Got Insurance? 529 Plans? Financial Aid? Read On . . .
Posted by Larry Doyle on January 13, 2009 5:10 PM |
At the request of numerous readers, I am offering a transcript review of my interview this past Sunday evening with insurance and financial planning expert, Sean D’Arcy. Additionally, if you’d like to listen to this interview in its entirety, just click on the Play button below for the audio recording. Once the playback has started, you can fast forward or rewind to any portion of the show by clicking at any point along the play bar. Archived programs are also available as a podcast from iTunes.
As a disclaimer, the opinions offered are Sean’s alone. The transcription is mine. I have no vested financial interest in Sean’s business or any of the views or companies mentioned. The purpose of providing this recap is strictly as a public service. To the extent that you find this material beneficial, my mission is accomplished. If you find this material helpful, please forward it along. If we grow our audience in the process that would be great!
Sean is a self-employed independent insurance and financial planning executive. He is a graduate of Columbia ’81.
LD: Sean, can you address how the insurance industry is regulated?
SD: The insurance industry is regulated by 50 separate state insurance offices. Each of those offices is responsible for the oversight of insurance business done within their state. Some states are very disciplined in this process, for example New York has very strong oversight. Other states are clearly lacking in the professional expertise to properly oversee insurance business within their state. Each state insurance commissioner is appointed by the respective governors. Each state insurance office is funded by a tax on the premiums written in that state. For example, New York imposes a 4% tax on each policy written in the state. An emergency fund is also put in place to address potential funding problems with individual companies.
LD: So even for large, nationwide insurance companies such as Prudential, each of those offices are regulated on a state by state basis?
SD: Yes, because each state office has the ability to maintain its’ own employees and collect tax revenue in the process. I believe the federal government is very interested in gaining an increased stake and foothold in regulating the insurance industry. It will take a large problem that the states can’t handle or don’t properly handle.
LD: How about the changes in the insurance industry over the course of the last 20 years?
SD: The big change in the industry is that a large number of insurance companies have transitioned from mutual companies, in which the policy holders own the company, to stock companies in which the shareholders own the company. As a stock company they are entering new lines of business and investing in ever riskier assets to “hopefully” generate greater earnings and grow the stock price. The key focus for policy holders, though, is that the stock companies have much larger embedded risks. Does the market appreciate these risks? What happens to policy holders if their insurance company runs into trouble? It is up to each respective state insurance commissioner to determine what level of payout policy holders may receive.
LD: Risk is a theme here at NQ’s Dollars and Sense. Do the insurance companies have the wherewithal within their respective companies to manage their risks?
SD: I think many insurance companies are simply too big for the risk managers and CEOs to fully appreciate and manage. The consumer has to realize that when buying an insurance policy from a company, they are taking the credit risk of that company. The risks can run from within their respective product lines to their investment portfolios to actuarial tables. Insurance companies are masters at massaging their finances, their reserves, and their risk profiles.
LD: Given that insurance companies are regulated by state offices, it is not as if every state isn’t already facing plenty of financial issues and problems aside from potential problems within their insurance companies.
SD: Right. The issue is what happens in an Armageddon scenario where problems hit a number of insurance companies simultaneously and consumers lose confidence. The insurance industry is ultimately a business based on confidence. An individual called with a 500k insurance policy and asked if his money was safe. I told him it is not guaranteed by the federal government and that it is a responsibility of the state of New York. People generally view insurance as a defensive part of their overall financial plan, but people need to realize the risks in buying a policy. The mutual companies have a decided advantage given that they do not have the pressure of pleasing the stock market.
LD: Given the pressures on insurance companies, would you envision that we will see some “forced marriages?”
SD: Absolutely. There are too many insurance companies in the United States. Now insurance companies are trying to figure out how to get some of the TARP money. Hartford Financial changed their structure to a bank holding company in order to receive federal funds through the TARP. How is an insurance company a bank? I don’t know, but if Uncle Sam is giving freebies the insurance company will take the cash.
Insurance companies will have reserves as a cushion against policyholders taking the cash value in their policies. If the reserves aren’t there, this is when the insurance companies get into real trouble. There is currently a real question in the marketplace as to the level of reserves in the industry.
LD: In regard to AIG, that company is currently trying to sell divisions in an attempt to pay back the government loan it was provided a few months back. The bids for insurance divisions are weak given the state of the economy.
