Must go faster

The securitization of all of this was the nuclear weapon of financial services. Companies packaged these things up and all of these firms were buying and selling them. Then all of the sudden, interest rates spiked. That's what caused the first wave of defaults to happen. People with adjustable rate mortages couldn't afford what they had and they defaulted. Big blocks of assets that had been rated AAA were starting to default. This started the housing crash.

There was a huge amount of leverage in the market. The government came in with TARP and bought $800 billion worth of toxic assets. It was the worst thing they could have done. If assets are down, and you pay for them at market value, you simply realize the loss.

Meanwhile, you had FAS113, or market-to-market accounting. It doesn't matter what the performance of the assets are, it's what the market is willing to pay for them. In a rational market, you pay fair value for an asset. But at the beginning of the financial crisis, you had assets that were worth 100 cents on the dollar on performance, but because of the climate of fear at the time, their market value was only 60 cents on the dollar. So their market loss was on paper. That killed a lot of companies. Even AIG. Part of their problem was market-to-market accounting.

Then there was volatility in the equities market, when it crashed. You had days when the market was 700 points up and then down 400 in the same day. When the S&P dipped to 400, a lot of variable annuites were destroyed by that, and so people got out of them. It was an odd combination of things that caused that particular collapse.

In the 1980s, the savings and loan crisis was a worse financial crisis, really, but you didn't have market-to-market accounting, and not as much subprime lending. But it didn't just hit insurance companies. It hit bank franchises as well. Citi's stock became a dollar stock. Bank of America, Merrill Lynch became a $10 stock.

The financial side of things has never recovered. And that creates a confidence issue for financial services and the life insurance industry. Especially when people like to market according to rating agencies. The rating agencies have faced a lot of criticism; even today, in the current environment, they are still doing their best to put a current appraisal on companies. It's a difficult thing to do.

What about the push to market life insurance as an investment? Is this more of a challenge or an opportunity?

With such low interest rates now, most life insurance contracts have a cash value rate somewhere north of four percent. Maybe five. If you're trying to put money in the bank so you can retire tomorrow, you can't do it. You'll be lucky to get one percent. But you're afraid to put it in the market because you're leery of what happened in '08 and '09. You could put it into fixed securities, but if rates go up, you lose principal. For long-term planning, life insurance, even in a low interest rate environment, is an attractive product. It gives you tax-deferred accumulation, death protection and it's credit rated. And indexed universal life is attractive because in a low interest environment, it gives a bigger upside in accredited rate.

Assume the market goes up 30 percent in the first year, then down 30 percent, and it zig-zags for five or six years. In equities, you would be down considerably. But in IUL with a 12 percent cap and a 1 percent guarantee, you could be up and down and average a six percent return. Right now, people have indexed calculators, and they put in if they had invested in insurance what their rate of return would have been. Most of them would be seven, eight or nine percent. I'd never tell someone who buys IUL they will make seven to nine percent, but it certainly has an upside and should play a part in a central crediting strategy.

So how would you differentiate IUL from variable annuities, given how badly the VA market turned out?

With IUL, you do give up a portion of the upside. When the market goes up 20 points and you have a 12 percent cap, you only get 12. It's how the product is designed and hedged. You pay premium dollars in, those dollars are invested in bonds, and income off those bonds provide that 1 percent guarantee and buys options on the markey. It is hedging itself on the upside of the market going down. With variabile annuities, you had the full upside and full downside. So the market went up to 1,400, and we built all those ratchets in there and guaranteed that the annuities would not go down, and with a death benefit of seven percent. When the market collapsed, assets went down with it, but annuities locked in at the old number, so we were just whipsawed. With IUL, there is not nearly the risk that was there in the VA business.

VAs had their share of regulatory blowback, eventually. What are you seeing in terms of regulatory headwinds for IUL?

The SEC did a thorough enough analysis on the activity around indexed annuities, and it's just not on their plate anymore. The market risk isn't there. Life insurance isn't even in that loop because you're not really investing in the market. It is the investment crediting strategy that ties to the market with caps. It's tied to options, but they are company options. The policyholder owns no options, just the policy they are buying.

The bigger federal regulatory issue, really is that the Fed is actively keeping interest rates very low. There are some reasons why. They think low interest rates will stimulate the economy. Second, we have $16 to $17 trillion in debt; if you raise interest rates, the interest on that debt goes up. The low interest rate environment doesn't impact banking like it does insurance. Banks don't have guarantees built into their products; they'll credit you at half a point. The fear I've got is the temptation by regulators to ignore the long-term impact on the life insurance business. That's why it is so important that we show the importance of life insurance to the world. This low interest rate environment s not a good thing.

Other than low interest rates, though, what is the biggest problem facing the industry?

Getting new professionals into the business. The population is aging. Our numbers are flat or not growing. We have a gigantic opportunity and we haven't captured it yet because the economics of it don't work properly. The future of distribution of life insurance is a big deal. People don't just buy it. It has to be sold to them.

So who is going to sell it? It is a big chalenge. Agents say, wait, we'll just go after the big affluent market. Sell five to seven big policies a year and make a good living. In the middle market, you have to sell 100 policies a year to make a good living. You have to work a lot harder in the middle market unless you have a quote shop. Mass prospecting works.

What is the worst-case scenario if the distribution side doesn't evolve?

The affluent market is still well underserved and penetrated, especially when you look at the number of people with large estates that are primarily in property or assets with appreciated value in them. When you die, you have a 50 percent tax on it. Where do you sell your assets? A good example is a $10 million farm The person makes $100-200K off that farm a year and he dies. You'd need to sell the farm to pay the taxes. That's why life insurance is an irrevocable trust, to protect the estate. The problem is if you are only focused on the affluent market, people might say that life insurance is founded on giving comfort and security to families if there is no breadwinner, and we don't want to be accused of not serving that market. But it is not an easy market to serve, and right now, we simply do not have enough people to serve it.