I am currently reading Moral Minds, the nature of right and wrong by Marc D. Hauser and I am trying to decide if I am blessed or cursed by this moral mind of mine. What does this have to do with life settlements? Well in reading this book, it has allowed me to understand how my moral compass has allowed me to make legal and fiscal interpretations on new life products, features and concepts without being wrong once with any of my interpretations during all of my career. This is surprising because quite often my interpretations were at the antipodes of those who are considered the experts; the ones with the CA, LLB, MBA or FSA. You know the very intelligent and highly educated crowd. After all, I was just a CLU, CFP, FLMI and I am a guy who climbed the corporate ladder from starting at the bottom in the trenches. I did not come from one of the big universities.
Before I discuss my position on Life Settlements, let me give you some examples of how I used morality in marketing and product development of life insurance. At the time, I was working at Maritime life and we wanted to offer a disability benefit in our Universal Life that would allow the owner to access the cash value of the policy on a tax-free basis in the event of total disability. There were a lot of discussions regarding this product feature since the term disability benefit was not defined in the Income Tax Act. Those against would state that since there was no element of risk associated with the cash value, Revenue Canada would consider this a taxable benefit. Those for the benefit pointed that nowhere in the Income Tax Act there is a reference to an element of risk in the definition of a disability or death benefit. That reference to risk was a phobia developed by Revenue Canada which went against the basic principle of life insurance and if applied would render most of all life policies taxable by age 100, since there is no more element of risk associated with these policies at that age.
Between these two camps, I stood alone asking myself whether this disability benefit was right or wrong. This illustrate how the experts or the decision makers only consider whether a decision is technically feasible and permissible without ever considering if it is morally feasible and permissible. We do need more morality in the financial industry.
The answer to whether this disability benefit was right or wrong could be found between reason and emotion. If we believe Descartes, reason defines morality and from this rationality we can make 2 forms of judgments as stated by Hauser: ‘we might deliver either a utilitarian judgment based on whether the outcome maximizes the greatest good or a deontological judgment based on the idea that every morally relevant action is either right or wrong, independent of its consequences.’
But I believe reason has little to do with sales. Emotions are actions and reactions while reason is just good wishful thinking (and it won’t help you close the deal). As stated by Hauser: “Humean creature,” equipped with an innate moral sense that provides the engine for reasoned judgments without conscious reasoning. Emotions ignite moral judgments. Reason follows in the wake of this dynamic. Our moral sense hands us emotional responses that motivate action, enabling judgments of right or wrong, permissible or forbidden.”
If society was to judge this disability benefit as either right or wrong, it would be from this emotional point of view. Let me offer you an example. A man suffers an accident and he is immobilized in bed unable to perform several activities of daily living. While some of the cost of his rehabilitation will be covered by society, he will still have to pay for some of the expenses out of pocket. The success of his rehabilitation has been proven to be linked to his financial well being. Now imagine this man lying in bed having lost so must. Is it right or wrong for him to get his cash value tax-free to pay for these expenses? Now if you have any empathy as Hauser said: Empathy is “the spark of human concern for others, the glue that makes social life possible” then you would be able to put yourself into this man’s bed and you would state that this benefit is right because he is not doing this to cheat the tax system. You would sympathize with his situation. You would also then use reason to pass a utilitarian judgment stating society has a stake in the successful rehabilitation of people who are disabled. There is a social cost with disability and any strategies that minimize this cost are good for society and therefore this benefit is right. When you know something is right, it makes the technical assessment easy to do.
This is why I had no problems in defending my position that the disability benefit was morally right versus those who believe it was technically wrong. I was proven right with Revenue Canada later endorsing my point of view. This is the point that we must never forget: life insurance is a very moral and utilitarian product born out of our emotional engagement towards those we cherish. It is a highly moral product.
I used this technique again and again and it has always proven successful. When the Department of Finance produced a report on many new insurance features and strategies in 1998; a report that was so technically backward; I successfully fought this report using morality. I wrote different texts for Marketing Option and his editor Steve Carlson destroying the positions advanced by this department in this report to such an extent that a senior government official of the Department of Finance communicated with CHLIA requesting their intervention to silence my criticisms. Morality is indeed a powerful weapon. In this report, the Department of Finance was objecting against many product strategies targeting business owners seeing these strategies as a way to cheat taxes while I argued based on a public report that the greatest problem faced by businesses was transition and business continuity. I argued that efficiency is not cheating. As a society do we want businesses to continue operating when they transition to another generation? As a society do we want companies to continue employing people? What is wrong with strategies that minimize the cost of insurance allowing the business to purchase the right amount of insurance while at the same time maximizing other advantages offered by these policies such as accumulating funds for the retirement of the current owner or for the purchase of their shares allowing the business to survive through generational transition?
When I started to work for Manulife. I quickly determined that increasing cost of insurance would have a negative impact on sales of my region. As a way to offset this, I believed we had to start bundling benefits. I tried to convince the product manager to put a high priority on creating term insurance that offered life, disability and critical illness coverage into one product. Every meeting I would try to push this as a priority but it was going nowhere. Finally I cornered the product manager in Montreal and asked her what was holding this initiative. Her response was incredible. One of the technical experts at Manulife had decided that combining coverage such as disability and critical illness undefined in the Income Tax Act under one product would taint the life insurance and it could be considered as not being life insurance. My reaction was immediate. Who could believe it was wrong to create an affordable life insurance product for a population that is already under insured; a problem that could only increase with rising cost of insurance. Our society has a tremendous vested interest in life insurance measured in hundreds of years of history. We want people to have the right amount of insurance because we understand that when there is not enough, families and businesses get destroyed. It took five years for Manulife to come to this point of view and they are now offering this product.
