Richard Proteau is the author of Unraveling The Universal Life Scam (The Shorter Truth) and talks to Jason today on the show about universal life insurance and why it’s almost always a bad investment (unless you’re extremely wealthy). Richard talks about some of the differences between US life insurance and Canadian life insurance, does a break down on premiums, and more on today’s AMA episode.
Key Takeaways:
2:30 – Richard explains the various types of life insurance you can have.
6:10 – There’s always a state versus federal regulations war going on in the US.
10:30 – Richard explains what 108 is and talks about universal life premiums.
18:00 – Insurance companies are influenced in creating the best contract possible, but what’s on paper may not actually be what’s reality.
22:40 – MERs, management expense ratios, are not shown on the contract and can fool the consumer into thinking they have a better deal than they really do.
26:45 – Richard says buy insurance for the right reason. Jason and Richard both agree that insurance is not a good investment.
Tweetables:
“We always have this battle in this country of states rates versus federal government.”
“In Canada, we’re 40 years behind in terms of regulation of life insurance.”
Mentioned In This Episode:
Unraveling The Universal Life Scam (The Shorter Truth) by Richard Proteau
http://www.consumerights.ca/
Transcript
Jason Hartman:
It’s my pleasure to welcome Richard Proteau to the show. He is the author of Unraveling The Universal Life Scheme (The Shorter Truth). I have long thought that life insurance is life insurance and that’s great, but it’s not necessarily an investment. However, there are some distinction that we are trying to make for you here n this interview and I think the conclusion at the end will be that it is not an investment for most people, but there are a select few where it makes sense. So, Richard, welcome, how are you?
Richard Proteau:
Very good, you?
Jason:
Good, good. It’s good to have you on the show. Tell our listeners where you’re located.
Richard:
I’m in New Glasgow, which is in Nova Scotia, Canada.
Jason:
Fantastic. I’ve been up there and that is a beautiful part of the world. No question, but it’s probably kind of cold right now where you are.
Richard:
We’re in the northern part, so the weather is a little bit gentler than other regions of Canada.
Jason:
So, you have been in the life insurance business for many years, right?
Richard:
25 years.
Jason:
This kind of seems like maybe you’re outing some of your colleagues or some of your industry who is really marketing universal life as an investment. Is it an investment or is any life insurance an investment? Actually, sorry Richard, before you answer that question I’d like you to just give our listeners an overview of the different categories of life insurance, if you would.
Richard:
Well the insurance, the basic insurance that you have would be term insurance, which is traditionally used to insure your income on a temporary basis. Usually the insurance will stop at age 75 or 85, then you have permanent insurance, which comes in all kinds of flavors and usually you will have whole life, which can be guaranteed. Usually you’ll will pay it over a 20 year or 10 year payment and everything is guaranteed there. So, what you see on the illustration is what you get and then you have what we call participating whole life where you participate into the profit of the participating funds of all the policy owner of this type of product and then you have the universal life, which comes also in different flavors and that’s basically your different type of product you have available to you on a temporary or permanent basis.
Jason:
Okay, so what you’re saying there are three basic types of life insurance and then under one of those times, there are different types of universal life, right?
Richard:
Yes, there’s going to be three types, which is your traditional universal life, which is basically an universal life built on interest rate assumption. The investment or interest incidents and then you have the index universal life, which is linked to an inequity index, but that process has a cap, what they call a minimum and a maximum. Now, I have to say that in Canada, I didn’t write about this product because the index universal life is not available in Canada. It’s available in the United States and then you have your variable universal life, which is basically where you invest in equity-type of investment. Now, a big different between Canada and the United States. In United States, your variable universal life is considered a security. In Canada, it’s considered an insurance product. So, in terms of disclosure and information given to the owner is quite different. It’s a lot more disclosure to be done if an investment is considered a security versus considered an insurance.
Jason:
Does that require a different type of license by the person selling it to you?
Richard:
No, in fact in Canada, they instate an insurance agent licenses and an insurance agent can sell a variable life, a universal life. I think it’s the same in the United States because, well, insurance of variable life, variable universal life, has been considered security. The supreme court in the United States I think has exempted it under the investment advisers act, so when insurance agent sell universal life…
Jason:
So, the investment advisers act, this was probably a huge lobbying push by that very, very wealthy industry to get all sorts of laws passed in their favor I’m sure.
