In 1963, Jessica Mitford published an exposé on the “cost of dying,” and it became a best-seller. The book was called The American Way of Death. It focused mainly on the funeral industry, but since life insurance is entangled with that industry, the author had to briefly cover some features of life insurance. Mitford revealed that the undertaker or funeral director was an expert on death benefits and Social Security payments (The American Way of Death, 1963; Crest, 1964, 26). Indeed, a study proved that “undertakers continued to skim off all that could be skimmed from the insurance money accruing to survivors” (Ibid, 36). Although people are motivated to buy life insurance so that their families can pay for a funeral, they want their dependents to have something left over. Undertakers in the past were able to charge people based on their ability to pay. Mitford found their pricing methods to be peculiar: “A person can drive up to an expensive restaurant in a Cadillac and can order, rather than the $10 dinner [a lot of money at the time], a 25-cent cup of tea and he will be served. It is unlikely that the proprietor will point to his elegant furnishings and staff, and will demand that the Cadillac owner should order something more commensurate with his ability to pay so as to help defray the overhead of the restaurant” (Ibid, 30). Maybe the funeral business has changed. If not, then such practices might still be a factor when one is deciding on what the face value of a life insurance policy ought to be. Funeral costs may be an important motive for buying life insurance, but other details about funerals and pricing are beyond the scope of this blog.
A much less well-known exposé, if one should call it that, also came out in the sixties. It is obscure, but since it focused solely on life insurance, it satisfies a niche market. (Used copies are still selling for a decent price on the internet.) Like Mitford’s book, The Mortality Merchants by G. Scott Reynolds tried to argue that the public was being cheated. Both books probably have some outdated information by now, but by the sixties, the life insurance business had evolved into a unique enterprise. The unique features that distinguish life insurance sales from other types of marketing are still prominent today. Because Reynolds, as we’ll see, had an agenda, he attacked specific policies first. Only later in his book did he draw attention to unflattering aspects common to all life insurance companies. Here, we’ll analyze his book out of order because his general observations have aged relatively well.
Reynolds reported that insurance companies recruited salesmen not based on what they knew but on who they knew (or, to put it more accurately, because they were expected to know quite a few people): “Only one thing is expected from the new man, and that is the ‘natural market’ he brings with him—relatives, friends, acquaintances, lodge brothers, and so on” (The Mortality Merchants, New York: David McKay Company, 1968, 169 & 170). The recruit is “told to compile a list of everyone he knows on a first-name basis. The recruit starts off with his family, friends, and so on down the line until he has at least a hundred names” (Ibid, 171). In industry jargon, the people on that list are the “natural market.” Despite all of the advances in technology, life insurance companies still use recruits in order to market products directly to individuals in the manner described above. Recruiters today have said that they believe that they are giving recruits a “lifeline.” Decades ago, Reynolds bluntly wrote, “Few men go from college into life insurance sales. Most recruits have tried their hand at other jobs, and many wind up in the business out of desperation” (Ibid, 170). Reynolds cited an industry publication that admitted that salesmen have to start making sales before they can really learn much about insurance. Today, the law requires that only licensed people can earn a share of commissions. Some companies, however, will recruit people even before they get a license. According to Reynolds, most of the large companies surveyed were “most interested in this ‘natural market’ that the new man could bring them” (Ibid, 171 & 172).
Instead of paying for advertising, companies will use that budget to pay commissions to licensed (because that’s the law) recruits who can find customers for them. The compensation scheme left the companies open to another critique: “A man selling anything, be it life insurance or automobiles, can scarcely be considered an impartial adviser so long as his remuneration depends upon commission” (Ibid, 174). One could rebut that there are many other businesses where the interests of customers and salesmen aren’t aligned and that those others often aren’t as regulated as life insurance. (Reynolds did take shots at insurance commissioners/regulators in one of the funniest chapters in the book, but the shortcomings of regulators won’t be covered here).
