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Tom Schori DBA Millennium Marketing Research®, 808 Ironwood, Normal IL 61761, 309-532-8466

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Domino effect of the life insurance 'churning' scandal.

By Thomas R. Schori, Ph.D., and Michael L. Garee, Principals,  Millennium Marketing Research, 808 E. Ironwood, Normal, IL 61761-5239. Tel. 309-532-8466 -

The lawyers have already gone after many of the "biggies" in the life insurance "churning" scandal. Metropolitan and Prudential have already taken major hits in policyholder class-action suits. State Farm Life just recently settled a multi-million class-action suit with its policyholders. Now, with the recent settlement of a similar suit by the life insurance affiliate of Nationwide, it appears that the lawyers, flush with their success, have trained their sights on the next tier of life insurance companies. Can the smaller life insurance companies be far behind?

What’s at the heart of this issue? Let’s briefly review how it all started.

Way back in the early 1980s, when interest rates were in the solid double digits, there was a veritable explosion in the life insurance industry of the sale of so-called "interest-sensitive" life insurance policies. Principal among these policies was Universal Life, and to a lesser extent (at least at that time), variable life policies.

Virtually everyone in the life insurance business knows how the scenario unfolded. Life Insurance companies, and the agents who represented them, made it a marketing and sales priority to push these new "go-go" products. Ironically, the life insurance companies themselves much preferred that the sale of these new products be made principally to new customers, or at least be new policy sales to existing customers. Why? Because, for the companies at least, "churning" existing money clearly wasn’t in their best short-term interest. The companies would have to pay additional agent commissions on the "churned" business, plus the net result usually wouldn’t be any new premium dollars, at least for the immediate future.

The agents, on the other hand, set their sights on far easier, far more vulnerable targets: existing customers with existing whole life policies that had substantial built up "cash value." The sales pitch went something like this: It simply didn’t make much economic sense for policyholders to continue earning dividends in the single-digit range on whole life policies, when they could instead be earning double-digit returns by buying these new interest-sensitive policies.

Another key selling point, of course, was that whole life policyholders usually had enough "cash value" buildup in their policies that premium payments for the new interest-sensitive policies could be defrayed for, in some cases at least, many, many years down the road! What could be better? The policyholder was oftentimes able to acquire these new policies with a higher face value than their existing whole life policies, plus premium payments, even though they may have been higher than premiums for their current policy, wouldn’t have to be made immediately! Add to that the opportunity for policyholders to realize far higher "returns" on the new policies!

To say that this scenario was a classic setting for potentially widespread abuse, particularly by life insurance agents, is a gross understatement. With so much money to be made, the temptation for some agents to play "fast and loose" with the economic facts of the situation proved to be far too great.

It wasn’t many year before the bubble burst. Interest rates began their descent, a descent that was to become quite substantial. (Indeed, interest rates paid today on these interest-sensitive policies are about what was being paid on the whole life policies at the time they were terminated to buy the interest-sensitive policies.) Premium payments that were supposed to be perhaps years down the road suddenly became due and payable or policies would lapse. Gone was the policyholder euphoria. Replacing it was a growing sense of outrage, a feeling that they had been deceived.

Now, don’t misunderstand us. We’re not life insurance industry "bashers." Quite the contrary. During our professional careers, each of us has spent considerable time employed in the industry in various capacities. We personally know many, many executives, agents and employees in the industry, and we know the vast majority of them are honorable, ethical, decent people.

How, then, did the industry get into this mess? In our opinions, the explanation is as simple as it is old. A few "bad apples" literally spoiled the "barrel." A few people in key company positions (unfortunately), as well as some unprincipled agents, let greed and avarice fog their better judgment. Some agents became more concerned with their own increased short-term commissions than with their clients’ best interests. These few¾and we honestly believe that they are relatively few in number¾ultimately created a literal fire storm for their companies, and moreover caused an unnecessary blemish on the life insurance industry in general.

If the impact of this scandal were to be confined only to the mega life insurance companies, it would be bad enough, of course. But, in our opinions, once the lawyers have taken their best shots at these insurers, and have gotten substantial settlements for their clients and themselves, it’s only a matter of time before they’ll be knocking on the doors of the "little guys" as well. And, while the mega insurers can better take the "hit," many of the smaller companies may not be able to without substantial suffering. In the end, everybody¾ companies, agents, policyholders¾stands to lose. The companies and the agents will lose because of negative publicity and diminished trust, and policyholders will also lose because of a generally weakened life insurance industry.

We therefore predict¾and we certainly hope we’re wrong, but don’t think we are¾that the "churning" scandal that had its origin in the 1980s, will get a whole lot worse in the 1990s and into the next century, before it starts getting any better.

One other thing: there is a moral to this story, and that is, honesty really is the best policy. Always. Had life insurance companies been more diligent in supervising agents’ sales practices, and had the agents who sold the interest-sensitive policies been more completely honest with policyholders, i.e., by making sure that they, the policyholders, understood that there could also be a very real downside to these new policies, all of this mess easily could have been avoided. At the very least, it could have been substantially mitigated.