Richard:
Yes, well, you know, it’s quite interesting if you look at the regulatory environment between the United States and Canada, which I’ve done quite a bit. United States, you had quite a bit of a war between state and the federal government on who is going to regulate insurance based on the fact does the business of insurance fall under federal regulation or state regulation. So, what you’ve seen involved in the states is that they decided that the verbal universal life was a security, but that the companies selling it didn’t fall under the company investment act and the investment advisers act indifference to the state is saying that it was up to the states to legislate there.
Jason:
Very interesting. Yeah, we always have this battle in this country of states rates versus federal government.
Richard:
It’s a good battle in the states, because it forces changes and war is a great catalyst for change and this is what is pushing the United States regulation forward. In Canada, this has not happened, so therefore we’re 40 years behind in terms of regulation of life insurance.
Jason:
So, is that being behind good or bad? I would kind of wonder. I would wonder.
Richard:
It’s extremely bad, because we basically now for example in Canada, we just the regulators for the different provenance in Canada are recognizing that insurance is sold to what we call intermediaries called managing general agent, MGAs, while in the states it’s been recognized in the regulations for quite awhile, right. So, we’re very far behind in Canada. This is very bad in terms of consumer protection for the consumer in Canada.
Jason:
Let’s go back to the first question I asked you about whether or not it’s an investment. I just think it’s really quite interesting how this industry has turned an insurance product into an investment product. Does it qualify as an investment or is it really just insurance? I mean, look, if you want to have insurance, fine, get some insurance. I mean, I have lots of insurance policies that have nothing to do with investment, they’re just insurance for protection.
Richard:
Well, insurance is a great asset, it’s great to protect your estate, protect your income, protect yourself. I always said that insurance is about giving away risk, it’s not about taking risk. So, for most people and most consumers, insurance is insurance. You should keep your insurance separate from your investment. Yes, if you’re wealthy, very wealthy, and you can take quite a bit of risk, then insurance can become a way to create wealth. It can be an investment strategy, but for most people it is not an investment.
Jason:
I’m so glad you clarified that. So, first of all, how do the very wealthy use insurance? I mean, I know they have what’s called captive insurance companies sometimes and those can be used as an investment and a tax shelter I believe too, but is that what you’re referring to when you say the very wealthy can use insurance as an investment?
Richard:
In Canada, because I can only talk there in Canada, because this is where my experience has been working with a very wealthy clients. I’m seeing insurance being tailored to take advantage of tax laws and this is where they created the lies is taking advantage of the tax environment using life insurance. Sadly sometimes we push the envelope too far and we get into what we call tax avoidance and in Canada, for example, the sell of universal life was subsidized by the tax payer, because the department of finance looked the other way on some very advantages self-concepts like the 108.
Jason:
Did you say 108?
Richard:
Yes, the 108 was the leverage concept where basically a person can put premium into universal life policy and leverage the premium back, borrowing against the premium and get it back. This was done in Canada quite a bit, because the insurance company what they did is say, okay, you put the premium in the universal life, we’re going to guarantee you a rate of 8% if you borrow this premium back at 10%. Now, since they can deduct the interest at 10% as a tax expense, your net costs falls down 5%. So, for the insurance company, they charge a lone rate of 10, credit 8, they make a profit of 2 and the policy owner can basically is net costs 5% and he is credited 8, he’s going to make 3% profit as the tax payer that basically pays for this concept through the laws in tax revenues. So, this is how in Canada the sell of universal life was basically a subsidized and if you’re very wealthy to do this and can take the tax risk associated with a tax avoidance strategy, then yes, it’s very good for you.
Jason:
Very interesting. So, the tax payers again are subsidized another class of people. Sounds familiar.
Richard:
This was, you know, there was millions and millions of dollar premiums sold on that basis and it’s just last year that the Mr. Funds of Canada basically said that was enough and they stopped that practice.
Jason:
Very interesting. Okay, good, so what else would you like people to know about this? I mean, when you talk very wealthy and those it can be an investment for, how wealthy do we need to be? I mean, what are we talking about? We’re just talking about upper middle class here, we talking about Mitt Romney wealth, what are we talking about?
Richard:
Very wealthy, usually people that are taking advantage of the policies in knowing this $50,000 – $200,000 a year in premium and this is really just something the small policies that I’ve seen. I’ve seen millions of dollars in premiums being put into a type of arrangement, so when we see the universal life sales report in Canada, universal life sales are increasing. How much is it a reflection of those tax concept and how much of it is a reflection of regular people buying this type of product. I think it’s queued towards the very wealthy.
