I have found throughout my career that many financial advisors are uncomfortable talking about life insurance. In some cases, they have an irrational fear of the product. In fact, a Study of Saybrus Partners found that more than half of financial advisors (56%) don't talk about life insurance even if their clients bring it up. And almost half don't review existing life insurance policies with customers every year. That study was done over a decade ago, and I don't think things have changed much since then.
i understand It is difficult to discuss death or disability with clients when you are trying to help them achieve a more fulfilling life. And some financial advisors think life insurance is a huge waste of time because of the paperwork and cumbersome application/underwriting process (I agree). Further, they may feel that selling permanent life insurance is inefficient and uneconomical. So, they have convinced themselves that term is the only insurance product one should buy because the ever-large premiums eat into the customer's investment budget.
Therefore, the default answer is “Buy the term and invest the difference”.
Financial advisors with this mindset may be doing their clients a disservice. Life insurance is bought because someone loves someone or something. In addition to providing guaranteed income and financial security to the client's loved ones, there are other important reasons for clients to purchase life insurance that matches financial planning:
- Pay off mortgages, lines of credit and credit cards.
- Financing income taxes and possibly wealth taxes for clients above the exemption threshold.
- Finance a buy-sell agreement or buy an interest in a business.
- Facilitating the transfer of assets within the family.
- Finance the purchase of real estate.
- Create additional retirement income for business owners or key employees.
Three overlooked concepts
Unfortunately, I have found that many advisors are not educated on the merits of life insurance and overlook three important concepts:
- All life insurance is term insurance. The assumption that there is a difference between permanent insurance and term insurance is wrong. All insurance is based on the scientific principle of predictable mortality. The death cost is the same whether you are buying term or one of the many variations of permanent insurance. The only difference is who pays the cost of mortality. With term insurance, the policy owner pays the mortality costs out of pocket. With permanent insurance, a portion of the premium is funded out of pocket, but a significant portion is paid with tax-free earnings on the cash values generated by the premiums. It is not about which type of insurance is best for the customer; it's about how long the customer wants the coverage to be in effect. If your client wants insurance to fund their lifetime needs, they'd better consider something other than term insurance.
- Alternative asset allocation. Another benefit of permanent life insurance is that the stability of cash values can be used as an alternative to asset allocation. Most insurance agents are not financial advisors. They don't think about asset allocation or alternative ways to ensure stability in a portfolio. Financial advisors recognize the merits of fixed investments and have dealt with “mark to market” risk. Cash values do not have this problem. Cash values are a stable addition to the fixed portfolio that provide stability and liquidity if needed, without damaging the portfolio. Many policy owners have borrowed against their cash values. Insurance remains in effect and the investment portfolio does not have to be destroyed to meet economic needs.
- Finding the right carrier is more important than price. There is a common misconception that customers should shop around for the cheapest price on life insurance, just like they do with auto and homeowners insurance. However, the insurance industry operates as an oligopoly. Due to heavy regulation, competition among the larger carriers is limited. There are four pricing variables that all carriers face, which I will discuss in more detail shortly: (1) administration costs; (2) rates of return; (3) mortality costs; and (4) persistence.
Four price variables
Life insurance is a mathematical science based on the predictable probability of death. Every carrier—whether a joint-stock company answerable to shareholders or a joint-stock company answerable to policyholders—is bound by sound economic principles to adhere to science. Government regulators and auditors scrutinize companies to make sure they are following prudential guidelines. By understanding the four pricing variables below, you can see how operators potentially differentiate themselves in the market:
Administration expenses. THESE can be broken down in policy services, underwriting and marketing. With the advent of the computer, policy services have largely been reduced in number of employees. Most of the data tracking is done through management software. Service includes making changes and answering questions. Underwriting a policy requires data collection and evaluation. The more efficiently a company provides these services, the lower the cost and the higher the profit.
Rate of return. The conservative nature of insurance carriers' portfolios has limited the companies' ability to differentiate themselves through returns. Don't be fooled into thinking otherwise. While asset allocation can vary widely within asset classes, the National Association of Insurance Commissioners (NAIC) has provided guidelines for asset allocation within a portfolio. These guidelines are broad, but the consolidated results suggest that companies adhere to a similar formula.
As of the end of 2023, for example, the NAIC reported that US insurance companies had approx 15% of their total cash and invested assets in ordinary shares. This shows a general trend towards maintaining a relatively modest allocation to stocks compared to bonds, which accounted for around 60% of the total investment portfolio. Mortgages (9%), BA program assets (6%), short-term cash and riskier alternatives make up the remainder.
Mortality costs. These vary between carriers. Life insurance companies may use different mortality tables depending on various factors, but generally there are nominal differences because the underlying statistics are the same. Yes, carriers have some latitude when it comes to how they use mortality tables to price insurance. But people still die according to a predictable pattern of death. If the carrier is too aggressive and gets its assumptions wrong, its financial stability can be jeopardized. As a result, consumers and their advisors should be wary of large variations in premium estimates.
Persistence. This is a crucial factor in premium calculation and the overall financial health of life insurance companies. Durability refers to the retention rate of issued policies. You may be surprised to learn that it takes seven to 10 years for a carrier to start making a profit on an insurance policy. High durability rates mean the carrier has a better chance of profiting if policyholders continue to pay their premiums over time. If policies are terminated early, the long-term financial stability of the operator will be adversely affected.
Persistence helps maintain a stable risk pool. When policyholders stay with the company for longer periods, it makes it easier for the insurer to predict and manage the risk associated with its insured population. Higher sustainability rates mean that more funds are available for investment over longer periods, potentially leading to better returns and financial growth for the company. High retention rates also indicate customer satisfaction and trust in the company. Satisfied customers are more likely to renew their policies and recommend the company to others, contributing to the long-term success of the business.
Providing more value
Life insurance is a valuable product and should be fundamental to all financial plans. Because it is a science based on sound economic principles, it can be integrated into the financial matrix for anyone who needs insurance to protect those they love. Financial advisors can provide more value than ever by aligning with a strong company and integrating insurance into a holistic 360-degree view of your client's life and goals.
Dr. Guy Baker is the founder of Wealth Teams Alliance (Irvine, CA).