I’ve always had a nerdy fascination with financial products: what they’re “made” of, how they’re structured, and (my favorite) where the various fees and expenses are quietly buried in them. As far as I’m concerned, the more complicated the better, and virtually nothing is more complicated than insurance “products.”
Many years ago (January 1988 if you must know), I had the pleasure of delving into the loads on the then new variable life policies, using the Linton Yield calculation developed by the venerable actuary M. Albert Linton in the 1920s, and a far less complex “cash-in, cash out” method proposed at that time by Bill Brownlie in Boston. Variable life was invented during the Reagan bull market to allow policyholders to benefit from the climbing stock market by directing the investment part of their policies into mutual funds, which would still accrue tax-free within the insurance wrapper.
But VL was also ripe for financial abuse as these complicated policies could and often did have fees and expenses charged at each of three levels–the policy level, the account level, and the subaccount–plus the death benefit. Sorting out the actual return that insureds got on the premiums they paid into these “products” required, well, an actuary, and often it wasn’t pretty. But I was in spreadsheet heaven.
I’ve always thought the practice of calling insurance policies or any other financial vehicles “products” was a pretty nifty bit of marketing misdirection. They aren’t “products” of course. Products are produced by someone, somewhere: Cars are produced by auto workers most anywhere other than Detroit, milk is produced by cows in Wisconsin, and iPods are produced who knows where–by God as far as I can tell–but they are produced somewhere.
But insurance “products” aren’t produced anywhere–they are created, usually by one person or a small group–so they aren’t really products at all: they are ideas. Sounds like some inside semantics, doesn’t it? But this distinction is important, trust me. Products themselves are morally neutral, it’s how we use them that can be valued. A car can be used to rush your pregnant wife to the hospital or be driven by a drunk. A baseball bat can be used by the Indians to beat the Yankees, or in an armed robbery. But the products are neither good nor bad.
Ideas, on the other hand, are often inherently good or bad. Riding your motorcycle without a helmet is a bad idea. Trusting your financial future to an independent advisor is a good idea. By categorizing insurance policies as neutral “products,” insurance marketers have quite successfully removed them from scrutiny as either good ideas or bad ideas. For instance, buying any kind of a whole-life policy in which the hidden loads and fees greatly outweigh the benefit of the tax-free compounding, is a bad idea (you’d be far better off buying term and investing the difference). While “products” that enable us to manage risk at a fair cost or that help to customize cash flow for a clearly stated price (think ATMs) are good ideas.
A Problem from the start
The problems with most insurance or financial “ideas” stem from their creation by folks at large institutions working to benefit those institutions. And any benefit to the end users of these “ideas” is often purely coincidental. One silver lining to this sad state of affairs is, of course, that people need independent advisors to protect them from just such products and institutions. Another silver lining is that the financial industry also includes a few far-sighted mavericks, who have come up with good ideas for helping people to solve their financial problems with relatively simple “products” at a fair price. These are the folks that advisors get paid the big bucks to know about, and I try to bring to their attention whenever I come across them.
One such maverick is Larry Fondren of Legacy Funding Group in Malvern, Pennsylvania. In financial services since 1973, Fondren has made a career out of identifying inefficiencies in financial markets (that not coincidentally often seem to favor the big institutions) from bond offerings to the Internet, and coming up with ways for smaller players and individuals to level the playing field. He has even testified before Congress about the need for more transparency and equal access to real-time pricing and financial information in U.S. markets, and “the adverse impact of these upon consumers.”
Fondren’s latest mission is to provide alternatives to the current life settlement approach for consumers who want or need to liquidate their assets in life insurance policies. To understand the advantages of his solution, you first need to know the current situation in the life settlement industry. Back in the ’90s, one of the old life insurance pioneers told me that the whole insurance industry was changing because risks had changed: people had become far more likely to outlive their assets than to die early, and now needed life benefits more than death benefits. Life settlements have become one of the solutions to that problem.
Life settlements grew out of the viatical settlements, which became popular in the mid-80s, in part due to the need of terminal AIDs patients for access to the death benefit to pay for medical treatment as their illness ran its course. As that industry developed, it became clear that policyholders had needs for their insurance assets that went far beyond medical treatment. As insureds got older, so did their beneficiaries, who often became more successful as well, and didn’t need a large death benefit anymore. At the same time, elderly insureds on fixed budgets often find high insurance premiums to be a burden.
Life settlements let you access your death benefit before you die, but at a price. And because it was a buyers’ market–people usually needed the money and had few alternatives–that price was, and is, high. For a $5 million policy on a 70-year-old man, a life settlement offer might be $1 million. That’s more than the $500,000 surrender value, but not a big chunk of the death benefit. In addition life settlement offers tend to be low because they are actually buying the policy from the insured. That means not only does the new owner have to keep making the premium payments, but the longer the insured lives, the more they have to pay, so they significantly discount the purchase price to cover the longevity risk. (I don’t know about you, but personally, I’m a little squeamish about someone else having a substantial financial interest in my dying sooner rather than later.)
After studying the life settlement industry, Fondren saw the inherent flaw in this conflict of interest, and realized that everyone would be better off if they each had a vested interest in the insured living as long as possible. His solution is Legacy Funding, which is based on the simple premise of lending money to insureds secured by a portion of their death benefit, rather than buying the policies. Because insureds are borrowing against their policies, they continue to own them, pay the premiums, and still leave some of the death benefit to their beneficiaries. But they can also get up to 90% of their death benefit in cash, today. (Insurance companies, of course, also lend money against their policies, but on the cash value, which is usually much smaller than the death benefit.)
Fondren charges a guaranteed 9% on the amount borrowed (which accrues until the death of the insured), and only loans against policies that have been in force for at least two years. To secure the loan, he takes a lien against the death benefit, which is paid off at the time of death. His revenues, then, come from the interest paid on the loan, which means the longer the insured lives, the more he makes–a textbook win/win.
For the insureds, who might possibly be your clients, the advantages of this solution are pretty obvious. They not only get more cash out of their policies, but have greater options to restructure their finances: they can increase their current cash flow by borrowing just enough to pay up their premiums, or they can use the proceeds to meet pressing needs of their beneficiaries now, rather than have them wait for the death benefit, or they could reinvest the proceeds in a potentially more lucrative venture, or they can just take the money to improve their current lifestyle.
Providing a tool that’s better than the current alternatives for advisors to solve some client issues clearly falls in the “good idea” category, but for me, it’s even more comforting that there are folks like Larry Fondren out there, making a living by trying to level the playing field between financial consumers (your clients) and the big institutions. Not so different, in my mind anyway, from independent financial advisors themselves.
Bob Clark , former editor of this magazine, surveys the advisory landscape from his home in Santa Fe, New Mexico. He can be reached at firstname.lastname@example.org.