SubscribeThe Coming Death of the Insurance Industry
September 17, 2007
This is frank discussion about growing epidemic that is set to become one of this countries biggest scams. It is so monumental that it has the potential of bringing down the entire insurance industry… Seriously. If you scare easily, stop reading now. (Note: Podcast 28 has an amazing interview with Steven Leimberg on this subject, subscribe via iTunes to ensure delivery on Sept 19th)
Never before has the insurance industry faced such a cataclysmic onslaught of potential claims than they will begin to see in only a few decades from now. This is a crisis, which was set in motion by a rather innocent idea and has now turned into a greed-infested scheme. If left alone with no intervention, it will have us all looking back in 20-30 years wondering how and why we could of let this happen.
The financial media is finally picking this up as a front-page concern (Business Week Story) and we are seeing something new just recently with shares of Life Partners Holdings (LPHI) that is beginning to look rather ugly. But why is this coming to their attention just now? It is because for years now, the insurance industry has been systematically pilfered and companies are starting to worry about their future. What started out as a small crack, has now become a major crevasse. Is it will be a wonder if some of the companies will actually survive. No, No, No, not because of a hurricane or tornado. Not even from massive fires or devastating floods or the threat of global warming. Nothing natural can come close to how this is going to affect the industry. This is purely man-made.
It started with an idea from Prudential around 1988. At the time, it was innovative and extremely beneficial to policyholders. You see, back then; AIDS was causing a terrible problem as experimental treatments were very costly. When a patient’s money ran out – they had few alternatives. Prudential devised a way for those who were afflicted to sell their life policies for a substantial amount in return for assigning the death benefit back.
This was the incarnation of what was to become known as Viatical Settlements. The original plan quickly morphed into an investment scheme for many unscrupulous companies who realized that those that were in need of funds would sell their policies for almost any amount. Fair or not. Investors poured in with the promise that within a short time (as AIDS patients had limited life expectancies) they would profit by 15%-25% on their investment. Even as concern was raised about the morals of such a plan, Viatical Settlement companies were popping up in record numbers. It was on later that investors learned that this no-risk plan had many problems and their easy profit wound up turning into ugly losses.
Along the way, the greedy got rich by setting up phony guarantees and investors were fleeced of millions of dollars.
This was just the beginning. These days everyone profits from this (except the insurance industry) and it is finally becoming topic in focus. It can be said that the plan has morphed into a win-win-win-lose scheme.
Now you have a basic background and the genesis of Viatical Settlements - though they are now referred to as Life Settlements amongst the politically-correct. (Think of Stewardess/Flight Attendants and Garbage Men/Sanitation Engineers)
Today, the players are many and the scheme is gaining popularity: It did not stop there; in fact it only gets worse. Presently, the numbers are a lot bigger as the schemes get more and more crafty. These days, seniors are the ones that are selling policies to investor groups – and why not? They too are in for a piece of the profit.
Here is how a typical plan works: First, an insurance agent approaches a senior (usually 75 years old or so) and sees if they are willing to have a life insurance policy bought on their life. Often times, the insured will be required to have a net worth well in excess of $1 million as this plan works much better with higher death benefits. A company, specializing in loans for this investment plan, will advance the annual premiums for 2 years. This is important, as there is no money actually changing hands or expended from the insured to the insurance company. When the policy is issued, the insured usually retains the rights for exactly two years, until the contestable period is over.
Contestable Period Definition - Life insurance policy clause that provides a time limit (usually two years) on the insurer’s right to dispute a policy’s validity based on material misstatements made in the application.
When the loan comes due at the end of the “contestabilty period” the agreement will usually stipulate that the policy will revert ownership to the company (depending on the exact terms of the arrangement) that provided the advance on the premium (premium plus interest of 10% plus annually). This is important, as this is where the profit potential is realized - For the second time! From this point they try to sell the policy to other investors looking to profit from the death of the original insured – the third profit potential.
We could stop there and say that there are several issues that stink to high hell:
- 1) Insureds are induced to do this, as there is BIG MONEY in it for them; assuming all goes well. I have personally seen insureds receive $100,000 PLUS for simply standing in for an insurance exam and signing policy paperwork. I know of several more who received much higher “inducements”.
2) Agents stand to make huge profits as they are usually paid anywhere from 50%-70% of the first years premium on these types of policies.
3) The loans for the premium are charged at a rate significantly above market
4) The higher the death benefit, the better the plan works for all involved
a. Higher Premiums equal higher agent commissions
b. The greater the financial worth of an insured, the higher the death benefit
c. The higher the death benefit, the higher the premium resulting in the more “inducement” the insured will be paid
Here is where it gets tricky. Since there is a significant financial incentive to showing a net worth as high as possible; financial creativity is key. Valuations can be “enhanced” on real estate and businesses rather easily as can the approximated value of other assets. This is a real conflict that should be (but isn’t) taken seriously. Unfortunately, I have also seen several occasions where agents show insureds how to “optimize” these values in order to qualify for a higher death benefit. Just to be clear, this is not just a friendly exaggeration of values that one may do on the golf course. This could be deemed FRAUD.
