An Education - How Life Insurance Goes Bad

By Mark Colbert
Expert Consultant, Life Insurance Company Fraud

In the following pages, you'll find my analyses of various life
insurance products, sales methods, and how they are often misrepresented.


Whole or "Traditional" Life is the kind of policy your parents or grandparents may have had. These policies cover you for your entire life, not just a specific period. Both your premium and death benefit, or face value, remain the same for the life of the contract. (With term insurance, your premium increases as you age to account for the fact that you're a bigger health risk.) Insurance companies keep both the premium and the death benefit constant during the life of a whole life policy by charging you a premium that's higher than the actual cost of the insurance when you're young and using some of the profit to pay for the higher cost of your insurance when you're older.

As required by law, the insurance company invests the premiums in low-risk instruments , mostly bonds and mortgages. The policyholder has no say in how the company manages these funds; long-range returns are comparable to bond funds'. Over and above the guaranteed rate of return, some companies offer policyholders the opportunity to share in the company's profit, just like shareholders do. The company pays policyholders dividends, based on the success of the company in the previous year. Policies with this benefit are called "participating policies" as opposed to "non-participating policies" - that is, ones that do not pay dividends. Think of it as,"participating or not-participating in the profitability of the company."

    **   Please note that amount of the annual dividend is based on many different factors and most companies will never guarantee them.

One of the more attractive features of any permanent life insurance is that earnings are tax deferred until they're withdrawn, and then only to the extent that they exceed the amount paid as premiums (capital gains). The invention of tax-deferred retirement plans, like 401(k)s and IRAs, and the phenomenal growth of mutual funds have made traditional whole life less popular as a means of college or retirement saving.

Another great feature of participating whole life policies is: it is also possible to offset premium payments in later years. With this option, annual dividends are put back into the policy and used to purchase additional amounts of paid-up insurance called paid-up additions. Once these additions or "paid-up adds" are sufficient to cover the premium, they are surrendered each year to make the premium payment. However, if the policy does not perform well you may have to make premium payments again.

Another significant benefit of the whole life policy is the fact that you can borrow against your cash value, usually at interest rates significantly lower than market rates (usually 8 percent). The rates are low because the lender is assuming little or no risk. If you don't repay the loan (plus interest), the company will take the money from your account. When you borrow against a policy, you don't have to pay any fees, and you can usually get a check in just a few days. If you die before the loan is repaid, the outstanding amount is deducted from the death benefit.

Some companies will pay a "terminal dividend", a type of bonus, if you will -- upon the death of the insured. Of course, a company makes no guaranty that it will pay this dividend (or any dividend, for that matter). However, most annual and terminal dividends are, indeed, paid.


Due to the simplicity of whole life, it is not an easy policy to misrepresent. However, over the years, the imaginative minds of some greedy salespeople have contrived some doozies.

The Vanishing Premium:   In this scenario, an agent highly exaggerates the earning potential of the whole life policy. A potential policy owner is "sold" on the company's financial strength and ability to earn sizable profits for its policy owners. Based on these "illusions of grandeur", policies are sold under the premise that they will be self-sufficient or "paid-up" much sooner than possible. Thus, policy owners are often wrongfully led to believe the premium will "vanish".

Premium Redirection:   As I elaborate on this section, keep this in mind: very seldom will a whole life policy survive without its dividends or accumulations. In essence, dividends are the policy's "life blood" in later years. Agents may sell additional policies to the policy owner or members of the family by representing that; since the older policy is now self-sufficient, you can use its dividends to finance a new product -- basically, robbing Peter to pay Paul. In very few cases will this work successfully and in most cases, both policies will eventually lapse with no value.

The Christmas Club:   Although I've seen this particular "scam" called by several different names, "The Christmas Club" stands out as the most flamboyant.

