Imagine that a man walks up to you with a proposal. He’d like you to lend him a large sum of money, possibly most of your worldly wealth, at an interest rate of less than 1 percent.
And then he says yes on your behalf.
In an excellent piece of reporting by David Evans, Bloomberg Markets magazine last week drew attention to the fact that many insurance companies are effectively doing just that. Instead of sending checks to the beneficiaries of life insurance policies, including relatives of soldiers killed on the battlefield, companies like Prudential and MetLife are sending IOUs in the form of “checkbooks.” The money from the death benefit has been placed in a special account for safekeeping, the companies tell the beneficiaries. There is a bank name on the “checks,” but the bank simply processes the transaction. The money itself stays with the insurance company.
In effect, these companies are electing to lend themselves money that belongs to the beneficiaries.
In the midst of their bereavement, many family members are too distraught to pay much attention to financial arrangements, leaving the insurance company to make interest off the money that remains in its hands until the family withdraws the sum. In many cases, this may translate into years of inadvertent loans on the part of the beneficiaries.
What’s worse, the money is not backed by the government, as it would be in a bank. The FDIC does not cover funds held by insurance companies.
Insurers should be in the business of assuming risks in exchange for premiums. Instead, this practice directly creates risk for people at a time when they are most vulnerable. A lump sum benefit that often represents a family’s biggest asset is invested in a low-interest loan to a single company, which violates the cardinal rule of prudent money management: diversification.
MetLife, in its standard beneficiary letter, says that the account into which it places the benefits is guaranteed by the company. Almost parenthetically, it adds, “All guarantees are subject to the financial strength and claims-paying ability of MetLife.”
It is hard to imagine that many beneficiaries would actively choose to invest their money at a rate of less than 1 percent (a typical rate, though insurers may pay some beneficiaries a little more), and that they would sink all of it into one company with no safety net at all. Yet the insurance companies claim that these accounts are convenient and designed for customers’ needs. Pennsylvania Insurance Commissioner Joel Ario told Evans, “I haven’t heard a plausible argument about why these accounts are better for the consumer.”
The financial reform bill recently signed by President Obama created the Consumer Financial Protection Bureau. That office may or may not find this matter within its purview. If it does, the bureau should outlaw this practice immediately, and should require insurance companies to send actual checks to beneficiaries who are due payments.
If the companies wished, they could enclose a form advising beneficiaries that they could send the money back if they wanted to. The form would need to make it clear that returning the money would constitute a loan and not a deposit. Of course, if I were an insurance company in that case, I would hardly sit by the mailbox waiting for the checks to roll in.
If the Consumer Financial Protection Bureau does not take action on the matter, states can outlaw the practice themselves, as Ario is already attempting to do in Pennsylvania. New York Attorney General Andrew Cuomo announced last week that he is investigating whether the insurers’ current practices violate state laws. At minimum, states should strongly consider creating a requirement that such accounts cannot be used as the default method of payment.
States also could require insurers to pay a reasonably high rate of interest from the date of an insured’s death until the day the benefit is withdrawn. Such an interest rate, for example, might be equal to the floating rate that the Internal Revenue Service charges individuals who underpay their taxes. This would make companies much more eager to encourage beneficiaries to withdraw their funds.
Insurers seem to have taken a page from the playbook recently copyrighted by bankers: Take advantage of your customers at every turn, and then wonder why no one likes you. If insurers don’t see it in their own interest to deal with bereaved families in an open, above-board way, state and federal regulators should waste no time showing them the light.
August 4, 2010 - 11:40 am
May I respectfully suggest that’s a very unfair characterization of a practice that has evolved over decades to deal with the delicate situation of handing over life insurance payments to the bereaved at the time of the death of a loved one.
Here’s a comment from the CBS News blog on this subject:
by WillyRC July 30, 2010 12:22 PM EDT
This is much ado about nothing. I served in the Marine Corps for 29 years and saw several sad, but predictable, situations prior to 1999, where a survivor received a lump sum check and burned through the money in a few months. That is why the Department of Defense agreed to the “checkbook” method currently in use.
It it also used by the Office of Personnel Management for civilians. If you really think it’s a good idea to hand a $400,000 insurance check (and a $100,000 death gratuity check) to an 18-year old survivor (or a 52-year old grieving mother as mentioned in the story), then go ahead and support the return to a lump sum check.
I understand that the insurance company is investing the money it holds and turns a profit on it. I also know that the bank where a survivor deposits a check does the same thing. So long as the Prudential doesn’t default on their obligations, they have every right to keep their administrative costs down by investing the money they hold.
Come on people, look at the whole picture. Casualty Assistance Officers tell every survivor that as soon as they get the “checkbook” they can cash it in. The smart ones also tell the survivors to resist the temptation to spend the money quickly. The “checkbook” method puts a little bit of a brake on the urge to spend.
