- The "Vanishing Premium" Phenomena
In the 1980's an unprecedented sales phenomenon, that of "vanishing premiums" swept the life insurance industry. In the 1990's another unprecedented phenomenon is sweeping the industry. It is the vanishing premium litigation which has resulted in huge jury verdicts, multi-million dollar class action settlements, and changes that go to the very foundation of the life insurance industry.
What was "vanishing premium" life insurance? What is the litigation that is changing the way life insurance is illustrated and sold? This paper will address these and related questions from the perspective of the life insurance purchaser. It will also share insight into how the life insurance industry got into the "vanishing premium" quagmire in which it finds itself today -- insight derived from depositions of current and former life insurance industry executives and three years' of litigation in vanishing premium cases in Mississippi, Texas, California and throughout the United States.
2. Terminology
Unfortunately, it is impossible to discuss the "vanishing premium" phenomenon without at least a cursory overview of life insurance terminology . A few years ago the terminology of life insurance, like life insurance itself, was much simpler than it is today. In the 1970's, however, enhanced computer technology and the competitive environment described in Section II, below, gave rise to a myriad of complex, new insurance products which laid the groundwork for the situation being discussed today.
Historically, there were two types of life insurance policies: term insurance and whole life insurance . Term insurance provided pure insurance coverage without any associated cash value build up. Term life insurance simply paid a predetermined sum (the face amount) to the named beneficiary if the insured died during a set number of years (the policy term). Whole life insurance paid the predetermined sum to the beneficiary when the insured died, regardless of when the death occurred. It was insurance for the "whole life."
Generally, there were two types of whole life policies, ordinary life , in which premiums were payable throughout the lifetime of the insured, and limited-payment whole life, in which premiums were charged for a limited number of years only, after which the policy was "paid up" for its full face amount. The most extreme form of limited-payment life insurance was the single-premium whole life policy . Such a policy carried one large premium, was fully paid up from inception, and had a substantial immediate cash and loan value.
The most popular whole life products were participating products offered by mutual companies and fixed premium,accumulation-type products offered by stock companies. Both had accumulation values , or "cash values," which the policyholder could access by either surrendering the policy, or where dividends had purchased paid-up additional insurance, by surrendering the additions with no impact on the policy proper.
In participating policies the policyholder participated in the company's experience through receipt of dividends . Premiums were based on conservative mortality, interest, and expense assumptions. Dividends were set retrospectively, usually at the end of the year. They reflected deviations of actual from anticipated experience.
Prior to the 1970's all life insurance policies sold in the U.S. were fixed-premium policies issued on either a participating or guaranteed, non-participating, basis. In the late 1970's, the life insurance industry was revolutionized by computer technology. A myriad of new concepts and products were introduced, and a number of additional terms attained significance.
Adjustable life policies, introduced in the early 1970's, permitted the policy owner to select, within limits, the premium he wished and later to adjust, again within limits, the premium and/or the policy face amount. policies, introduced in the early 1970's, permitted the policy owner to select, within limits, the premium he wished and later to adjust, again within limits, the premium and/or the policy face amount.
Universal Life (UL) policies, introduced in the late 1970's, revolutionized the life insurance industry. UL policies provided an "unbundling" of the savings and pure insurance protection elements of whole life insurance, affording flexibility in premium payments and contemporaneous interest rates for the investment or savings aspect of the policies. Universal life policies were flexible-premium policies with adjustable-death benefits. policies, introduced in the late 1970's, revolutionized the life insurance industry. UL policies provided an "unbundling" of the savings and pure insurance protection elements of whole life insurance, affording flexibility in premium payments and contemporaneous interest rates for the investment or savings aspect of the policies. Universal life policies were flexible-premiumpolicies with adjustable-death benefits.
Flexible enhanced ordinary life
Flexible enhanced ordinary life
adjustable-death benefits.
Flexible enhanced ordinary life Flexible enhanced ordinary life products were introduced by a number of companies to compete with universal life. These products involved complex combinations of whole life insurance, term insurance, and paid-up additions in proportions allowing favorable premium levels and adjustable face amounts. Policy dividends, additional premiums, and "dump ins" were all used to purchase paid-up insurance that would offset the temporary term coverage.
The complex new products were all interest sensitive. They were illustrated and sold through the use of computer-generated "sales illustrations" produced by agents on PC's using software developed and distributed by the insurance companies.