Here, agents contact senior policy holders with large cash values in their permanent policies representing that, because the insured has been such a loyal policy owner for so many years, they are eligible for membership in the "Christmas Club". As a member of this prestigious club, they have a choice between a "free" paid-up life insurance policy or cash. The agent (who was secretly given the amount of the policy's cash value by the company) will try very hard to "sell" the policy owner on the value of "free" insurance. Because the policy's face value is usually very small, a medical examination is seldom required.

When the "victim" selects the new policy, the agent has them unknowingly sign the appropriate forms to withdraw money from their policy's own cash value and secretly uses this money to pay several years' premiums on the new policy in advance. If the policy owner decides on the cash, which is very seldom the case, the money is given back to them in a check from the company. In just a few years, the old policy lapses because its cash value was taken and the new policy lapses because the premiums paid in advance have "run out". As you may expect, I have not yet seen an agent who's sold policies like this stay with the same company very long.


The U/L or Universal Life policy:   was introduced to the insurance marketplace back in the early 80s when interest rates were in the 10 to 12 percent range. Universal Life insurance is a form of whole life insurance--but with much greater flexibility. Like whole life, you have two components: a term insurance policy and an investment account from which the term insurance premiums are paid. But with universal life, you get to choose your options, and your choices are generally laid out in front of you. You know how the premiums may change the death benefit and cash value, and it's much clearer how much of the premiums go toward your insurance protection, how much toward your cash value, and how much toward administrative expense (including commissions). Beginning with a planned death benefit that you worked out with your agent, you determine your planned premium, based on how much you can afford and the cost of the insurance. The company subtracts an expense charge based on its fees, usually a fixed percentage of the premiums. You're left with a cash value that generates interest.

But understanding universal life insurance doesn't end there. From the cash value, the company subtracts the current cost of insurance (the mortality charge), including the charges for any options (or riders), and monthly administrative expenses. And then the company adds in interest that your investment money earns. Your ending cash value is the accumulated value that belongs to you when you cash out (or in some cases, to your beneficiary when you die).

Often, companies charge you a termination fee or surrender charge to cash out (known as back-loading), leaving you with the surrender value. The surrender charge, which usually decreases over 15 or 20 years, is most often a percentage of the total cash value. I have seen cases where agents have advised people to surrender old policies, representing that the earning potential of a new policy is enough to more than make up for the loss. This is very seldom true and policy owners usually lose a great deal of money.

A few of the "hi-lights" are:

If you decide to stop paying premiums, the company will continue to pay the premium for you by deducting from your policy's accumulation fund. The company will continue to do so until no cash value is left. This is another way to continue coverage without paying premiums.

The interest rate is usually tiered, in which part of the cash value earns one rate while another part earns a different (usually higher) rate. For example, your interest rate may be 4 percent for the first $1000 and 6.5 percent for the balance.

You can also borrow against the cash value of your policy at a fixed interest rate, usually below market rates

Like whole life, you have two basic components: a term insurance policy and an investment - or cash value account from which the term insurance premiums are paid. But with the U/L policy, the policy owner gets to choose the options, and the choices are generally laid out in front of you. You know how the premiums (or lack thereof) may change the death benefit and cash value, and it's much clearer how much of the premiums go toward you basic cost of insurance, how much toward your cash value, and how much toward administrative expenses (including commissions).

In the past, while teaching the universal life concept at seminars, I've used the following analogy: (This is by no means intended to fully explain the intricacy of the U/L policy. It is a basic synopsis of the U/L theory for those without the insurance education possessed by some, but certainly not all, agents or company reps.)

For this example, we'll use a $100 monthly or "Target" premium, a $100,000 death benefit, and a 35 year old, male, non-smoker who is in "preferred" health.

The premium is placed into a "fund" managed by a life insurance company. For this, the company will be "contractually bound" to pay the beneficiary $100,000 at the moment your heart stops beating. However, the term (or unseen) cost of insurance for a 35 year old is not $100.00. It is, for our purposes, only $25.00 dollars per month. If only $25.00 goes into the cost of insurance (COI) where does the extra $75.00 go? Into the cash value or accumulation fund - which earns interest. You, as the policy holder do not get to choose where the money is invested.