Reynolds’s book is not completely analogous to Mitford’s. Reynolds was not simply a “muckraker.” He was arguing for what he called “pure death protection.” He tried to show that all other policies were scams. He recommended term life insurance, but he clarified in the Preface that he was not writing a “buy-term-and-invest-the-difference book” (The Mortality Merchants, vii). I believe he was sincere. In one of the most eloquent paragraphs, he implicitly attacked the advisers who lived by the aforementioned creed:
The idea of “buy-term-and-invest-the-difference,” whether the two operations are kept separate or not, is a misleading concept from the start. It assumes that the buyer has set aside a definite sum which is to be divided between the purchase of life insurance and investment. This is the point at which the separation should be made. No “difference” should be considered when death protection is being sought. (Ibid, 64)
Other than in that paragraph, advocates of permanent or whole life insurance won’t find much agreement with Reynolds. He sincerely wanted people to replace their whole life policies with term policies. Before examining his reasons, let’s learn the difference between term and whole life. Those who are familiar with the basics can skip to the next paragraph.
Ironically, Reynolds was against whole or permanent insurance because he believed that it was “the industry’s version of buy-term-and-invest-the-difference” (Ibid, 62). Instead of using Reynold’s definitions, let’s look at a (sort of) contemporaneous textbook. The basics of life insurance have not changed in the fifty years since these books have been published. Therefore, much in them is still accurate. Term life insurance almost doesn’t need an explanation. Anyone who has any insurance is probably familiar with term insurance whether he knows it or not. Term life insurance, according to the old textbook, “resembles automobile insurance, fire insurance, and the like, which are always term insurance” (C. Arthur Williams, Jr. & Richard Heins, Risk Management & Insurance,Second Edition, New York: McGraw-Hill, 1971, 346). “Term insurance protects the beneficiary if the insured dies within the term specified in the policy. If the insured lives to the end of the term, the policy expires” (C. Arthur Williams, Jr. & Richard Heins, Risk Management & Insurance, Fifth Edition, McGraw-Hill, 1985, 466). Whole life or permanent insurance may be unfamiliar to people who only have car insurance or renter’s insurance. A whole life contract can last for one’s entire life—that’s why it’s called “whole life.” Permanent insurance is also called “level premium” insurance because once one has a policy, he can pay the same premium for as long as he lives (or until he reaches one hundred years in age). When people pay premiums for a term policy, they get protection, but they can never get the premium money back. With whole life insurance, customers can get some of their money back (usually after a year or so has elapsed), but they “surrender” the protection. The money that they get back is, therefore, known as “cash surrender value.” Recall that Reynolds said that whole life was just “buy-term-and-invest-the-difference” in another form. He wasn’t trying to mislead, but the truth is more complicated than that. As the old textbook explained, whole life insurance is “a combination of decreasing term insurance (the pure-protection element) and an increasing investment element which equals the face amount [amount of protection] at age 100” (Risk Management & Insurance, Second Edition, 349, emphasis added). In practice, insurers won’t sell policies to people who are very old because 1.) the premiums would be almost as much as the amount of the policy because of the high likelihood of death of the insured and 2.) adverse selection. As the textbook explained, term insurance “would be too costly to be salable at the advance ages, especially since only persons in poor health would be likely to continue the protection” (Ibid, 348). Whole life, therefore, is not simply two elements that can be separated. People are free to buy term and invest, but people will not be able to renew their term policies indefinitely.
Now that we’ve covered the basics, let’s try to understand why whole life is so maligned (For example, one company refers to cash value as “trash value”). We’ll assume, for the sake of argument, that insurance is not inherently a scam. In general, insurance involves “pooling of risks.” It is “a device by means of which the risks of two or more persons or firms are combined through actual or promised contributions to a fund out of which claimants are paid” (Ibid, 193). Reynolds was fine with that aspect of insurance: “Life insurance came into being so that an individual might share the financial risk of meeting an early or premature death with thousands of other people” (The Mortality Merchants, 9). What he didn’t like was the cash value part. He was indignant because cash value was essentially a deductible, but the industry never outright told people that they were paying for a deductible. Calling cash value “savings” or an “investment” gave people a false impression: “Americans, from nuclear physicists to ditchdiggers, innocently assume they have their life insurance protection and their so-called “savings,” or Cash Surrender Value, as well. Nothing could be further from the truth…. [T]he life insurance industry goes about assuring the public that it can have its cake and eat it, too” (Ibid, 9 & 13). His criticism of the marketing wasn’t really a criticism of the policy itself. Reynolds has two objections to whole life that I think everyone can agree with. I’ll cover the most widely accepted one first.
