same, etc. So, we figured today was as good a day as any to address some speculation but also to discuss what the industry does to plan for various interest rate movements—because it’s not as reactionary as people tend to believe.

So, does the insurance industry just sit around and wait to see what will happen, then scramble around to figure it out after that?

As much as the people at the financial blogs who like to make money bashing life insurance want you to believe that’s how it works, no. That’s not what how it works.

There is a little forethought. I’m understating it—there’s a lot of planning and modeling that takes place at life insurance companies to address interest rate risk.

Let’s start with the doom and gloom first, then we’ll move on to sunnier pastures.

What Happens if Interest Rates Stay Down?

Say interest rates stay low—which probably isn’t going to happen, at least to the degree that they’re at right now. We know that one of the biggest threats facing insurers is interest rates that continue to trend below various targets that they have set as profit markers. Insurers derive a vast majority of their profits from the spread that is achieved over and above the interest rates they have guaranteed policy owners.

An example illustrates the point:  if you buy a Universal Life Insurance policy, and the company guarantees you 2.5%, and they buy bonds that pay 4.5%, life’s not so bad.

If, however, fifteen years down the road, the 2.5% guarantee is still in place but they can’t buy bonds that pay any more than 2.25%, life isn’t so good. Now, that’s an extreme example, and not what the insurance companies are facing, but it illustrates the point.

Keep in mind that the life insurance industry has been dealing with this prolonged period of artificially low-interest rates for nearly a decade. There’s no doubt it has compressed their margins substantially.

In prior decades, the insurance industry was in a situation where they could guarantee you 5% on a portion of your cash in a Whole Life policy. Yes, you read the correctly…5% on the guarantee.

Then they would take that money and put it into a bond that paid about 8.5%. Things were great and with participating Whole Life Insurance, they returned a big portion of it to the policyholder.

So, it was good for the insurance company, good for the policyholder, and life was good for everyone. These days, that scenario isn’t quite as rich.

Now that we’re here as a result of this prolonged period of super low-interest rates, what do we speculate will happen if insurance companies if they have to continue to deal with low-interest rates moving forward?

In the short-term, the likelihood is that they won’t have to deal with low-interest rates. Interest rates are certainly on the rise…for now.

Understanding Short-Term Interest Rates vs. Long-Term Interest Rates

First let’s take a detour and make an important distinction: When everyone talks about the Fed raising rates, that’s the Fed fund rates. The Federal Reserve doesn’t control rates on long-term bonds. It can influence, but it cannot dictate.

Interest rates on long-term bonds are set by the market.

How interest rates apply to whole life insurance

If rates continue to stay low, insurance companies will continue to struggle, not in terms of solvency, but in terms of getting you the return you were hoping to get. There’s a good chance that if you bought a Whole Life Insurance policy twenty years ago, and their dividend interest rate was over 8% at the time, your policy has greatly underperformed what you hoped it would.

And if interest rates continue to stay low, it will continue to underperform into the future. Actually, it’ll always underperform because you can’t get back the interest that you lo...

Everybody wants to know what is going to happen with the insurance industry if interest rates go up, go down, stay the same, etc. So, we figured today was as good a day as any to address some speculation but also to discuss what the industry does to plan for various interest rate movements—because it’s not […]

Today we’re talking about what happens when it all falls apart. DISCLAIMER: We’re not offering any sort of individualized investment advice. This is for entertainment purposes. We just sell life insurance.

For most financial advisors, there are a lot of discussions about retirement/financial plans, portfolios, adequacy, and strategy, but there’s not a lot of talk about risk. And what does get discussed is somewhat underwhelming.

We’ve had to fill out forms with potential clients, an RPQ (risk profile questionnaire, though every firm calls them something different) that would ask the same 7-10 questions to rate scenarios on a scale of one to five. They said things like… “if the market fell 20%, how worried would you be and what would you do?” These sorts of questions are incredibly hard for people to answer, most have a hard time quantifying that sort of thing practically.

And then we would ask them questions like, “How much money do you make? How comfortable are you with mutual funds?” After that, we would calculate a point value and come up with a score that put you either one point above or below a certain threshold.