When you turn 40 years old, your new cost of insurance will be $40.00 per month - so only $60.00 will go towards your accumulation fund. At 60 years old, your monthly cost of insurance will be $70.00 per month - so only $30.00 will go toward your accumulation fund. For all intents and purposes, your cost of insurance will increase each and every year. It goes to figure that - as you get older - you get closer to death. This is called a mortality calculation. Based on this calculation, understand that at some point in the life of your policy, your premium will be $101.00 per month. If you are only paying $100.00 per month, where will that "extra" dollar come from? - Why your cash value, of course. At this time, you are theoretically, "robbing Peter to pay Paul."

However, this is not a bad thing, this is the way the policy was designed to work. Once you have become unable to afford the constantly increasing cost of insurance, the policy will do it for you - internally. Again, for the purposes of this example, this is how policies become "paid-up" - when the increasing value of the accumulation fund surpasses the increasing cost of insurance. Unfortunately, there are far too many factors associated with the U/L policy for me to cover on this page. For those of you who would like to know more, feel free to contact me or any other trustworthy insurance professional.

BEWARE! and keep my expert opinion in mind: I once told a high-profile journalist that, 40% of the agents who make up the whole, or 100% of the industry would "stab you in the back, take your last dime, and not lose one minute of sleep. 59% of those left are the most courteous, kind, caring, trustworthy, honest, wonderful agents ever to bless a kitchen table with a briefcase. However, if one of these great agents find that you've been "victimized" by one of the 40%, they'll usually suggest you replace the policy and possibly ask for your money back. They will by no means "put on the gloves and step into the ring for you" against a major insurance company because quite frankly, "it's just not worth it." So this journalist I was chatting with does her math, "Mark, 40 and 59% is only 99%, that leaves 1%." I smiled and said, "yeah, that's where I live."


I'm afraid that if I were asked to pick the one single product that has most damaged the life insurance industry, it would undoubtedly have to be the Universal or Flexible Premium Life policy. I have often remarked, "if the U/L product is put together correctly, managed honestly, and reviewed periodically, it is a fine policy - maybe even the best. However, this policy can also be made to operate on that fine line separating the "white" from the "black". From this perspective, it can also be an agent's license to steal.

In the example above, I mentioned the term "Target" premium. Remember this as the amount necessary to take a policy through to maturity. According to the most recent cost of insurance and mortality calculations, "Maturity" can only be one-of-two things; the death of the insured or age 95 (or in some cases, age 100). Back in the early days of Universal Life, the target premium only had to be met for one year before it could be voluntarily "flexed" by the policy owner. Thus, if the target premium was $1,200 per year, this goal could be reached any number of ways - either from a single $1,200 deposit, $100 per month, $300 per quarter, or $600 semi-annually. By any means, if that $1,200 goal was met at least once, the following year's premiums could be reduced to as little as $0.

In the early 90s, some of the companies soliciting the U/L policy changed their "Target Premium" requirement from one year to two years. Referencing the example above, this meant that now, $2,400 needed to be placed into the policy before the premium could be altered.

Keep this very important point in mind: It did not matter what your desired payment method was - lump sum, annual, semi-annual, quarterly or check-o-matic; as long as that required amount was paid, your premium could be lowered.

Using this flexibility option to their advantage, agents would "roll, transfer, kick-start, bind, shift or churn" the sometimes large cash values from much older policies into new U/L policies in a practice called, "frontloading". By doing this, they could place more than enough money into the new policy to cover the target premium requirement. Usually at the point of sale, the agents would often have the policy owner sign blank Service Request Forms which could be later used to withdraw the cash values or dividends needed to alter future premium requirements; often without the policy owner's knowledge. Then, last - but certainly not least - came the promise of "much better insurance coverage for far less money".

