Insurers Propose a Standard for Illustrations

As his 40th birthday approached, it occurred to Hal Ferrell that he was going to die someday. His wife, a schoolteacher, would have a tough time putting the kids through college if something happened to him. So he decided to shop for life insurance.

Relying on complicated computerized print-outs designed to “illustrate” what the policy would be worth many years down the road, Ferrell bought a so-called “participating cash value” policy. According to the illustrations, the policy would build up an $800,000 death benefit and $142,000 in cash value in 20 years. All Ferrell had to do is make one $32,000 premium payment, the agent said.

So Ferrell, a Mississippi resident, sold some real estate and paid the premium in 1987.

But the policy did not perform as illustrated. After four years and numerous written assurances that the illustrations used to sell his policy were “valid,” Ferrell’s insurer acknowledged that it probably never would. If Ferrell wanted the large death benefits and cash value he had bargained for, he would have to pay more--about $7,000 per year more.

Ferrell is one of thousands of consumers who have sued insurers, alleging fraudulent sales illustrations. He and they are in the midst of a maelstrom that promises to change the way life insurers do business. As the result of numerous complaints like his, the National Assn. of Insurance Commissioners plans to approve new standards for selling cash-value policies this September.

The resulting “model law” proposes to revamp insurance illustrations so that they’ll be painted realistically rather than prettily.

What are insurance illustrations?

They’re complicated projections showing what a cash value life insurance policy is likely to be worth years from when you buy it. They’re pivotal in selling policies because cash value insurance is designed not only to provide for heirs but also to build up a cash reserve that can be tapped in emergency or at retirement.

Illustrations are supposed to show how fast that cash reserve will grow. That’s done by speculating what a specific insurance company will pay in dividends or interest on the policy and what it will charge in administration and death benefit fees.

Most agents do their best to illustrate policies realistically, applying their best guesses about future interest rates to the specifics of the policy. However, some agents exaggerate policy returns. There’s a simple reason for that: The higher the projected rate of return, the better the policy’s future cash value looks, and the easier it is to sell the policy. In simple terms, if you invest $1,000 annually for 20 years at 4%, you’ll have $30,565 at the end of the period. Earn 10% on the same investment, though, and the value of your nest egg doubles, to $63,281. Chances are, you’re going to buy the policy that’s “illustrated” using the 10% return rather than one projecting your net return at 4%.

Most illustrations are not guaranteed--a fact that some consumers do not understand. Consumers would know this if they read their insurance policies, adds Peter van Aartrijk, spokesman for the Independent Insurance Agents of America, a Washington, D.C.-based trade group. But three out of five consumers do not, according to the group.

“A lot of people are not going to be as informed as they ought to be when they get into these sales presentations,” Van Aartrijk adds. “Agents have to educate, but they also have to sell.”

In other words, there’s little incentive to point out fine print in the policy that says your “guaranteed” rate is just 3% to 4%, unlike the much higher “illustrated” rate.

However, the NAIC wants to change that. The group, an advisory body of state insurance regulators, wants to create a “basic” illustration that shows what cash and surrender values would be worth at various points, given three different assumptions: Assuming that the interest rates the insurer was paying at the time the policy was sold remain steady throughout the contract period; that returns accrue at just the guaranteed rate; that rates linger midway between those two figures.

Agents could also create “supplemental” illustrations that incorporate different assumptions, the NAIC says. But they would have to provide the basic illustration too.

In addition, the NAIC model law would require insurers to provide a policyholder with annual updates that show how well the policy is doing. It would include information about how much was credited or debited to the policy during the year; the current death benefit; the surrender value and the value of any loans made against the policy. Policyholders could ask for updated illustrations too.

Some critics, however, maintain that the model rules are too little too late.

“They apply all these Band-Aids, but the fundamental problem is still there,” says Joseph M. Belth, editor of Insurance Forum, an Ellettsville, Ind.-based industry newsletter. “The fundamental problem is that insurers just do not give out the vital information. This model law does not change that one whit.”

Indeed, the NAIC model law would not require insurers to divulge a variety of key figures--such as how much the insurer will charge in so-called mortality and policy fees--when the policy is being sold. These figures can be important in comparison shopping for policies. They can also help consumers determine whether they’re better off with a cash-value life insurance policy or term insurance--a less expensive type of policy that doesn’t build up cash value.

Then, too, insurance illustrations have been problematic for more than a decade, Belth notes. And yet the industry’s main national watchdog is only now coming out with model rules.

Once the NAIC adopts the model law, it must be adopted in each state before it can become effective. In the best of circumstances, that would not be expected to happen until 1997.

In the worst case, these rules would not be adopted because the NAIC has no enforcement power. Some states could voluntarily adopt the group’s model laws and others ignore them completely.

In other words, when buying a cash value policy, you still need to heed that simple Latin phrase: Caveat emptor-- let the buyer beware.

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Kathy M. Kristof welcomes your comments and suggestions for columns but regrets that she cannot respond individually to letters and phone calls. Write to Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or send a message to [email protected] on the Internet.