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Final
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About
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Low Risk Insurance for a High Price They say insurance is never bought and
always sold, and this may be especially true for preneed
funeral “whole life” insurance. Consumers shop for
funeral services, but often they are actually buying whole
life insurance. The policies are expensive. The funeral home
collects all the benefits—including interest and
dividends—even if the death benefit is ultimately
larger than the cost of the funeral. And structural features
of whole life that have little impact on a long term
investor seeking a tax protected savings vehicle, can create
problems for a preneed buyer. Whole life insurance is a product that
combines traditional life insurance, which pays a death
benefit to your survivors, with a “savings”
component. Whole life insurance typically offers a consumer
a level death benefit (say $100,000) and a gradually
increasing “cash value.” Although the death
benefit is relatively expensive compared to term life, the
cost does not typically increase as people age, and
consumers do not typically pay more in premium than the
death benefit. Preneed whole life policies, on the
other hand, are very small and consumers report paying
substantially more in premiums than the face value of the
policy. Kathryn Anderson of Dallas purchased a prepaid
funeral contract funded through a whole life policy that
cost $51 per month for ten years, or a total of $6120 for a
$2400 funeral. After paying for four years, she had paid
$2,295 and still had six years of premiums to pay before the
policy was paid up. She wrote to the company and to the
Texas Department of Insurance. Homesteaders Life cancelled
the policy and sent her a check for $725, the “net
surrender value” of her policy. Had her money been
placed in a trust account, she could have received a refund
of $2,055. But, because such pricing and refund schemes are
legal for insurance, the Department of Insurance could not
help her.(1) If a consumer cancels the policy by
ceasing premium payments, the potential for a refund is
reduced even further. Gregory Spenser Funeral Directors in
Fort Worth prearranged a $3,900 funeral for Estella Myles in
late 1996. Her Homesteaders policy would cost $52.65 per
month over ten years, or a total of $6,318. After paying for
eight months she ceased her payments and the company gave
her three options—reinstate her policy by making her
premium payments, cease her payments and take a reduced
“paid-up” coverage that would pay out $140, or
surrender the policy for its cash value of
$71.58.(2) The “cash surrender value”
is the available portion of your “cash value,”
which is a savings component of the policy in traditional
whole life. Cash value typically grows very slowly because
commissions and administrative costs absorb much of the
payment in the early years. In traditional whole life
insurance it can take a decade to build up significant cash
value.(3) A typical cash value whole life policy
may pay dividends, and consumers can use these dividends to
buy additional death benefits or simply accept payments in
cash. Since the IRS sees these dividends as refund of
premium rather than interest, such payments are not taxable.
When purchased as a long term savings vehicle, whole life
policies enjoy other tax advantages as well
and—depending on the price and the effective rate of
interest the company pays on the policy—can make sense
as part of a savings plan. But the very features that make a
traditional whole life policy valuable make it the wrong
choice to fund a preneed insurance contract. A preneed
funeral contract is designed exclusively to pay benefits to
a funeral home after the insured dies. At its best, it locks
in today’s funeral prices, and the funeral home covers
the higher prices after years of inflation from the death
benefit. The preneed plan is not a savings vehicle. Although
the policy has a “cash value” like other whole
life policies, consumers cannot take policy loans under most
contracts. (4)
And, like all whole life policies, cash value accrues slowly
in the early years due to commissions and other
administrative costs loaded on to the front. Therefore
consumers who cancel their preneed policy in the first few
years get very little back for the premiums they paid
in. And consumers do not benefit from
dividends on their policy as they would with traditional
whole life insurance because the policies are designed to
cover the additional cost of a future funeral by using the
dividends to “buy up” additional insurance. The
increased amount of insurance is paid to the funeral home,
and if it is more than the cost of the funeral, the funeral
home keeps the excess. (5) Finally, many whole life polices used
to fund preneed contracts do not have the same level
benefits enjoyed by most consumers of whole life insurance.
Instead, the policies pay substantially reduced benefits in
the first two years. In 1997 Joy Rose M. signed a preneed
funeral contract for $4,132, which she agreed to pay in
monthly installments of $87.02 for five years (a total of
$5,221.20). She died one year later. This policy paid only
25% of the face amount during the first 12 months, and 50%
during the next 12, so the company only owed $1,033 in
benefits although Ms. M. had paid $1,044 in premiums. If a consumer dies anytime within the
first two years of an illness that should have been reported
on the application, the company can either pay these reduced
benefits under the policy or refund the consumer’s
premium and “recind” policy—whichever is
less. In this case, the company didn’t really care to
investigate. “Inasmuch as the premiums paid to date
exceed the potential death benefit, however, there is no
need to investigate the claim,” wrote a Mission Life
representative.6 Benefit limits combined with high premium
rates protect the life insurance company from the risk of
paying a death benefit that isn’t already substantially
funded by the consumer’s premium payments. Like our earlier examples, Robert D.