Jason:
Yeah, very interesting. Okay, so if someone is spending a $100,000 in premiums annually, then it can start to make sense, right?
Richard:
If they’re willing to take all the risk associated and what’s interesting there, the risk, was tax avoidance, but even the wealthy when they look at investing in a universal life, they have to cheat a little bit for them to work, they were offered an 8% guaranteed interest rate, right. For most people that type of concept would not be available so therefore what’s created at the universal would be in relation to what’s available into an equity or into an interest rate or into a bond rate or so they would take the full risk of those investments. Here it was basically fixed, the game was fixed.
Jason:
So, Richard, let me just explain something that I’ve always struggled with about this stuff, you know, these insurance companies are not stupid, they have financial engineers, they have brilliant quants, and MBAs, and just brilliant number crunches working for them who figure out how to structure these policies, and I just don’t see how they would structure something that is not a great deal for them. That’s the first part. So, I would think, you know, with these policy payouts that they’re really expecting inflation in the future when they start to pay these out so they can pay them back in cheaper dollars or people borrow money from the policy and cheaper dollars or they pay out, you know, for a loss obviously on an actuarial level. So, that’s one side of it, but the other side of it is and this is just such an irony to me because I’m a real estate investor and I love real estate investing and think it’s the most historically proven asset class in America, what do the insurance companies do with the money? They invest in real estate. It’s just such an irony to me.
Richard:
Well, this is worse, if you buy universal life, you don’t see those real estate returns, because you’re the one decided where the money is going to be invested, that’s the whole principle of universal life versus participating whole life policy where, yes, in the participating fund, there’s a real estate holdings, then you’re going to basically have some real estate returns there, but for universal life where you’re the one deciding where you invest the money, you don’t have access to a real estate type of return.
Jason:
But the insurance company does.
Richard:
The insurance company does, but under excess that they get from your premium that you’re paying on their profits, but not you as a person that is and no owner of a universal life policy, because that’s the whole purpose of a universal life policy is to separate the insurance from the investment, but what’s interesting here, this is what’s on paper, this is how the universal life came about, but in reality what you found is there’s always a link between insurance and investment and you see this through the contract where there’s always back doors where the insurance company have been too aggressive over their cost of insurance and really go after your cash values to pay themselves back and this is another reason why I don’t like insurance as an investment. Why would you take such a risk?
Jason:
Richard, a lot of this trickery is done in what’s called the illustration, right, and the illustration, that’s the page where you see all these numbers in the policy when the salesman is selling it to you, right?
Richard:
Entirely. In fact, a lot of research has proven that when consumer is considering buying a universal life policy is the decision is based strictly on the illustration. So, therefore what you have, the problem that is created is company influence into creating the best illustration possible and this can turn into a real problem, into what I call a scam. So, the first problem that you have is when you look at an illustration, let’s say 8% rate of return, because you’re going to have a stated rate of return.
This illustration rate is based on a constant rate of return, but in fact, you’re going to get what we call a volatile rate of return. Your rate of return will vary year to year and this is where, if you were to buy something right into one lump sum payment, make no deposit and no withdrawals, right, the sequence of returns would not impact the amount of money that you will have at the end. This is what we call in mathematics the cumulative law of multiplication.
For example, if I have $2 and I multiply this by 4 multiplied by 5, I’m going to have the same amount if I take the $2 multiply it by 5 and by 4, but in life insurance, this does not happen, because you make premium year to year or monthly to monthly and also cost of insurance is deducted month to month. That means that this law does not apply and therefore the sequence of return is very important, so if you get very low returns at the beginning and high returns at the end, you will get a cash value that is lower than what was created at the end and if you get high returns at the beginning, you’re going to get the opposite result.
So, when you look at this, what you find is – I always say you look at your illustration, the illustration rate, this is your bench mark curve, okay, and the problem that you have is and the second problem that happens is you have what we call MER, which is management expense ratios. Now, in Canada, these expense ratios are very high, they’re going to be in the 4% range. They can go up to 12% and these are not reflected on the illustration, so when you see an 8% rate of return, you the consumer have to make the mental calculation and say, well, this not 100% its truly 12% and therefore what company has done and this is interesting, and you know, I always say I don’t want to go into a lot of math, but I always say, listen, if your illustration rate is your benchmark at the end, what you should have is the same 50% probability to have higher cash value and 50% probability to have lower cash value, but this does not happen, why? Because the interest rate that you’re assuming is too high versus what truly can happen and the easiest way to explain this is if you’ve assumed 12% total so that 8% plus the MER of 4, okay, you have to select a minimum and a maximum and in my analysis I’ve selected – your rate can vary from plus 25 to minus 25 so therefore if you do plus 25, you’re doing 13% above the 12% that’s been illustrated, but if you do minus 25, you’re doing minus 37%, so therefore if you do minus 25 is going to take you three years at plus 25 to get back your loss.
