Anatomy of a misleading sales pitch

April 4, 2005

Churning and twisting

Once a policyholder has been paying into a whole life insurance policy for some time, its cash value builds up, making the policy more valuable. Some unscrupulous life insurance agents then convince their customers to use the built-up cash value of their existing policies to buy a "new, improved" policy — one with more coverage, different features, or a different payment schedule.

What these agents may neglect to tell their customers is their existing policies could be adequate for their needs, and when they use the built-up cash value to purchase a new policy, they start from square one in building up cash value in the new policy. This practice is called "churning" or "twisting." It's unethical — and illegal. The motivation for agents to churn is their earning a commission for each new policy they sell.

The fallout from churning isn't immediately apparent. A customer doesn't have to shell out any money up front because the built-up cash value of the existing policy pays the initial premiums of the new one. Once you use the cash value; however, it's gone.

Texas insurance commissioner Jose Montemayor says "churning" profits insurance agents at your expense. "If you bought the original policy at an earlier age, the new policy might cost more and offer less coverage. In addition, if you should die during the first two years of a new policy, the insurance company can contest claims for the death benefits," Montemayor warns. "Many companies pay larger commissions to agents for new policies than for renewals."

A policy's cash value is actual money the policyholder owns, although usually just on paper. Cash value can be used as security for a loan or converted into an annuity. If a policyholder decides to cancel a life insurance policy with built-up cash value, he's entitled to that money, minus any surrender charge that may apply.

An example of "churning"

In the past 15 years, Joe has built up a substantial amount of cash value in his whole life insurance policy. His old agent has just retired.

The new agent calls Joe, offering to sell him a policy with a larger death benefit. The agent tells Joe he can buy the new policy at no additional cost. What Joe doesn't understand is by switching to a new policy, he is using up the cash value of the old policy — money he could have used to address many financial needs.

By replacing the policy, it will take him longer to build up that cash value. He also could have used the cash value to take out a loan from the insurance company. If he decided to cancel the policy, he would have received a check for his cash value.

State regulators say Joe was the victim of a scam. The agent never explained about the loss of cash value, despite the fact Joe was still paying the same amount in premiums.

A rash of policyholder complaints about misleading sales practices has fueled a growing number of class action suits against life insurance companies. The offending practices usually take one of two forms: "churning" (also known as "twisting") or promises of "vanishing premiums."

Vanishing premiums

Life insurance companies take the money they collect in premiums and invest it — that's how they make their money. In the case of permanent life insurance policies such as whole life and universal life, companies then apply some of those investment earnings back to the value of your policy.

During the early 1980s, interest rates were high and it looked like they'd keep on climbing. So, life insurance companies illustrated that the rate of return from investing today's policy premiums would eventually pay for any future premiums. Some agents told customers they would only have to pay premiums for a few years. The agents claimed returns on the insurance company’s investments would pay for the policy after that.

As it turned out, those rosy projections weren't accurate. Interest rates fell, and customers who'd been told their policies would start paying for themselves kept getting bills in the mail. Angry policyholders protested, only to be told insurance company illustrations weren't guaranteed. In some cases, customers were able to prove they were not informed of that when they signed up for their policies.

Vanishing premiums: “No payments after the first five years!”

Some time in the early 1980s, an insurance agent tells Joe he can buy a new insurance policy, which will be paid up in only five years. The agent shows Joe an illustration that projects double-digit growth for insurance company investments. The agent says those investment returns would pay for Joe’s insurance, after the first five years.

Joe signs up for a policy with a death benefit of $100,000 and pays into the policy for five years. During that time, he pays more than $10,000 in premiums and then stops making payments.

In the late 1980s, he gets a letter from his insurance company saying that he has to resume paying premiums on the policy in order to keep it in force. He complains to the company, pointing out the agent promised he would stop making payments after five years. The company tells Joe the agent is no longer affiliated with the company and there's no record of such a promise.

The Missouri Department of Insurance claims since the mid-1990s, state regulators and class-action litigation nationally have secured hundreds of millions of dollars in policyholder awards for "vanishing premium" violations.

Texas insurance commissioner Jose Montemayor says some common sense can help protect you from "vanishing premium" or "churning" scams. "Ask yourself whether the agent has your best interest in mind or is just trying to get a higher commission," Montemayor says.

Copyright © 2005

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