of Mission bought a $3,695 preneed funeral contract funded
by an insurance policy costing $53.35 monthly for ten years
(a total of $6402).7 Consumers Union compared the value of
the policy over time to the value of $53.35 placed in an
account earning the current Certificate of Deposit interest
rate and to funeral cost inflation for the $3,695
funeral. In this scenario, the insurance
company would pay out more than the consumer’s premium
payments if the consumer dies during the first five years,
and after that time the additional insurance premiums plus
interest would more than cover funeral price inflation. The
policy is most valuable as insurance in year three, but if
the risk of your death in the near future is slim, then
these whole life policies are not a good way to fund a
preneed funeral contract. Insurers argue that whole life
insurance offers your beneficiaries more flexibility because
the policy benefits can be switched from one funeral home to
another, allowing families to change arrangements if the
original choices are no longer suitable. But, the law only
requires that the insurer pay the face value Finally, many
whole life polices used to fund preneed contracts do not
have the same level benefits enjoyed by most consumers of
whole life insurance. Instead, the policies pay
substantially reduced benefits in the first two years. In
1997 Joy Rose M. signed a preneed funeral contract for
$4,132, which she agreed to pay in monthly installments of
$87.02 for five years (a total of $5,221.20). She died one
year later. This policy paid only 25% of the face amount
during the first 12 months, and 50% during the next 12, so
the company only owed $1,033 in benefits although Ms. M. had
paid $1,044 in premiums. If a consumer dies anytime within the
first two years of an illness that should have been reported
on the application, the company can either pay these reduced
benefits under the policy or refund the consumer’s
premium and “recind” policy—whichever is
less. In this case, the company didn’t really care to
investigate. “Inasmuch as the premiums paid to date
exceed the potential death benefit, however, there is no
need to investigate the claim,” wrote a Mission Life
representative. (6)
Benefit limits combined with high premium rates protect the
life insurance company from the risk of paying a death
benefit that isn’t already substantially funded by the
consumer’s premium payments. Like our earlier examples, Robert D.
of Mission bought a $3,695 preneed funeral contract funded
by an insurance policy costing $53.35 monthly for ten years
(a total of $6402). (7)
Consumers Union compared the value of the policy over time
to the value of $53.35 placed in an account earning the
current Certificate of Deposit interest rate and to funeral
cost inflation for the $3,695 funeral. In this scenario, the insurance
company would pay out more than the consumer’s premium
payments if the consumer dies during the first five years,
and after that time the additional insurance premiums plus
interest would more than cover funeral price inflation. The
policy is most valuable as insurance in year three, but if
the risk of your death in the near future is slim, then
these whole life policies are not a good way to fund a
preneed funeral contract. Insurers argue that whole life
insurance offers your beneficiaries more flexibility because
the policy benefits can be switched from one funeral home to
another, allowing families to change arrangements if the
original choices are no longer suitable. But, the law only
requires that the insurer pay the face value of the policy
to the new funeral provider, not the “growth.” The
“growth” is the additional amount of insurance
purchased over time with the “dividend” or
interest on your premiums. It is essentially comparable to
the interest earned over time on your money and is used to
make sure that the benefit is enough to cover the inflated
price of a funeral. Consumers also report trouble
transferring the interest on trusts (see
main story, p. 14). All in all, the preneed market
insurance is difficult to navigate and full of pitfalls, and
Consumers Union recommends several reforms that will ensure
that elderly consumers will get value for their money when
they try and plan ahead for their funeral costs by using an
insurance funded plan.
 The insurance benefit is greater than premiums plus interest, Years 2 - 5. If this consumer died earlier, the company can contest the benefit. During Year 6, the premiums begin to exceed the inflation adjusted funeral cost. Thus, this product is for you only if you are likely to die soon, but not too soon. ______ 2 Consumer Complaint File, Texas Department of Insurance 407288 3 Bamford, Janet et al, The Consumer Reports Money Book, Third Edition, 1997, p. 219. 4 Although Texas law requires a life insurance policy to allow consumers to take policy loans after the policy has been in force for three years (TIC 3.44(6)), pre-need funeral contracts that accompany the insurance policy will specify that the policyholder cannot take policy loans. 5 Pre-need funeral contracts for Guaranty Plan, Inc, The Mission Plan, The IEIS Fidelity Plan, and Homesteaders Life. 6 Consumer Complaint File, Texas Department of Insurance 364175 7 Consumer Complaint File, Office of the Attorney General M9912-0098 |
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