I’ve found over my career that many financial advisors are uncomfortable talking about life insurance. In some cases, they have an irrational fear of the product. In fact, a Saybrus Partners study found that more than half of financial advisors (56%) don’t talk about life insurance even if their clients bring it up. And nearly half don’t review existing life insurance policies with clients annually. That study was done over a decade ago, and I don’t think things have changed much since then.
I get it. It’s hard discussing death or disability with clients when you’re trying to help them achieve a more fulfilling life. And some financial advisors feel life insurance is a huge time drain due to the paperwork and cumbersome application/underwriting process (I agree). Further, they may think the sale of permanent life insurance is inefficient and uneconomical. So, they’ve convinced themselves that term is the only insurance product anyone should buy because large permanent premiums eat into a client’s investment budget.
Hence, the default response is “Buy term and invest the difference.”
Financial advisors with this mindset may be doing a disservice to their clients. Life insurance is purchased because someone loves someone or something. In addition to providing guaranteed income and financial security for a client’s loved ones, there are other important reasons for clients to purchase life insurance that align with financial planning:
- Pay off mortgages, lines of credit and credit cards.
- Finance income taxes owed and possibly estate taxes for clients above the exemption threshold.
- Fund a buy-sell agreement or purchase an interest in a business.
- Facilitate the transfer of assets within the family.
- Fund the purchase of real estate.
- Create supplemental retirement income for business owners or key employees.
Three Overlooked Concepts
Unfortunately, I’ve found many advisors haven’t been schooled in the merits of life insurance and overlook three important concepts:
- All life insurance is term insurance. Assuming there’s a difference between permanent insurance and term insurance is wrong. All insurance is based on the scientific principle of predictable mortality. The cost of dying is the same whether you’re buying term or one of the many variations of permanent insurance. The only difference comes down to who pays the cost of mortality. With term insurance, the policy owner pays mortality costs out of pocket. With permanent insurance, a portion of the premium is funded out of pocket, but a significant portion is paid with tax-free earnings on the cash values generated by premiums. It’s not about which type of insurance is better for the client; it’s about how long the client wants the coverage to be in effect. If your client wants insurance to fund their needs throughout their lifetime, they better consider something other than term insurance.
- Asset allocation alternative. Another benefit of permanent life insurance is that the stability of the cash values can be used as an asset allocation alternative. Most insurance agents aren’t financial advisors. They don’t think in terms of asset allocation or alternative ways to provide stability in a portfolio. Financial advisors know the merits of fixed investments and have dealt with “mark to market” risk. Cash values don’t have this problem. Cash values are a viable addition to the fixed portfolio that provide stability and liquidity if needed, without damaging the portfolio. Many policy owners have borrowed against their cash values. The insurance remains in force, and the investment portfolio doesn’t have to be decimated to meet economic needs.
- Finding the right carrier is more important than the price. There’s a common misconception that clients should shop around for the cheapest life insurance premium, just like they do with auto and homeowner’s insurance. However, the insurance industry operates like an oligopoly. Because of heavy regulation, competition among the largest carriers is limited. There are four pricing variables that all carriers face, which I’ll discuss shortly in more detail: (1) administration costs; (2) rates of return; (3) mortality costs; and (4) persistency.
Four Pricing Variables
Life insurance is a mathematical science based on the predictable probability of death. Every carrier—whether a stock company that answers to shareholders or a mutual company that answers to policyholders—is bound by sound economic principles to adhere to the science. Government regulators and auditors scrutinize the carriers to ensure they’re following prudent guidelines. By understanding the four pricing variables below, you can see how carriers potentially differentiate themselves in the market:
Administration costs. These can be broken down into policy services, underwriting and marketing. With the advent of the computer, policy services have mostly been reduced to employee count. Most of the data tracking is done through administration software. Servicing involves making changes and answering questions. Underwriting a policy requires data gathering and valuation. The more efficiently a company can provide these services, the lower the expense and the higher the profit.
Rate of return. The conservative nature of insurance carrier portfolios has limited the ability of the companies to distinguish themselves through returns. Don’t be fooled into thinking otherwise. While the allocation of assets can vary widely within asset classes, the National Association of Insurance Commissioners (NAIC) has provided guidelines for asset allocation within the portfolio. These guidelines are broad, but the consolidated results suggest companies adhere to a similar formula.
As of year-end 2023, for example, NAIC reported that U.S. insurance companies had approximately 15% of their total cash and invested assets in common stocks. This indicates a general trend towards maintaining a relatively modest allocation to equities compared to bonds, which constituted about 60% of the total investment portfolio. Mortgages (9%), Schedule BA assets (6%), short-term cash and riskier alternatives made up the remainder.
Mortality costs. These differ among carriers. Life insurance companies can use different mortality tables depending on various factors, but there are generally nominal differences because the foundational statistics are the same. Yes, carriers have some latitude when it comes to how they use mortality tables to price insurance. But people still die according to a predictable pattern of death. If the carrier is too aggressive and gets its assumptions wrong, its financial stability can be jeopardized. As a result, consumers and their advisors should be wary of wide variations in premium estimates.
Persistency. This is a crucial factor in the premium calculation and overall financial health of life insurance companies. Persistency refers to the retention rate of issued policies. You might be surprised to learn that it takes seven to 10 years for a carrier to start making a profit on an insurance policy. High persistency rates mean the carrier has a better opportunity to profit if policyholders continue to pay their premiums over time. If the policies terminate early, the carrier’s long-term financial stability will be negatively affected.
Persistency helps maintain a stable risk pool. When policyholders stay with the company for longer periods, it makes it easier for the insurer to predict and manage risk associated with its insured population. Higher persistency rates mean more funds are available for investment over longer periods, potentially leading to better returns and financial growth for the company. High persistency rates also indicate customer satisfaction and trust in the company. Satisfied customers are more likely to renew their policies and recommend the company to others, contributing to long-term business success.
Providing More Value
Life insurance is a valuable product and should be foundational to all financial plans. Because it is a science based on sound economic principles, it can be integrated into the financial matrix for anyone who needs insurance to protect those they love. Financial advisors can provide more value than ever by aligning with a strong carrier and integrating insurance into a holistic 360-degree view of your client’s life and goals.
Dr. Guy Baker is the founder of Wealth Teams Alliance (Irvine, CA).