Once the "frontloaded" money is exhausted and the lowered premium is insufficient to cover the cost of insurance (which was usually just a few years), the policy owner would often get a rather large bill directly from the company. Shaken, they would immediately get on the phone to find that the agent is no longer with the company (or that he/she has been promoted to management level) and cannot be found. From here, the excuses would vary. "Poor interest rates, the policy owner misunderstood the agent, clients only recall what they want, decreasing dividends and poor economic times" are the more common excuses for an agent's dishonesty.

In the times I have found numerous cases against the same agent - thereby establishing a pattern and practice - the company (while never admitting any form of responsibility) would call him/her a "rogue agent not acting in the company's best interest". Call it a "hunch" if you will but, I have found that when agents "strip" older policies of sometimes tens - of - thousands of dollars, making more in commissions than some people earn in a year, then leaves the policy owner without any coverage whatsoever in just a few years, they are certainly not acting in the best interest of the policy holder either!

Although I will not go into any detail on this page, most Economic experts can use terms like, "Mortality, Exposure, and Risk Tolerance" to prove that companies do actually benefit from "churning."

Over the years, I've found that the number of ways in which a life insurance policy can be "sold" is limited only by the imaginations of the agents. As I've said in the past, not every representative from every company needs to use "questionable" sales methods.


Term is the most basic of all life insurance policies. Basically; you pay, you pay, you die - they pay.

Term insurance, at its simplest level, provides life insurance for a specified period (usually one,- five,- ten,- up to 30-year term). For that coverage, you pay a monthly, quarterly, semiannual, or annual premium which remains level during the specified term.

But that's really the only constant. Because so many various options are available, such as decreasing term and increasing term policies, in which the face value or death benefit changes each year (rarely more than 18-20 percent above or below the original policy amount). Both these products are different from level term insurance, in which the face value remains level throughout the specified term.

Remember that term insurance provides a benefit for others if you die during the specified period. It is not an investment. - you receive no benefits other than the security of knowing that if you should die, your beneficiaries will receive the insurance proceeds.

The ideal life insurance policy is the one that's in force at the exact moment your heart stops beating. If you buy a life insurance policy, not only do you want your policy to remain in effect during the specific term you designated, but you also want to be able to keep buying the insurance until you decide to stop - not when the company decides that you've become too great a risk

Most term life insurance policies are renewable - but your premium may not remain constant for the renewed period. Based upon the mortality tables I spoke of in the last section, your premiums will undoubtedly increase as you get older - the older you get, the closer you get to death.

Without a renewability option, the insurance company can decide that it no longer wants to insure you when the terms of your policy expire. This option insures that you can still buy life insurance regardless of your future medical condition; after you qualify the first time, you don't have to take any additional medical exams to maintain your policy. Because you become a bigger health risk as your age increases, not passing a medical exam is the danger of not purchasing a renewable policy.

However, renewable does not mean that you can increase your policy's amount of coverage. If you decide that you want more insurance, the company will require that you qualify for it medically.

Decreasing term: Although maybe suitable for some people's needs, I personally have not found "the right situation" for this type of policy. For "ordinary" term, the face value remains constant and the premium increases over time. With a decreasing term life policy, the opposite is true: After the specified term, the death benefit of the policy decreases, while the monthly premium remains the same. In that way, the insurance company effectively increases its premium, which it must do because, as you age, you're at a greater risk for death. So the same premium purchases a gradually decreasing amount of insurance. This type of policy which is typically sold as a Mortgage Protection policy could end up costing an enormous amount of money for very little coverage.

Level term: A level term life insurance policy makes sense if there's not much chance you'll want (or need) to buy insurance later in life. In a 20 Year Level Term policy, for example, both the premium and face value remain constant for 20 years. The company can assure you a level premium by increasing the premium in the early years of the policy. If the company charges you more "up-front" and invests your premium dollars for themselves, they can afford to charge you less later on.

Convertible term: Most companies who offer term insurance often include a convertibility feature. This option allows you to convert to a different type of policy - whole or universal life - without having to pass another medical exam. Again, because your health is more likely to deteriorate as you age, this feature may be important if you think you'll have the need for insurance later in life.

