The Life Insurance Industry Has Its Own Volkswagen Scandal

Posted at on September 30, 2015

How do you feel when you pay for something that you don't receive?

A few weeks ago Volkwagen AG, one of the world's largest car manufacturers, admitted that millions of its diesel-powered cars did not, in fact, provide the combination of high performance and low emissions that its customers had paid a premium to get. VW car owners have expressed feelings of anger and betrayal. Lawsuits and investigations are multiplying.

Owners of traditional whole life policies should pull out their documents to see if they own a Volkswagen diesel. Did their agent convince them to pay a higher commission to get stronger guarantees?

Many whole life policies let you combine base coverage with term and paid-up additions riders to design policies that pay a lower commission to the agent and provide better values for the consumer. This is called "blending", and it creates an obvious conflict of interest for the agent. Will the agent present the full range of possible designs? How will the agent guide the client in making a choice?

In my experience, agents usually do not recommend the lowest-commission design. One common argument that they use to steer clients to a higher-commission design is that it offers better guarantees and less risk. Many consumers and surprisingly many advisors accept this argument and believe that blending creates risk. It naturally follows that more blending creates more risk, and there must be some point at which blending becomes imprudent.

"I don't like to go above 50%," the agent might say, displaying reassuring product knowledge and concern for the client. This must indeed be a serious person whose advice should be heeded.

Well, no.

This is a person who is displaying superficial product knowledge or an ethical blind spot or both.

As I explained in "Life Insurance Guaranteed Values Are a Big Fat Idiot", the columns of guaranteed values in sales illustrations for traditional whole life represent an absurdly implausible scenario. They show you what you would receive if the company suddenly stopped paying dividends as soon as you bought the policy.

This poppycock comes in several flavors.

Some illustrations omit the guaranteed values for the paid-up additions rider, even though the rider premium is included.

Some products do have lower guaranteed values when blending is used. This can happen, for example, if the term rider has higher guaranteed costs than the base policy.

Sometimes the agent just paints a scary picture without any supporting numbers, suggesting that the base whole life policy has a guaranteed maximum cost but the riders don't. Or the agent creates a blended design with a lower premium, and therefore more risk, and blames the risk on the blending rather than on the premium.

A policy design with more blending and the same premium has higher cash values. As common sense tells you, it's a good thing to have a higher cash value in your policy. You can borrow against it. You may be able to use it to pay premiums. You can elect a paid-up policy with a higher death benefit. You will have more opportunities to replace the policy with something better.

A higher cash value reduces risk. So whole life insurance buyers who follow the agent's advice are paying the agent more money to get a policy that actually has more risk.

Selling meaningless guarantees and cheating on engine emissions tests are kindred spirits. Will we see consumer outrage, admissions of wrongdoing, lawsuits and investigations?