Jason:
Unbelievable. Yeah.
Richard:
So, therefore, it means the illustration isn’t possible what is illustrated can not happen, it’s unachievable and this is the big problem. The second problem that we have is since MER are not reflected on illustration, what the companies, we call this smoke and mirror illustrations, smoke and mirror results, and this is a statement that they can fractalize that they’re designing those products and this is what they said they’d create and they create this very easily since they still have a universal life with an MER of 3%, I can increase the MER to 4%, this will have no impact on the cash value illustration.
Jason:
What is the number you’re saying? Did you say MER?
Richard:
MER, management expense ratio.
Jason:
Management expense ratio, MER, okay.
Richard:
MER, which is basically a loan that’s taken from your investment. So, every year they’re going to take, let’s say in this case, 3% of your investment and pay themselves from that. So, what you have here is since those MERs are not reflected on illustration, you don’t see them, but what the company can say is well, I’m not going to take 3%, I’m going to take 4%, this is not going to show on the illustration, because MERs are not shown there, but I’m going to give it back to you as a bonus of 1%, but the bonus now is shown on illustration, so what they’ve done basically is increased your illustration rate artificially by 1%.
Jason:
Unbelievable. How is this legal? How can they get away with this, because they have good lobbyists, let me guess, good lobbyists, good lawyers, and good PR firms, right?
Richard:
It’s unbelievable. In Canada what has been done, like, I’ve fought against this, we had one company that create what we call even went further in creating better cash value, we were at the time in the cash value war, everybody was fighting to create better cash value in the illustration, they created conditional bonus based on new earning 8% return, but you the consumer don’t see this, the MERs, so it’s true they base it on 12% return. Now, the kick is if you do the illustration at 8%, concentrate the return, the bonus will be created at 100% of the time, but in reality you can not achieve a constant rate of return like this. Your rate will fall below and above, so maybe you’ll get this bonus 50% of the time or 25% of the time, but you won’t see that on illustration and this is what I call a real scam. That is a real fraud. It’s showing something that can not achieved and this approach that has been done in Canada sadly, I don’t know why deregulators did not intervene, I still don’t know why, it’s a very, I agree with you, in Canada, the insurance lobby is very big, very powerful.
Jason:
In the US it’s even more powerful, I’m sure. It’s just ridiculous what happens. You know, these big companies have all the advantages and they can just deceive you, they can take advantage of you, and they’ve got all the tools and the power to do it. It’s amazing. Do you have a place on your website, Richard, where, you know, this is sort of hard to understand on an audio format, do you have something they can look at or is it just in the book or is it on your website, some sort of visual example of this?
Richard:
It’s in the book, you see the tables, I have very simplified and very easy to see and understand. I agree with you, it’s very difficult to talk about this verbally when it’s easier when you have the numbers in front of you, but on the site, I would say no, you really have to purchase the book and sit down and read it.
Jason:
So, I think the advice here, if you want life insurance, get some life insurance, I would just say get some term insurance, you know, and have insurance, just like your car. You might disagree, go ahead.
Richard:
If you need insurance, buy it for the right reason. I always say, you know, if you have an estate, permanent insurance is the only tool that can provide for your estate. Term insurance will not solve this problem, so permanent insurance in that situation is a great product and you should use it, but don’t use it as an investment. It’s not for you, you’re going to be – you can not achieve a better result in universal life when you more charges, when you pay commission that is worth 190% of the initial premium when you have all kinds of loads that are not even guaranteed where the insurance company can increase those loads contractually, why would you take such a risk? It’s a big investment risk.
Jason:
Yeah, it’s a good point and it’s a good question. Very good. Well, Richard, give out your website and tell people where they can find more and get the book.
Richard:
The book is available on Amazon, you just input the title and you can get it there, and basically I’m a consumer advocate in Canada and our site if people want to visit it is http://www.consumerights.ca/.
Jason:
Excellent, consumerights.ca?
Richard:
One r.
Jason:
Yeah, okay, you combine the rs, I see what you did. Good, good. Good stuff. Well, Richard, thank you so much for joining us today.
Richard:
Yes, thank you.
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