The risk is weighed against the potential for a nice payday if the plan is approved. The usual decision is no surprise. (Picture the three monkeys with their hands over their eyes, ears and mouth)
Now, here is the reveal of how the life insurance industry is facing potential extinction if nothing is done:
As a practical matter, insurance companies build assumptions as to the percentage of policies written that will lapse into their pricing models. Since policies purchased only to be sold to investors will never lapse, insurance companies will have to pay claims much greater than they paid for. To add insult to injury, rather than paying full premiums, investors usually pay in only the minimum necessary to keep the policy going, thereby depriving the carriers of the capital necessary to invest to pay interest or dividends and cover maturing claims.
As for the insurance industry: “Be careful what you ask for; you might get it….” To be fair, the insurance industry is not without blame. They welcomed the record breaking sales and have turned a blind eye to the potential abuses in pursuit of short term profits. As one described it, “they took a bite of the poison apple; and they liked it….” Now, they’re bailing water as fast as possible to avoid the pending actuarial disaster.
The concept of life insurance was born out of a notion of public trust and common good and special tax incentives were granted as an inducement for bread winners to buy insurance to protect their widows and orphans from becoming wards of the state. While the greedy modern day robber barons will argue that it’s property and you ought to be able to do what your want with it, we can not lose sight of the fact that it’s a very special type of property and different from stocks, bonds, real estate and other commodities.
To purchase life insurance one must have an “insurable interest”- a risk of loss that would occur if the insured dies. Theoretically, one’s life and children are presumed to be better off if their husband or father stays alive. The purpose of the insurance is to replace some or all of the income the insured would have earned had he lived.
In these pre-sold, financial arrangements, it’s exactly the opposite. When outside investors are the beneficiaries, the sooner you die the better their internal rate of return. Life insurance is reduced to no more than a gambling contract which is against public policy.
With ever mounting deficits, it may only be a matter of time until congress strips life insurance of it’s favored tax treatment; thereby making it more costly for “Average Americans” to obtain the coverage they need and upholding a sadly ever-expanding phenomenon of the greedy few destroying an important family financial instrument for the masses.
Many carriers are now fighting back. Some send out investigators to interview insureds as to why they bought the insurance or what they expected would happen so they can rescind contracts. Others simply are refusing to accept collateral assignments and requests for change of ownership. Many have updated their applications to include questions that require disclosure of any financing arrangements, up front incentives or potential sales opportunities.
Even though promoters still tell prospects “not to worry about it” there’s no statute of limitations on fraud.
While the market for purchase of policies remains strong as fortune 500 pension funds and major financial institutions seek to acquire large trenches of life insurance as an uncorrelated asset, there’s now so much “tainted paper” out there (i.e. insured’s misrepresented their net worth, financing and/or intent to sell) that it is becoming harder and harder for “legitimate” policy owners whose circumstances may have changed, to sell their policies they no longer need or can afford. And it is becoming harder and harder, especially for older people with legitimate needs for life insurance for their business and estate planning, to be able to acquire the coverage they need and want for their own families.
One can only wonder how long it will be until this golden goose is dead…….
And what about the tax consequences to the unsuspecting insureds who were induced to give their bodies to this science experiment with the lure of “free money”. What about the ordinary income tax they will owe on the sale of property not eligible for capital gains treatment; or worse yet, on the phantom income from the forgiveness of debt when policies are given up in satisfaction of the otherwise non-recourse debt?
This is story that is going to unfold with nasty consequences. The question is: What to do about it… Avoid or Short? Stay tuned….
Companies: (LPHI)(MET) (MMC) (PRU) (AEG) (MFC) (SLF) (ING) (PFG) (AIG)
Disclosure: Horowitz & Company clients do not hold positions of companies mentioned directly (may be owned in funds etc)
Tags: Markets, Short Ideas, Rants, PoliticsRelated posts
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25 Responses to “The Coming Death of the Insurance Industry”
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Wow - what an article. I have to admit I like your writing style. You are very easy to read and mildly entertaining. However, You would have much more impact if you actually had your facts straight…. Maybe you should have spent a little more time researching the real definition of a life settlement. You are describing something entirely different in your article - nonrecourse premium financing. And even your description of that is a bit off. You are describing only one of many programs. If you took the time to do the necessary research you would have found there are nonrecourse premium programs which do not induce clients to apply for insurance as well as programs which do not require clients to reliquish their policy at the end of the loan term. Do your homework Andrew… maybe the Cliff Notes aren’t enough to produce an accurate article!