In his book, Reynolds cited the famous economist Paul Samuelson and his observation about how hyperinflation will make life insurance policies worthless (Ibid, 147). To a lesser degree, “normal” inflation reduces the real value of the cash value and, ultimately, of the face amount of the policy. He had a point. In a section titled “The Tax of inflation,” he quipped, “Not only should a policyholder avoid these life insurance ‘savings plans’ which are actually automatic ‘losing plans,’ but from the point of view of life insurance he should hedge against inflation by buying much larger amounts of the much lower-priced forms of ‘term’ insurance” (Ibid, 34). If anything, the case against whole life may be even stronger because now we live under fiat money. According to investment legend Robert Prechter, Jr., whole life policies “are almost always a terrible idea under a fiat money system” (Conquer the Crash, John Wiley & Sons, 2003, 223). If it’s not clear, anyone buying whole life today will want to make sure that the cash value in their policy is indexed to inflation or perhaps has a guaranteed minimum rate of return. The truth is that, historically, hedging against inflation was not easy to do. Reynolds suggested just buying a large term policy. What if the insured outlives the term? He paid all those premiums, and like with other insurance, he doesn’t get any of it back.
Reynold’s other main objection is, for the moment, obsolete, but at the time, he devoted an entire chapter to it. Frankly, I appreciate it because he focused on opportunity cost, the valued forsaken alternative, as any good economist should. He pointed out that the cash value portion of a whole life policy could be put into the safest investment, a saving account, where it would at least earn some interest. Today, and really since 2008, interest rates on savings accounts have been at zero or very close to it. Interest is not, for that reason, a factor any more. Even if interest rates were at a small single digit number, it’s not clear whether one would be better off buying term and letting the excess money earn some interest. It’s complicated, but at the risk of oversimplification, let’s just say that there will be less excess money because when one buys term unbundled from cash value, the term policy costs more than the term portion of a bundled policy. Why? Different types of people buy each type of life insurance. The “pool” of people who buy term are, for whatever reason, more expensive to insure than the “pool” of people who buy whole life. As the insurance textbook explained, “insurers experience higher mortality rates under separate term insurance and charge accordingly” (Risk Management & Insurance, Second Edition, 353). Reynolds, to my knowledge, never mentioned that drawback to buying term insurance. In a low interest rate environment, it would matter.
In a chapter called “The Cost is Prohibitive,” Reynolds insinuated that whole life insurance is too expensive. It places a “severe burden” on young people (The Mortality Merchants, 49). Even the textbook conceded that “the persons who die in the early years will contribute much more in premiums if they purchase straight [whole] life insurance” (Risk Management & Insurance, Second Edition, 348). (In either case though, the amount of the death benefit for someone who dies “prematurely” will be much larger than the sum of the premiums.) Unfortunately, people don’t know when they are going to die. If one were omniscient, he could say for sure whether whole life will be a bad deal for him. One could wonder why he should risk it. Whole life is or was undoubtedly a big risk in the first year. According to the textbook, “there is no investment element in the first year, the cash values usually becoming available in the second year” (Ibid, 349). Anti-whole life commenter and author Dave Ramsey has written that the period in question now lasts for three years. Ramsey wants you to think that the person who bought whole life is a fool because he could have bought term and put the difference between term premiums and whole premiums into a “cookie jar” (The Total Money Makeover, Nashville: Nelson Books, 2013, 54 & 55). After three years, the man who bought term would at least have the money in the jar. What happens though if he outlives the term? Will the money in the jar be even close to the face amount of the policy? If the man who bought whole can pay his premiums, his family will still get the face amount of the policy if he dies after twenty years (or ten or however long term insurance is normally active). In the early years, of course, the cash value will be less than the amount that’s in the “cookie jar,” but, for the reasons given in the preceding paragraph, it’s plausible that eventually the cash value will catch up to and surpass the “jar” amount. Although the benefits of whole life are in the future, it’s still technically true that if one buys whole life, he doesn’t have to keep it for his whole life. If he decides later that he should have bought term because he ended up being healthy and insurable, then he can surrender the whole life policy and take the cash.
Given how esteemed and successful some “whistleblowers” have become, it’s understandable why someone would want to “blow the whistle” on an industry. It’s always newsworthy when an “insider” reveals abuses. Disadvantages, however, aren’t abuses. Being nonterm, whole life insurance is alien to a lot of people, and many will misunderstand the details. If you have read up to this point, you won’t be one of those people.
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