WholeLifeRescue?: Buy the bank and sell the risk.
‘Folks are usually about as happy as they make their minds up to be.’
- Abraham Lincoln
‘A bank is a place where they lend you an umbrella in fair weather and ask for it back when it begins to rain.’
-Robert Frost
Life insurance is undoubtedly one of the most unrealized assets in existence. More than two-thirds of U.S. families own life insurance and the average size of a new policy is twice the median net worth of a household. Each year over $100 billion in premiums are paid on life insurance policies bought directly from licensed agents in the individual market, and most policies lapse before they expire.
Adam Smith would aver that a vibrant secondary market for an asset enhances the value of the asset in its primary market. Insurers deny this adage when it comes to the niche product of life settlements. Ownership and the beneficiary revert to a stronger (institutional) hand, albeit one that overpays for an asset with historically troubled durations, i.e., life expectancies. Rich people surprisingly live longer and ‘settlers’ often make more accurate determinations of their own health than the actuarial experts. Hoocoodanode?
This article though is not about life settlements.
Industry trade groups regularly swear on a stack of King James that insurers do everything within their power to minimize the lapsing of policies, however the numbers belie this effort.
$29.7 trillion of new individual life coverage was issued in the United States between 1991 and 2010 and 80% lapsed within that same period. Term and permanent lapse rates regularly hover over 80%.
‘Tis time for a solution.
Empirically, almost all term and permanent life policies are front-loaded resulting in folks ‘overpaying’ early in order to ‘underpay’ later; this is exacerbated by illustrating premiums and coverage amounts in nominal terms rather than adjusting for inflation.
Lapsing is a result of an unforeseen event. Front-loading makes it more challenging for the policy to survive one. This event is, simply put, a result of the client overweighting mortality risk at the expense of other risks. The fancy pants term for this is ‘disjunction fallacy’ or ‘local thinking’. As an example, folks are more willing to pay more for a policy that specifies covered events than for policies covering all details.
Cue the marketing.
Life insurers make money on (most of their) clients that lapse their policies and lose money on (most of) those that keep their policies. Through the lens of the insurer’s balance sheet, lapsing policyholders subsidize those that keep their policies.
The exception is whole life insurance. Negative capitalization early on and a small net amount of risk later on creates economic incentives to keep the policy in force, hence the emphasis put on persistency ratios.
The whole life policy can be seen, if fully funded, as an asset that requires deposits, makes loans and invests in securities. With enough capital, the revenue generated from this asset is greater than the expenses associated with paying its liabilities.
Back in the pre-internet age it became fashionable to break down investments into their component parts. Mortgages became ‘interest only’ and ‘principal only’ and were sliced into tranches. Bonds had coupons stripped and investors bought rights for durations certain. In that spirit, a whole life policy can be imagined as a series of instantaneous term contracts, renewable thru life without providing new medical evidence of insurability. It can be held forth as a linear combination of term life and savings, the latter holding value as described in the previous paragraph, i.e., ‘be your own bankster’.
Securitization of the constituent parts of a whole life policy with other insurance products that are in need of financing, such as tertiary life settlement portfolios that are valued in aggregate at almost 100 billion, creates quite a bit of capacity to keep whole life policies in force.
Cue WholeLifeRescue?.
Unbundling the whole life policy is the impetus for the concept ‘buy term and invest the difference’. This approach necessitates that folks are willing and able to save on their own and can change their behavior by deferring consumption until later in life. In truth, people put money into ‘buckets’, if they can get into the movie for free they are more likely to splurge on some popcorn then save it for future films. The fancy pants term for this is ‘hyberbolic discounting’ which is the tendency for people to discount by large amounts the utility of something that could be purchased later, thus making almost any purchase today seem more valuable than putting it off for later and saving for tomorrow.
The problem with the ‘being your own bank’ concept is that this institution’s investment committee is guided by the client’s inner monologue.
A happier path is to buy the bank and sell the risk.
WholeLifeRescue? lets your client hire the bank as opposed to their taking upon the risk of being one .
WholeLifeRescue? case studies will be presented exclusively within the ‘Whole Life Agents’ Linked In Group.
H/T K.Smetters & D.Gottlieb