In addition to WillyRC’s comments, I’d beg to differ with you on your characterization of the Bloomberg article as “an excellent piece of reporting.” The reporting may have been good, but the editing and particularly headlining was sensationalist and pandering. To give but a few examples:
Only about 5% of life insurance policies of this type affect the military; yet that’s what the author chose to highlight, knowing that a combination of bereaved mother of a war hero, lined up against a faceless Wall Street corporation, is a script so out there that even a Hollywood script writer would blush;
Andrew Cuomo announcing an investigation is arguably 95% politics, 5% policy;
The Insurance Commissioner of Connecticut says they have NEVER had a complaint about the system;
Very few people confuse Prudential with an FDIC-insured bank–the FDIC issue is a complete red herring. Not to mention FDIC insurance typically tops out less than the state-insured life insurance payments guaranteed by Prudential.
What you’re complaining about in terms of interest is usually more generous than what one gets in a money market fund. Most checking accounts pay zero for short-term money; yet we don’t object that banks lend it out until we demand it.
This is a scandal, all right; but it’s not an insurance scandal a la Wall Street or BP; it’s a scandal exactly like Shirley Sherrod a few weeks ago. It’s a case of a very selectively written article, purporting to give the whole story, which in fact takes things egregiously out of context.
There are villains in this scandal, but they’re not Prudential et al: they’re the mainstream media, the columnists and bloggers who repeat the out-of-context news, and the politicians–Cuomo, Schumer, the VA–who can’t get behind a populist wave of resentment fast enough. All of them deserve a shame-on-you for not investigating more deeply.
I’ve made my own attempt at writing up a deeper examination of the issue. I have no axe to grind: I don’t sell insurance or any financial products, I am an independent consultant on the subject of trust in business. I don’t claim omniscience, or perfect ethical clarity, but I do know a slanted piece of reporting when I see it, and I hate to see it passed along without critical judgment.
May I offer to your readers my own take on it at:
August 4, 2010 - 3:58 pm
Your thoughtful and accurate comments (I agree with most of what you say) really merit a response, even though I don’t usually want to be the writer/publisher who insists on having the last word.
I agree that the issue isn’t about soldiers (overemphasized by Bloomberg, probably because the military is sensitive to how men and women in uniform are treated), and it isn’t about interest rates. There are three problems with the pseudo-checkbook handling of beneficiaries’ money: 1) the arrangements are uninsured; 2) the arrangements are undiversified; and 3) the arrangements are uninformed, at least by that portion of beneficiaries who accept this handling simply because it is a default. I could live with any combination of two of these factors. When all three are present, I think the arrangement is an unfair and abusive business practice, and it should be banned. If we need a default liquid account into which to safely place insurance benefits, a bank account or a diversified money market fund is a much more reasonable choice.
If someone came to me and said, “I have $500,000 from a life insurance settlement, and it’s my biggest asset, and the insurance company said I can get better interest if I leave it with them,” I would object. So, I think, would most advisers. Some of us are old enough to remember when Executive Life and Mutual Benefit — two highly-rated life insurers — went bust early in the 1990s. Everyone remembers AIG. The parallels are not exact. Policyholders were generally protected in the earlier cases, though it took time to work out, and policyholders were shielded from AIG’s recent problems. But creditors in these pseudo-checking accounts are not policyholders. Who wants to be the guinea pig to find out what will happen to these creditors if another apparently stable company goes south?
Like so much else, these accounts will work well up until the moment that they don’t. They are a poor tradeoff of risk and reward. If someone wants to knowingly enter into this arrangement, that’s fine with me. But I wouldn’t want my family to be automatically placed into this creditor relationship, and I don’t think yours should be, either.
August 4, 2010 - 2:22 pm
Last summer, my husband and I had the opportunity of experiencing this new life insurance disbursement policy. When my brother-in-law died and I contacted the insurance company, I was surprised to receive a package from Prudential with a book of checks. The instructions were clear and we opted to deposit the entire amount in our checking account, as the sum was not large and we needed it to pay for the funeral. Looking back now, I think my initial reaction included some feelings of annoyance. It’s as if the insurance company had decided to make an investment choice for us. Perhaps there are situations “where a survivor received a lump sum check and burned through the money in a few months”. But, does anyone believe the insurers are in the business of protecting someone from a spending spree? Most of us are adult enough to know something about investing our money, and if it’s a large amount we can always consult with a professional. To the insurance companies: Don’t treat us like children so that you can profit.
August 4, 2010 - 4:44 pm
Larry and Helen,
Thanks for both your comments–which I find extremely reasonable, by the way. I don’t know if I totally agree with it all, but we’re all well within range.
My main point, I guess, is that your discussions of these points are sensible, rational, educated and thoughtful.
By contrast, the reaction of most politicians (e.g. McCain, Cuomo) look to me like knee-jerk pandering; and the mainstream news media treatment has ranged from Bloomberg’s inflammatory example to yet more personal-story based journalism, e.g. CBS.
The result has been yet another level of hysterical, divisive, name-calling in blogs, radio shows, etc. In a week, the issues may be forgotten–but the experience of divisiveness won’t be. And that’s a real issue for all of us trying to get along in a body politic and in a society that’s ever-more linked together, for better or worse.
In that light, I thank you for contributing to a rare, thoughtful dialog on the subject via this site.