You are confusing a lot of facts. You discuss the financing of policies, but life settlements/viaticals are different! There is no financing of policies; life settlements are allowing elders to get out of old, under performing policies, by shopping them in a competitive market. There is nothing more American than being able to sell your property to the highest bidder in this capitalistic system. Before, the only option was to go back to the carrier that wrote the policy…that is called a monopolist (Very bad for the consumer!). Please make sure you know what you are talking about before you bash it. Life settlements/viaticals have given back billions to the consumer that would have otherwise just lined the already fat pockets of the insurance industry.
Jerry:
As per your comments, I realize that you have an interest in this subject, but I know quite about this issue. Surely there are reasons why life settlements can be good for some consumers, but the incarnation of what is occurring with the SOLI (stranger owned life insurance) is much bigger than you seem togither know or wish to admit.
I assume that you or your company are involved with the industry. Jerry, I would love to have you or a representative on a podcast. In fact, I can squeeze you into the one for tomorrow as we just finished th tape and can put in th alternative side.
Seriously… Andrew
I’ve investigated this market and believe that the danger to the insurance companies is overblown. In order to sell a policy, one has to be sick, not want it anymore and own the kind of policy that can be sold. Not many people fit that description. Moreover, many families now borrow money from banks to keep policies in force on older family members who are sick, so I believe the projected effect on death claims is way, way overblown and, in fact, may not cause any more death claims to be paid than are being paid now! Heck, the largest life settlement brokers in the country are only closing less than 50 such deals per month. That’s a meaningless drop in the bucket for the U.S. life insurance industry.
Bob:
With respect, you are obviously way out of the loop on this one..
Are you aware that there are droves of agents looking for HEALTHY seniors to buy life insurance on and they are willing to PAY the SENIOR to take out a policy AND the AGENT lines up companies to pay for it? Then, after 2 years the policy ownership changes to the premium payors, who sell it… Not sure where you got your statistics, but I know insurance producers who close 50 a month on their own.
Thanks for your input.
Andrew, I agree with you, Bob and Jerry probably are involved in the industry. Viaticals (pre SOLI) should have been a win-win, but turned out to be win (viator) win (viatical industry) lose (investor).
What confuses me, however, about premium financing of life insurance, is why the insurers aren’t doing something about this legislatively. They have the money and the lobbyists. It wouldn’t be difficult to eliminate these entirely or at least make any lies on the application relating to financing subject to a longer (post-contestable period) time.
What are your thoughts on this?
Bob P.
This is an excellent article, but my conversations with carriers have proved different than your findings. To the contrary, I have found most will still write large face values, only stipulating that they are not premium financed. But they will still write the policies for those that finance the premiums themselves. There are also large carriers (like ING) that are embracing this business, providing hybrid financing themselves (in conjunction with national agents). Almost all carriers claim they do not have lapse-supported pricing in their products.
If this is true, then the real losers here are the sellers (the seniors) and the buyers (the investors). Some promoters of these products claim 40%-60% returns to investors, with very little risk. The transaction fees are outrageous, and would not/should not hold up if they were ever seriously investigated.
Bob P:
The industry is doing what they can as it is hard to whine about their agents ripping them off if they are also profiting and have basically been putting it to all of us for some time.
So, who is going to feel bad? It is hard to project 20 or 30 years on this as well. So unless this becomes more of a issue, nothing is going to happen….
Andrew, I have been involved in the life settlements market on the buyside and sell side, as well as a producer, wholesaler and in-house technical expert for various life companies. In my opinion, your article would have been perfect had it been written 3 years ago as what you describe was occurring without much notice. Since then, there has been significant movement to curtail this activity. For example, insurers now require a form at policy inception that makes the insured/owner attest to the fact that they have no current intention of selling the policy. Also, to establish insurable interest, many times a charity was involved. There is legislation sponsored by, among others, Senator Grassley that would put a 100% excise tax on the proceeds of life policies that had the charicteristics of being sold in SOLI/IOLI market. Many charities are now steering clear of anything involving insurance because they don’t understand when they are or are not subject to the proposed excise tax. The word is also out within broker/dealers and many companies. However, I geuss there will always be a company that wants the premium that would look the other way in these deals, however, they are not among the several highly reputable companies doing the majority of traditional life business now, at least absent fraudulent behavior by the producer that conceals the activity. I agree that the SOLI/IOLI market would have devastating effects on the life market if were allowed to continue, however, I believe the practice to be dying a rapid death. I would caution you that the life settlement market is a very legitimate market absent SOLI/IOLI activity. There are many seniors that simply do not wish to continue to have policies that require future premium payments and the life settlement market offers a greater payout than the cash value within the policies themselves. That is simple economics. If the insurers found a way to create higher cash values that would take the economic incentive to sell the policy, the practice would be utilized far less.
