Insurer's churning detailed
By Douglas Armstrong
The Milwaukee Journal Sentinel
July 14, 1996
Peter Katt knows of one case in which a Prudential life insurance agent sold a Minneapolis man more than a dozen policies over several years, assuring the purchaser that the dividends from his old policies would pay the premiums on the new ones.
"Actually, the agent was funding the new policies by killing off the early ones purely to generate commissions," says Katt, a fee-only life insurance adviser from Mattawan, Mich., who was called in by lawyers to advise policyholders who sued Prudential over its practices.
Katt compares it to a doctor who sets up a transfusion in a hospital ward to save one patient by sucking the blood out of another, and then repeating the process down the row, killing off successive patients to collect more and more money.
A settlement of $210,000 plus costs has been offered in the case, which typifies the sort of "piggybacking" and "churning" problems that led to a $35 million fine imposed last week against Prudential Insurance Co. of America by a task force of 30 state and local regulators.
Jim Hunt, an actuary for the Consumer Federation of America, advises Prudential customers who think they might be eligible for some of the $100 million or more that Prudential will pay out in restitution to sit tight.
"People ought to just relax for awhile," he says. "Prudential will notify them."
Hunt believes that policyholders with the best chance of collecting money will be those who were persuaded to borrow against an existing insurance policy to buy a new one so-called piggybacking "unless you were given full disclosure about it."
Churning in which an agent talks you into dropping an existing policy to buy a new one also is a prevalent practice that usually makes no economic sense for a policyholder.
That's because the value of a permanent life insurance policy builds slowly during the first few years, when commissions and expenses eat up most of the premium. The money you've spent is lost if you let the policy lapse.
Yet it goes on all the time.
"Raiding your own company's policies has pretty well stopped," Hunt says. "Raiding everybody else's policies has not diminished as far as I know."
A spokesman for the American Council of Life Insurance called last week's developments "an indication that the regulatory system is working" and Prudential's response an indication that "the industry is serious about dealing with these problems."
But Glenn Daily, an independent, fee-only insurance consultant in New York City, thinks attention to life insurance abuses will "be moving down the ladder of size to smaller companies."
"There are more lawsuits now," he says. "And that has more impact than regulators are having. The life insurance industry understands lawsuits. I'm not sure they understand ethics."
Daily, who discussed life insurance churning in this column a year ago, says it is not just rogue agents who do this. There is pressure on all agents because there are too many insurance salespeople chasing too few prospects.
He estimates that for each of the nation's 200,000 full-time agents, there are only 133 likely customers.
And many agents don't understand what they're selling. A life insurance policy is one of the most complicated financial instruments you can buy.
"These guys aren't financial analysts," Daily says. "They're salespeople."
So they make promises without any way of knowing if they can be kept. And more of these sale pitches will be coming back to bite the parties involved.
For example, the next big potential source of life insurance litigation, according to Katt, will be over what he calls "vanishing premium" promises made by agents during the 1980s. "Buy this policy, make just seven payments and it will be fully paid," was the claim.
"They went nuts with this for six or seven years," he says.
It actually will take 27 years to pay off those policies, according to Katt, because the dividend rate on which the assumption was based was at a historic high of 12.5% in 1984 and 1985 (against a 6.5% postwar average) in Prudential's case.
"We're claiming that they had a duty to tell consumers how implausible the vanishing premium idea was," Katt says.
Prudential did not return my phone calls.
The biggest scam today? According to Katt, it's "exaggerated guarantees" in which guaranteed performance comparisons are made by some agents to get consumers to switch policies. Guarantees that are out of line with industry norms probably are not supportable, he says.
Insurance companies may be powerful, Katt notes, but they aren't governments and can't set interest rates or collect taxes. "(They) don't print money or have aircraft carriers," he says. "How can they make these promises?"
It wouldn't take an international financial meltdown or a lethal airborne virus wiping out half the world's population to make the "guarantees" impossible, either, says Katt.
"Just a balanced budget in Washington," he says. Insurance companies invest heavily in fixed-income investments. Lower prevailing interest rates that could result from a shrinking federal deficit would throw off the assumptions on which the "guarantees" are based.
Such abuses have left Katt more than a shade cynical.
"Life insurance," he says, "is a legally regulated criminal enterprise."
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