And based on that score, it told the advisor the asset allocation the client should have. It was never about anything more than telling clients, “You should own 60% stocks and 40% bonds.”

But we’ve always felt very underwhelmed by the risk analysis that’s done because it always seems to be that the investment industry would like to pretend that the risks that we all face from a financial point-of-view can only be solved by the tools that it sells. To even discuss anything that can’t be addressed by those tools is a dereliction of your duty. And if that happens, too bad.

Focusing on Diversifiable Risk vs. Market Risk

We realize now it was probably a CYA component for compliance. There’s not a lot of proof that the RPQ is a great tool to help clients.

The traditional way to deal with risk—as it relates to losing money because of a market downturn—has been asset allocation. That has always been the industry’s answer to solving the riddle…

How do you minimize the drawdowns when the market inevitably takes a dive?

Answer: You don’t buy all stocks. And you’re all set. You don’t have to worry about it. You’ve now diversified your risk.

Listening to other advisors around me, I’d hear them market themselves as “investment geniuses,” and of course the proof was in the impressive gains their client portfolios were experiencing or that money manager they picked. Never heard anyone bragging about how they planned to play defense when the market inevitably regresses to the mean.

And here’s the other interesting tidbit. When I talked to a few people about investments, they regularly wanted to know “how are gonna protect my money from a market crash?”

Giving the answer that basically says, “well, I’m gonna sprinkle your money around in all these different kinds of stock and bond funds” feels incomplete and inadequate.

People do worry about this. And a lot of people who are in the investment sales business spend almost no time thinking about it or discussing it.

What’s the most common answer from an investment advisor concerning the event when the market goes down?

Answer: Time.

“When the market drops, give it some time, and it will come back.”

“Well, you can’t time the market.”

“It’s about the long-term.”

These are the answers you’re going to get. They’re the ones we hear and read most often. If you search on the web, you’re likely to find about a billion people who say the same thing.

One of the considerations that never comes up when looking over risk analysis questions is the stability of employment or income.

Today we’re talking about what happens when it all falls apart. DISCLAIMER: We’re not offering any sort of individualized investment advice. This is for entertainment purposes. We just sell life insurance. For most financial advisors, there are a lot of discussions about retirement/financial plans, portfolios, adequacy, and strategy, but there’s not a lot of talk ... Keep Reading

We’re going back to a topic that circles the indexed universal life Insurance wagon. This subject comes up from time to time, and the core question is: is indexed life insurance worth it? And, why do we assume the indexed credit interest rate that we do?

A percentage of you will know what we’re talking about and some will not—so let’s back up and explain what all of that is.

When it comes to indexed universal life insurance, the interest rate (that is earned on the cash value) is not fixed. It fluctuates, and it depends very much on the movement of an index and which index is being tracked.

For example, you could choose an index segment that follows the one-year change in the S&P 500 Index, typically referred to as a one-year point-to-point, which is most common. What that looks like is: from the beginning of the policy year to the end of the policy year, whatever the percentage change is in the S&P 500 Index is your corresponding interest earned on the cash value earned up to a certain limit—called the cap rate.

If the cap rate is 10% and the S&P 500 movement in the index is 7% for the year, then you’re going to get 7%. That’s going to be your effective interest rate on cash value in the policy.

On the other hand, if the S&P movement is up to 25%, then you’re going to cap at 10%.

Now when it comes to building proposals and projecting cash value, because of this variability, we have to have some way to look at the plan and speculate on what the cash value growth will be—because it will change every single year. But just like we can model projections for real investments in the stock market by assuming a certain interest rate will be earned effectively over the course of several years, we can do the same with indexed universal life insurance.

We can say—given the parameters, cap rate, and floor—”this is what we think will happen” and we can plug in an interest rate that is assumed in all years that generates value that we think are the closest to reality.

Assumed Interest Rates for IUL Were the Wild West

For a long time, the interest assumption was left up to interpretation.

Insurance companies could say, “okay, this is the current floor and current cap rate, and if we go back 20/30/40 years and look at what the average index earning would have been over a period, that is the max amount of interest we can assume.”