Andrew, I also have been involved in insurance and settlements for several years - though I have not taken part in SOLI schemes and beleive them to be vey dangerous. There is plenty of fraud and abuse in the life settlement and viatical business even beyond SOLI schemes and yet a settlement sometimes really is the best option for a senior in need of cash. Anyway, I agree with 95% of your article although there are a few minor technical things that only a life insurance expert would quibble with. (eg, Prudential probably does not want to take credit for inventing the Viatical market - they did invent the accelerated death benefit rider to counteract the attractiveness of viaticals.) I see SOLI programs still being marketed aggressively and everytime an insurance company devises a way to fish them out, some clever marketer finds a loophole.
I wonder if the life insurance industry is going to suffer as much as you say. Right now the 2 year SOLI policies are starting to come out of contestability and many settlement buyers will not touch these policies because of the risk of litigation (note the MCC lawsuit in Orange County). If there is no market for these policies as promised, will some of these lenders or settlement companies suffer or go out of busines - and will the lapse rate on these policies end up being much higher than predicted? If so, then keep going long on insurance stocks….
You mentioned that some carriers are refusing to do assignments or changes of owernship. If you have specific companies or evidence of such please elaborate (email me privately if you prefer) - I am very curious to know if this is true. Thanks.
[...] Morbid Tale of Profit: AKA -The Death Of the Insurance Industry covers this topic in detail and has the industry concerned. We tackle the very troubling area of [...]
Very good article with half truths. As was previously written you have blended life settlements and IOLI/SOLI. While a life settlement is a part of an IOLI/SOLI arrangement, it is the arrangement that is flawed and not the life settlement, which under the proper circumstances is a wonderful alternative tool for a senior to either sell an unwanted or underperforming policy or in most situations restructure that contract with a superior result to a straight 1035 exchange.
So insurance companies underwrite clients and have to pay out death benefits when the insured dies?
ED. ED. ED.
Not so simple , you are really not reading…try again
No, I read it. Insurance companies are being made to pay out death benefits on policies they accepted. They have every right to decline policies if they feel there is no insurable interest, but they’re eager to issue policies because so many lapse. If they designed products where the internal cash values actually reflected the real value of the asset, there wouldn’t be an issue. Andy.
I didn’t understand the “rather ugly” part. Isn’t the stock in question up over 700%?
Andy, Andy, Andy, the possessive form of “it” is “its”, not “it’s”.
Ed/Eddy/Eddie (or is it JackStraw?)…
How shall we profit from the grammar lesson? Also, the “rather ugly” comment has the word “beginning” just before it. Was that something that was unimportant or was it intentionally left out from your comment?
Also, maybe you are unaware of what is really going on in the industry. Agents and insureds are falsifying applications to show insurable interest when there is none. If that is true, does it change your opinion at all?
Grammar lesson aside, if you look at the date of this post, the stock was down $14+ from its peak only a few days prior on some serious news.
Give me something more than an apparent broker looking to protect his business, no matter how shady it may be. (not referring to anyone in particular of course)
Thanks for the effort…
So since you said it was “beginning” to be something “rather ugly”, the stock is up 35%? What does that company’s earnings guidance or short squeeze on the stock have to do with premium financing?
OK Time to OUT Pig/Eddy/Mark…
All the same person gang. What a joke. He is of the belief that by changing the name on the post that we won’t know that it is the same person? If you read the original post, I mentioned the lying and cheating that goes on in the industry, specifically related to this issue…Chalk up another one.
(BTW, comments are tracked by IP so that spam does not get through and that the integrity of the board/blog is maintained)
YEEESH! Come on, put your comments down and their validity will hold if you are right. No need to make us think that there is a crowd with the same opinion. Then again…maybe there is… Remember that movie Sybil?(sp)
You didn’t answer the question. I was just playing around since everyone makes up names. You know what they say about fighting on the internet.
Stock was up quite a bit again today.
The pig was to make fun of you saying they were getting slaughtered on crocs?
And what’d you do with Darryl Hall?
Wall Street Journal had a good article on this issue.
http://webreprints.djreprints.com/1530950584910.html
Andrew it seems you have a bit of the chicken little syndrome. If an Insurance company will write the policy, then the policyholder has a right to the payout promised. It is odd that you are concerned about insurance companies actually having to pay the amount they write the policy for. If they can not afford to pay it, regardless of the circumstances they should not write it. As far as the sick and elderly being swindeled out of there money…I think HGTV gets the award for that.
The insurance companies are their own worst enemies. Is all they have to do is raise the rates on people 75 and over, there will be no arbitage and the life settlement business will be history. The trouble is that insurance companies want it both ways. They want to sell large policies, but they don’t want them sold.
When they wake up, they can get out of trouble.