thedrifter
08-05-04, 07:21 AM
07-29-2004
Protecting Troops from Insurance Scams
By Robert G. Williscroft
The New York Times broke a story on July 20, 2004, about how several insurance companies and financial firms were scamming young enlisted personnel with inappropriate insurance and investment programs. The scam went something like this.
Near the end of basic training each new military unit is required to attend a compulsory classroom briefing on personal finance. The underlying idea may have been sound, but the execution turns out to be nothing short of a scandal. Since the typical drill sergeant knows less about insurance than my pet schnauzer, the unit commander would arrange for a local insurance agent to teach the class. This is the same guy who sits outside the AAFEX or Navy Exchange Department Store on your local base selling insurance and mutual funds.
In the class, the agent makes a short and sweet presentation explaining about different kinds of insurance, and then hands out forms for the individuals soldiers to complete and sign: “Remember, guys, you’re on your way into combat. This is the best way to protect your family and loved ones in the case a bullet with your name finds a home.”
Not knowing any better, most of the recruits sign the forms. Consequently, the agents have a continuing source of fresh commissions, the commanders have met their mandatory personal finance education responsibilities, and the kids own a paltry insurance policy they don’t need and can’t afford. It’s pretty effective, especially since these kids usually know nothing about insurance. The irony is that neither do the agents nor the commanders who bring them in.
So here’s the straight skinny, right from the horse’s mouth: I am a licensed insurance agent and stockbroker for the State of California and a myriad of other states from coast to coast. Here is a fairly simple and straightforward strategy by which young military people (and their civilian counterparts) can identify and buy the actual type of insurance they need without getting ripped off.
Ask your insurance agent to explain the difference between various kinds of life insurance. He will tell you that there really are two kinds: temporary and permanent. Term insurance, he will explain, is the temporary kind, and is best suited for people who have temporary insurance needs, like protecting a house mortgage. Whole life insurance, on the other hand, is the permanent kind, and its derivatives are best suited to protect a person’s estate or to create and leave a meaningful estate for one's heirs.
Your agent is regurgitating what he learned at insurance school. Before the state issued him his insurance license, it tested him extensively on this material, so there is a good chance he believes it.
Unfortunately, faith won’t make it so. Your agent’s justification for the existence of whole life insurance is pure, unmitigated balderdash.
To understand why this is so, let’s review some basic insurance principles. Let’s start out with pure insurance. From actuary tables representing decades of demographic observations, insurance companies can tell with a high degree of accuracy what the probable remaining lifespan is for a man or woman a given age and lifestyle. They also can determine how many men and women in a given demographic will die in one, two, or any specific number of years.
With this information, insurance companies can calculate exactly how much they must collect from a pool of living individuals over a given period of time in order to cover their overhead and pay the expected death benefits. They then reduce these numbers to the actual cost per thousand dollars of benefit, stated as a function of gender, current age, and lifestyle factors such as smoking and marriage status.
These tables make it abundantly clear that the cost per thousand for pure insurance goes up each year. This means that if an insured wishes to have $1,000 of coverage, he or she will have to pay whatever the cost per thousand is for that person’s age. If that person wishes to purchase $10,000 of coverage, then the cost is ten times as much.Since with every passing year, the insured is more and more likely to die, the cost of insurance goes up each year. At some point, the cost is exactly equal to the benefit, because it is virtually certain that the insured will die that year.
Insurance companies quickly discovered that the general public – lacking any useful background in mathematics – does not understand insurance, and tends to balk at paying an increasing annual premium for a shot at a fixed dollar reward. The argument that the value of the reward really increases every year as well – reflecting the rising odds of the insured's family actually collecting the reward – was beyond the capacity (or interest) of the public to comprehend.
In response, insurance firms came up with a marketing solution based on the time-honored principle of telling the public what it wants to hear. They created a life insurance product with a constant annual premium, reflecting the cost per thousand dollars of coverage at the establishment of the policy. Then, every year, they reduce the coverage amount – the death benefit – so that its cost to the insurance company still works out to match the constant premium. Eventually, the odds that the insured will die in the current year approach 100 percent, meaning that the required premium equals the expected payout of the policy, and continuation of the policy becomes pointless.
This is decreasing term life insurance.
Since the effectiveness of decreasing term insurance is by definition limited by the age and demographic of the insured – in other words, since the coverage is temporary – insurance companies undertook to design a “permanent” type of life insurance. They soon found a solution.
The table that describes how a given decreasing term policy’s coverage decreases over time is called a decreasing term amortization schedule. Given such a schedule, one can determine how much additional money must be added to a fund each year so that the current insurance level, combined with the accumulated cash in the fund, exactly equals the original amount of insurance coverage. Add an amount to the decreasing term premium that constitutes a periodic deposit to this fund, invest the fund to generate a small-but-reliable interest rate, and the result is a level of coverage that remains constant over the years.
The system is designed so that, by the time the decreasing term coverage would have run out, the cash balance in the fund will be the same amount as the original coverage, and at this point there is no more need to make any deposits. Seen over its full amortized lifetime, this “insurance coverage” is permanent, because the insurance company can pay the original coverage amount whenever the insured dies.
Furthermore, once the policy is “paid up,” the firm can retain future interest earned by the fund, and simply designate the policy as a “paid up permanent policy.” When the insured dies, the beneficiary receives the money that the insured deposited plus the associated interest earnings, which – due to the typically extreme conservatism of such investments – usually reflect an annual rate of 1 percent or less.
continued.........