"Vanishing premium" "Vanishing premium" was one of the most aggressive techniques used to sell the new products. Employing complex actuarial techniques, the computer-generated sales illustrations of the vanishing premium companies illustrated how a customer could "roll over" his cash value from an existing policy, or make only a limited number of premium payments, in some cases as few as four (4). Based upon the assumptions (frequently undisclosed) employed in the illustration software, the premium would "vanish" and no further cash outlay would be due.
3. Sine Qua Non of Vanishing Premium:
The Computer-Generated "Sales Illustration"
Vanishing premium life insurance never would have been possible without the development of the personal computer. Life insurance companies wanting to offer vanishing premium products developed software for agents to run on their PCs. The vanishing premium software generated individualized "sales illustrations" for each prospective customer. Based on the customer's age, smoking habits, and other classifications, the vanishing premium software would compute instantly the complex combinations of whole life, term life, "step-rate" coverage, paid up additions, etc. necessary to produce the desired result, i.e. to make the premiums "vanish" after a limited number of years. The complex pricing calculations were done internally by the sales illustration software. The software would then produce columns of figures illustrating the performance of the resulting vanishing premium "product." The result was a highly effective new sales tool. Attached as Appendix A are sample Vanishing Premium Sales Illustrations.
Vanishing premium life insurance never would have been possible without the development of the personal computer. Life insurance companies wanting to offer vanishing premium products developed software for agents to run on their PCs. The vanishing premium software generated individualized "sales illustrations" for each prospective customer. Based on the customer's age, smoking habits, and other classifications, the vanishing premium software would compute instantly the complex combinations of whole life, term life, "step-rate" coverage, paid up additions, etc. necessary to produce the desired result, i.e. to make the premiums "vanish" after a limited number of years. The complex pricing calculations were done internally by the sales illustration software. The software would then produce columns of figures illustrating the performance of the resulting vanishing premium "product." The result was a highly effective new sales tool. Attached as Appendix A are sample Vanishing Premium Sales Illustrations.
II. VANISHING PREMIUM SALES
1. A "Creature of the Times"
The vanishing premium insurance sales phenomenon was strictly a creature of its times. A product of the computer revolution of the 1970's, it flourished in the laissez-faire business environment of the 1980's. Its collapse in the 1990's has given rise to financial problems for thousands of individual policyholders, and is costing its purveyors millions of dollars in damages. It has also caused unprecedented damage to the reputation of the life insurance industry as a whole. What is unfolding in the vanishing premium litigation may be viewed as yet another example of the legal "fallout" from the unique situation which existed in the financial industry of the 1980's.
2. The Competitive Environment of the 1980's
The insurance industry was faced with a fiercely competitive environment in the early 1980's. Interest rates were at historic highs and the life insurance industry was suffering a massive disintermediation of funds. Historically, the insurance industry, the securities industry, and the banking industry were three distinct entities. By the early 1980's, however, the life insurance industry had evolved into a full financial service industry competing with both the securities industry (E. F. Hutton, Merrill-Lynch, etc.) and the banking and savings and loan industry. Competition for investors' dollars was fierce.
Billions of dollars of "cash values" had built up over an entire generation in traditional whole life insurance policies earning low or fixed rates of interest. Policyholders nationwide were cashing-in these old policies, or borrowing their cash values, to invest in bank CDs, securities, and other investments earning double-digit rates of return.
At the same time a new laissez-faire regulatory attitude prevailed in the financial industry. An attitude of "anything goes" permeated much of the business community. Life insurance companies led by now defunct Executive Life Insurance Company, developed and marketed competitive new "interest sensitive" insurance products. The increasingly competitive environment of the mid-1980's spawned even more complex variations of these products and illustrations which rested on increasingly questionable, and ultimately downright deceptive, actuarial assumptions and devices.
3. The Vanishing Premium "Pitch"
The "pitch" for vanishing premium insurance was simple and effective: "Make just a limited number of premium payments and your life insurance premiums will ‘vanish.' The ‘dividends' will carry the premium from then on. You'll never have to make another cash outlay for life insurance." There it was in "black and white" on the computer-generated sales illustration on company letterhead. Projected death benefits on "vanishing premium" illustrations increased to figures many times the original face amount of the insurance. So what if interest rates fell? If the policy produced only half the death benefit illustrated it was still better than the whole life policy on which the customer was then paying.
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