SD: That’s right. Other insurance companies will be very reluctant to buy troubled institutions thus putting greater pressure on the states. Businesses that I am scared about are long term care insurance where when the claims start coming in 10, 15, 20 years from now. These contracts are not premium guaranteed contracts. The insurance companies are losing money on these contracts today and I’m thinking if they are losing money today what is going to happen to them tomorrow. How do the insurance companies go back to a 75 year old individual and keep increasing the premium on these policies?
A caller added that she found it hopelessly difficult to find out from Washington state as to which insurance company is the best. As a result, she bought insurance through Costco. If Costco is recommending the insurance company, she felt comfortable. Is that reliable?
SD: We do not know what Costco’s self-interest is in promoting a specific company. I would get started by getting rating agency reports (be mindful that the rating agencies are generating fees from the very insurance companies they are rating), including those offered by Duff and Phelps, Standard and Poors, Moody’s, and A.M. Best. For stock companies, you want to read stock ratings reports provided by Morningstar. There could very well be insurance companies rated AA but trading at very depressed levels in the stock market. What does the market know that I do not know. You have to dig deeper!!
LD: Where can people go to get those rating agency reports?
SD: Any good insurance broker should be able to produce these reports on an insurance company. You should tell your broker you want them. Tell the broker you need the reports before you can make your decision. Make them earn your business!! A resourceful broker can dig and find these reports.
The caller asked about health policies, including Medicare and supplemental health policies.
SD: Health insurance is an absolute nightmare. It is state regulated. The governor of New York has proposed expanding health care coverage for children to age 30, up from age 22. There are so many uninsured 23 and 24 year olds. The only reason insurance companies are offering health coverage is because the states make them.
The caller added that in looking for health coverage she was frustrated by companies not returning her calls. She then found in the state of Washington a state-run service known as SHIBA that set her straight on all her health care questions.
SD: You bring up a valuable point in that there are resources in our own backyards. Dig into your state insurance offices for information.
LD: before we get into insurance products, can we spend a little time focusing on the 800 pound gorilla that is the Credit Default Swap. CDS is effectively an insurance “type” product that is indexed to an underlying company, security, or index. Do you think this product, created by Wall Street, may be categorized as an insurance product? Additionally, we know that AIG has been decimated by its exposure to CDS in the U.S. housing market. Are you aware of any other companies that may have significant exposure?
SD: In regard to AIG, remember the “criminal is always ahead of the cop.” AIG had this business that was largely run out of London. How can insurance commissioners, the cops, stay on top of a situation like this? Well, they should have but they weren’t. AIG was clearly booking the premiums paid on these CDS as an immediate profit without appreciating the degree of risk they were assuming. Additionally, they paid out very handsome bonuses to the genius employees who executed this business!!
LD: What a joke!!
SD: It is a joke. The question for consumers is whether any other companies are doing this. I would want to know and consumers should ask their insurance brokers to dig into the respective companies for answers. CDS is as far away from insurance as anything.
LD: Do you think that under the Obama administration CDS may be categorized as insurance and regulated as such?
SD: I am not involved with companies with exposure to CDS but there have to be other companies with exposure to this space. Obama was two years behind me at Columbia. I did not know him, but under his administration we have a growing government on our hands. I think that within 4 to 8 years, and perhaps even sooner, there will be increased regulation within the insurance industry. Any chance that the government has to say, “I told you so.” It’s going to happen. Maybe it’s for the better, I don’t know.
LD: To the extent we can root out contemptible and corrupt practices that has to be better.
LD: You mentioned that AIG has London based operations. Any thoughts as to why the UK has not helped in the bailout of AIG.
SD: I do not know that market, but I do know the UK has had lots of their own insurance problems. I do not know the inner workings of the UK system, but this does show how entangled our financial systems are from a global standpoint. You probably need all these countries working together to police the system.
LD: I do know that coming out of the G-20 in November, the idea of globally coordinated regulatory systems was promoted by Sarkozy. We will look for that.
LD: Let’s dive into the different insurance products. We have so much to talk about. How is guaranteed premium universal life different from term insurance and different from whole life?
SD: Let’s start with term first as it is the easiest to understand as there is no cash value in that product. If a consumer buys a term policy, they still need to understand that it is a credit based decision. Will the company be in business to perform in case you need it? Term is great for those with moderate economic means. It is great leverage. After 9/11, I probably shelled out close to $30 million over the next two weeks. At that moment of crisis, insurance companies executed on policies that were written just days prior to 9/11. Term can be easily quantified and understood. People need to know that in the state of New York, term insurance is not enforceable after the age of 80. Term insurance dies. It gets very expensive and ends in later years.