Protecting Troops from Insurance Scams
By Robert G. Williscroft
The New York Times broke a story on July 20, 2004, about how several insurance companies and financial firms were scamming young enlisted personnel with inappropriate insurance and investment programs. The scam went something like this.
Near the end of basic training each new military unit is required to attend a compulsory classroom briefing on personal finance. The underlying idea may have been sound, but the execution turns out to be nothing short of a scandal. Since the typical drill sergeant knows less about insurance than my pet schnauzer, the unit commander would arrange for a local insurance agent to teach the class. This is the same guy who sits outside the AAFEX or Navy Exchange Department Store on your local base selling insurance and mutual funds.
In the class, the agent makes a short and sweet presentation explaining about different kinds of insurance, and then hands out forms for the individuals soldiers to complete and sign: “Remember, guys, you’re on your way into combat. This is the best way to protect your family and loved ones in the case a bullet with your name finds a home.”
Not knowing any better, most of the recruits sign the forms. Consequently, the agents have a continuing source of fresh commissions, the commanders have met their mandatory personal finance education responsibilities, and the kids own a paltry insurance policy they don’t need and can’t afford. It’s pretty effective, especially since these kids usually know nothing about insurance. The irony is that neither do the agents nor the commanders who bring them in.
So here’s the straight skinny, right from the horse’s mouth: I am a licensed insurance agent and stockbroker for the State of California and a myriad of other states from coast to coast. Here is a fairly simple and straightforward strategy by which young military people (and their civilian counterparts) can identify and buy the actual type of insurance they need without getting ripped off.
Ask your insurance agent to explain the difference between various kinds of life insurance. He will tell you that there really are two kinds: temporary and permanent. Term insurance, he will explain, is the temporary kind, and is best suited for people who have temporary insurance needs, like protecting a house mortgage. Whole life insurance, on the other hand, is the permanent kind, and its derivatives are best suited to protect a person’s estate or to create and leave a meaningful estate for one's heirs.
Your agent is regurgitating what he learned at insurance school. Before the state issued him his insurance license, it tested him extensively on this material, so there is a good chance he believes it.
Unfortunately, faith won’t make it so. Your agent’s justification for the existence of whole life insurance is pure, unmitigated balderdash.
To understand why this is so, let’s review some basic insurance principles. Let’s start out with pure insurance. From actuary tables representing decades of demographic observations, insurance companies can tell with a high degree of accuracy what the probable remaining lifespan is for a man or woman a given age and lifestyle. They also can determine how many men and women in a given demographic will die in one, two, or any specific number of years.
With this information, insurance companies can calculate exactly how much they must collect from a pool of living individuals over a given period of time in order to cover their overhead and pay the expected death benefits. They then reduce these numbers to the actual cost per thousand dollars of benefit, stated as a function of gender, current age, and lifestyle factors such as smoking and marriage status.
These tables make it abundantly clear that the cost per thousand for pure insurance goes up each year. This means that if an insured wishes to have $1,000 of coverage, he or she will have to pay whatever the cost per thousand is for that person’s age. If that person wishes to purchase $10,000 of coverage, then the cost is ten times as much.Since with every passing year, the insured is more and more likely to die, the cost of insurance goes up each year. At some point, the cost is exactly equal to the benefit, because it is virtually certain that the insured will die that year.
Insurance companies quickly discovered that the general public – lacking any useful background in mathematics – does not understand insurance, and tends to balk at paying an increasing annual premium for a shot at a fixed dollar reward. The argument that the value of the reward really increases every year as well – reflecting the rising odds of the insured's family actually collecting the reward – was beyond the capacity (or interest) of the public to comprehend.
In response, insurance firms came up with a marketing solution based on the time-honored principle of telling the public what it wants to hear. They created a life insurance product with a constant annual premium, reflecting the cost per thousand dollars of coverage at the establishment of the policy. Then, every year, they reduce the coverage amount – the death benefit – so that its cost to the insurance company still works out to match the constant premium. Eventually, the odds that the insured will die in the current year approach 100 percent, meaning that the required premium equals the expected payout of the policy, and continuation of the policy becomes pointless.
This is decreasing term life insurance.
Since the effectiveness of decreasing term insurance is by definition limited by the age and demographic of the insured – in other words, since the coverage is temporary – insurance companies undertook to design a “permanent” type of life insurance. They soon found a solution.
The table that describes how a given decreasing term policy’s coverage decreases over time is called a decreasing term amortization schedule. Given such a schedule, one can determine how much additional money must be added to a fund each year so that the current insurance level, combined with the accumulated cash in the fund, exactly equals the original amount of insurance coverage. Add an amount to the decreasing term premium that constitutes a periodic deposit to this fund, invest the fund to generate a small-but-reliable interest rate, and the result is a level of coverage that remains constant over the years.
The system is designed so that, by the time the decreasing term coverage would have run out, the cash balance in the fund will be the same amount as the original coverage, and at this point there is no more need to make any deposits. Seen over its full amortized lifetime, this “insurance coverage” is permanent, because the insurance company can pay the original coverage amount whenever the insured dies.
Furthermore, once the policy is “paid up,” the firm can retain future interest earned by the fund, and simply designate the policy as a “paid up permanent policy.” When the insured dies, the beneficiary receives the money that the insured deposited plus the associated interest earnings, which – due to the typically extreme conservatism of such investments – usually reflect an annual rate of 1 percent or less.
continued.........