WARNING! Although the term insurance idea makes sense at an early age when incomes are generally lower and obligations few, please consider it carefully before making the decision to enter into a long-level term contract. The cost of replacing a term with permanent coverage at an increased age could be 2-3 or 400% higher than buying the permanent coverage initially.


Not very likely. The simplicity of term insurance is most often its "saving grace." I would strongly urge anyone looking for a term policy to consider these points:

1) Find a stable company with a good financial history. The ratings of most companies are available through various sources including A.M. Best.

2) "Shop" the price. Some of the companies whom you'd think would have the lowest premiums, (typically Property and Casualty carriers) have got the highest prices in the industry.

3) Research the cost of converting the policy at 10-, 15-, or 20-years. If you discover the need to convert later on in the life of the policy, who will be the most cost effective?

4) Another excellent point that very few people think of is, "checking up on the agent." Who is he? How long has he been selling insurance? Can he give any references besides his Mother? - Don't laugh, I investigated an agent who "ripped off" his own mom. How many different companies has he worked for? Is he from the same general area as you? Most State's Department of Insurance have a toll-free number that you can call to verify his credentials.

Don't be mislead by credentials alone: Agents who often claim to be the "best thing since sliced bread are often found to be toast."
A few years ago, I was named as an expert in a case in which the alleged "bad agent" was the son of the #3 man in a major insurance company. Besides having an income in the mid 6-figure range, this guy was a permanent fixture at all the top functions, social gatherings, Million Dollar Round Table, trips to far-away lands, cruises, etc., etc. By his own admission, he was so good, he could sell snow to an Eskimo. At sales meetings where there was sometimes hundreds-of-thousands of dollars (and life-savings accounts) on the table, this guy was unstoppable. He could "talk the talk and walk the walk" with the best of them.

After examining boxes of evidence and interviewing policy owners for over a year, our team was thoroughly convinced this guy was about as "innocent" as O.J. Simpson. We all felt he preyed on the elderly and relied on his credentials (and Father) to "get him in where the big fish were." In the end, he was found innocent of the allegations and went back to work in search of new blood. In the process, an elderly couple's future was literally "hung out to dry." This outcome was unimaginable to anyone who saw the evidence we did; how could this happen? It wasn't until later that it all came to light. Being that he was, "who he was" his legal defense team had an "open checkbook" with which to work. It's amazing how the ability to spend $millions on a defense team can often work to a person's advantage, right O.J.?

Understand the terms of the policy. Don't be sold a 5-year level term policy by an agent who tries to convince you that the premium will never change. Agents will sometimes represent that a 5-, 10-, or 15-year level term policy will remain level for a much longer time. Remember that you can always fall back on "black and white." A 10-year level term policy has a level premium for 10 years, not "15 years with the possibility of 20."

Look carefully at what you've purchased: I realize this example sounds almost funny, but it really does happen.

A few years ago, I was asked by some senior policy owners to help them review their policy with a "top-rated" insurance company. During my investigation, we discussed what their agent represented the policy to be and what they expected from it. The interview was going relatively well and no "red flags" were shooting skyward when they assured me they purchased a 15-year level term policy. As I reviewed the policy, I found it to be a Yearly Renewable Term or (YRT) policy - this meant the premium was due to increase each and every year. Furthermore, given their age, the premium was incredibly high. As I explained my findings to them, they seemed obviously confused. I later found that the agent had taken a large sum of money from an older whole life policy and used it to pay several years' premiums in advance on the new term policy.

The agent had represented that they would not need to make premium payments at all for several years and when they did, the payments were going to be small. When I showed them the "fine print" on the policy that refuted the "sales pitch" they were completely astounded. Obviously disturbed, they told me they had known this agent for years and he was a "regular" at their church. His kids played with their Grandkids and had even gone to the same school. Imagine their astonishment when, after a brief telephone call, we found that their insurance company didn't even sell a 15-year level term policy.

How did their claim against the company turn out? - they won.

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