What are my other choices? It gets very complex. Most consumers don’t know what they’re doing. In my opinion, if they are going to buy a product, if it is with a large, well established insurance company and you buy a whole life policy, meaning it will be with you for your entire life, the first litmus test is look at the cash value. If you pay $5,000 for the premium and you see the cash value is immediately zero, then you purchased an “agent friendly” policy. Tell the insurance broker to go back and work on it. If you pay $5,000 and the immediate cash value surrender is $4,000 then you know the fees are reasonable. Make the insurance agent work at improving his proposal. With whole life, the insurance company “guarantees” the cash value and “guarantees” a return on that cash. Thus, there is less risk for the consumer.
The variable product empowers the individual to make investment choices with the cash value in the policy. The problem here is that most consumers over the last ten years have not done a good job at managing the risk in their investment selections. The consumers predominantly put the cash into the stock market and the losses that have been generated are NOT deductible.
LD: Consumers need to realize and FULLY appreciate that they have market exposure and risk to whatever asset class they have selected, much like they would with a mutual fund.
SD: That’s right. Additionally, many companies — both stock and mutual — have embraced guaranteed premium universal life policies. I view these policies like “permanent term.” What happens with these policies is that as long as the consumer continues to pay the premium out to age 90 or whenever they die, their beneficiaries will receive the benefits. What insurance companies are hoping, and actually expecting, is that a certain number of these policies will lapse as people or families either forget or for whatever reason do not pay the premium, in so doing the policy will no longer be in effect.
LD: Obviously, if you buy this type of policy you need to stay on top of it.
SD: Yes! Make sure that statements are being sent in duplicate and triplicate to everybody so the policy does not lapse.
LD: To the extent that we have listeners in that age bracket or with parents in that age bracket, make sure you check on these policies so that they stay in effect.
LD: I have to believe that insurance companies in this environment would like to see more of these policies lapse so that they can save money.
SD: Yes, and their actuaries have priced this into their models.
LD: Sean, one of our readers inquired about life insurance settlements and the buying and selling of these policies given the economic decline.
SD: This is a game with the country club crowd and other crowds in which well to do individuals in their later years buy policies for a year or two and then try to sell the policy. Often the premiums are paid by finance companies. This business is as far away from what the insurance industry is truly set up to address. Eventually, our friends in Washington will regulate this business and shut it down. There are situations where this business is helpful, but not often. I do not think it is typically in the best interests of policyholders. I am not comfortable with this piece of the industry.
LD: Let’s address some personal financial planning issues. We are a little short for time. How should consumers handle 529 plans for purposes of planning to finance their children’s’ college educations?
SD: First off, they should not be putting money to work in risk assets to fund what is largely a fixed expense. This becomes a question of matching assets versus liabilities. I would recommend they go to a site, www.independent529plan.org, where approximately 300 colleges are members of a plan that offers fixed rates of returns plus a spread over the college inflation index. You have no risk of principal and you match a fixed asset against a fixed liability. Check with colleges to see if they are members of that program and encourage them to join!!
LD: Ok, Sean, we are going to move right along. How about an individual or parents who have a son or daughter in college, how should they best position their assets or liabilities to improve their chances in maximizing financial aid?
SD: There is a game here. People should implement these moves by the time their child is a junior in high school. Assets that are excluded by colleges are home equity, retirement accounts, cash value life insurance policies. What is looked at favorably from a liability standpoint is mortgage debt, while credit card charges, auto loans, et al are looked at less favorably. Thus, people need to juggle their assets and liabilities in positioning them for maximum financial aid. Find a person who knows this “game” well in advance of actually applying to schools.
LD: What should a person look for in an insurance agent?
SD: Ultimately you need to make sure you find an agent who is very smart, very honest and reputable, and wants to develop a long term relationship versus just trying to make a quick buck in writng a policy. Do your homework. Get referrals. Ask questions. Dig for info. A great broker is well worth the fees paid and a bad broker can cause real damage.
LD: Sean, what about a person who has a young child and has $1,000 or $2,000 to invest, is there an insurance product for them?
SD: There are single premium life policies in which a consumer can put $1,000 or $2,000 into it for their child and it will grow at the insurance company’s dividends rate minus a likely fee of .50% or 1.0%. The appeal is that the cash value will be excluded from the calculations for financial aid. That may change but it is the rule as of now. This is “quiet” money.
LD: Sean, this has been fabulous. We definitely have to get you back to No Quarter’s Dollars and Sense with LD.
Sean: My pleasure. I’ve enjoyed it.