And most departments of insurance looked at that, blessed it, and moved on. Or more likely, they didn’t look at it all that closely.

Then a couple years ago, we had a bit of a regulatory initiative that changed that.

The regulatory change defined the period that could be used to set the maximum and added another test that capped interest rate assumptions to a certain percentage over the average yield on assets over a certain period.

And it’s going to use the lesser of those two things: either a period look-back or the corresponding yield on your assets with a little increase over that to accommodate for the fact that you’re generating a return through options and not just the other assets inside the general account.

That effectively pulled the maximum assumed interest rate down. It didn’t change the functionality of indexed universal life insurance, but it changed what could be projected.

Prior to that, it was not uncommon to see projections up to 8% or more. There were times certain indexes were created—proprietary indexes—that gamed the system and allowed companies to assume higher interest rates. If you cherry pick the historical data, you can justify everything and build an index around it.

There are a couple problems with the approach that says: historically, this has been the average index earned so you can use this number.

We’re going back to a topic that circles the indexed universal life Insurance wagon. This subject comes up from time to time, and the core question is: is indexed life insurance worth it? And, why do we assume the indexed credit interest rate that we do? A percentage of you will know what we’re talking ... Keep Reading

Today, we’re talking about the “scam” that has been perpetuated by life insurance companies for over a hundred years. I know, I can hear you saying to yourself, “which scam is that, there are so many to choose from”?

Am I right? I'm talking about the supposed scam to sucker you out of the gains that you could be making. if you skipped life insurance and bought the investments that they put their money in—yourself.

As you know, when you give a life insurance company your money (aka paying your premium), they're just investing your money in something you could do for yourself. And it’s a question we get a lot. Various articles and blog posts have been written on this argument, suggesting that you could skip that, avoid paying those fees and invest your cash in those things they are going to buy yourself.

No Need to Buy Whole Life Insurance, Skip the Middleman

Well, you could also put your house on the market by yourself, leave it there for a couple of years, and make way less money. Your choice.

Okay, we’re hitting the punchline early today, and we’re going to suggest that maybe—just maybe, it’s a little more complicated to invest in those securities yourself than some of those people have led you to believe.

Let’s break it down, shall we?

We’ll back up and roll the argument out as it’s traditionally presented: about 85% to 90% (or more) of the general account at most insurance companies are invested in bonds. So, the argument is: you just go buy the bonds yourself.

Now only if we were in a big room of people, and we could ask everybody in the room to raise their hand if they’ve ever directly bought a bond—not a bond fund—an actual bond. I'm guessing it would be a small number. Likely, if you do not know what a CUSIP number is, then you have not ever bought a bond.

And for those of you not familiar with a CUSIP number…every security that’s traded has one. It’s a unique identifier, and they’re very important. Most companies issue more than one bond. So, to identify each one, the bonds get a CUSIP number.

Now, you can buy them from most discount brokerages—but it’s not an online transaction. You will have to call in and talk to a broker, and it’s not something you’re going to get $7 a trade for. There’s a markup in bonds—which is not disclosed and not required to be.

Not saying this good or bad, just the facts.

So, when you buy a bond—an actual bond—you don’t necessarily know how inflated the price you pay is. But you will find out a few days later when the trade settles and you're able to see the market the value of your bond. In my experience, it's usually less than what you paid for it. Bonds have a market price, and it will fluctuate. A fact that's misunderstood by way too many people.

Don't let bond see-saw smack you in the butt

Okay, this point might be a little cryptic, so let’s use an analogy.

Imagine you buy a house, and the price is set at $305,000—and you don’t have the luxury of an appraiser. You decide to pay with cash–no appraisal necessary since there's no lender. A day or week later you discover that the house is actually worth $275,000. It was just marked up to $305,000.

Or in a similar scenario, you find out it was actually worth $305,000, but when you decide to sell, you have to pay a realtor and as luck would have it, you'll net some number less than $305,000.

To be clear, we’re not maligning the bond industry or real estate transaction costs. This is just the way it works.

Bonds can be a wonderful place to invest, but it’s not a beginner’s game.