I also used morality in sales. It is morality that allowed me to close a case for one of my agent involving hundreds of millions of dollar of insurance. The agent had knocked on every insurance company’s door and each time he was faced with a refusal on the basis that you could not put that amount of insurance on children. I was the agent’s last chance and I decided to present the case to the reinsurers not on a technical basis but from a point of view of what was right or wrong and this is how I wrote my underwriting letter for the case. I agreed that yes it is wrong for a person like me to insure my children for hundreds of millions of dollars. But this did not apply to this case as we could see that the family involved had implemented 3 estate freezes for 3 generations with each generation insured for their taxable liability associated with the estate freeze. So would a family having planned to such an extent in order to defer taxes plan to kill their children to pay the taxes they owed to the government? The answer is quite obvious. There was indeed a need for this insurance independent of the age of the insured and it was therefore right to insure that risk. As soon as I convinced all the stakeholders that this was right suddenly everybody was on board and the case was done.
My last example is a product I created when I was working at Maritime Life. It was the Financial Insurability Option Rider (FIOR) which allowed the policyholder to purchase additional insurance in the future without medical underwriting based on the future value of an asset. What was amazing with this product is that I was able to reinsure it at 100%. Everyone had told me this was impossible to do but again I felt this product was right and I just needed to convince the reinsurers of this, which I did. In less than 6 months, I was able to put on the books 500 millions of insurance on a future option basis and it was all reinsured. Sadly I tried to convince Maritime Life to create a simpler version of the product for small businesses but Maritime Life decided to pursue the holy grail of insurance which is to create a Universal Life product that is better as an investment than a mutual fund. This was a disaster and I was proven right a year later when Manulife introduced its Business Value Protector (BVP) which was exactly the product I had pitched. Years later when I started to work for Manulife, I was able to witness how this BVP made Manulife the dominant insurer in the business market. An interesting fact here again linked to morality is that I used all the BVP which I considered free sales (without medical underwriting) to increase my total sales with such a success that I received a call from a senior underwriter at Manulife complaining about this. This underwriter told me: “We never priced this product on the possibility of the people using it.” I have to say this made me mad and I responded: “If this is the case this means your pricing was a bet that clients would be too stupid to recognize a good thing or that we the sales people would not act in the best interest of the client by NOT recommending that they purchase the additional insurance. Either way this pisses me off because it’s not ethical.” That ended this conversation right there and I hope that some senior executives at Manulife read this last passage. There is a need to reconnect with morality within this company.
Are life settlements right or wrong?
To first answer this question using morality; let’s look at what the people against life settlements are saying and the arguments they used.
Fear: There has been fraud in the US involving life settlements. This is the position of CHLIA representing the insurance companies in Canada. Is this a weak argument? Based on this logic, we should close down the mutual fund industry because there had been fraud (MADOFF) in order to protect the customer. What about the subprime fiasco? Should we close down the mortgage market?
Fear: The cost of insurance will go up for new products. Basically the argument is that life policies are lapse supported. Life settlements will reduce lapses which will impact the profitability of the insurers which will have no other choices but to pass this cost to new customers under the form of higher cost of insurance. Can someone explain to me how insurers who have marketed heavily zero lapse sales strategies to spruce up their sales such as back to back insurance and triple back to back can make this type of statement? The fact is that the insurers have corrected for lapses either by reducing their lapse rates and increasing their cost of business or by going out of business. Life settlements can indeed impact the profitability of the insurers but only for the insurers that have bought other insurers and their toxic life insurance products. This will depend on whether or not the insurer when buying the other insurer has corrected his bid/price under the assumption there will be no lapses with these toxic life products. If we look at Transamerica and how this company has managed the acquisition of NN, we should be worried considering the aggressive strategies used by Transamerica to increase lapses on NN products. Transamerica got caught in the act and was forced to settle a Class Action on this subject. Still this is not the problem of the policy owner and they should not be subsidizing acquisitions of other companies by losing their right to use their insurance as they see fit.
Insurance is not an investment/asset that should be monetarized. Again the insurers use hypocrisy to support their arguments against life settlements. Insurers and their sale managers have long forgotten the meaning of insurance. You only have to open their marketing materials and it’s all about how insurance is a great investment. But suddenly if the policy owner wants to take advantage of this investment suddenly it is portrayed as insurance with the argument that it should not be traded. However an insurer promotes concepts such as shared ownerships that are based on the trading of life insurance. Also with Revenue Canada allowing the gifting of life policies at Fair Market Value instead of at Cash Value, these gifts are truly life settlement. Basically the argument seems to be about the insurers controlling the use of life settlements for their own benefits and opposing life settlements that are to the benefit of the policyholder.
There is no more insurable interest when there is a life settlement. Again there is such hypocrisy with this statement. Insurers have been the first to dilute the notion of an insurable interest with their tax strategies. There is no need for insurance just buy it as a tax shelter. This statement is also partly false and will depend on how the life settlement will be done and whether there is a change of ownership on the policy. In a mortgage type life settlement, where a loan is made against the Fair Market Value of the policy, there are no change of ownership and the insurable interest remains the same. Finally the question of insurable interest is only material at the issuance of the contract and not after.
So now that we have demonstrated the very weak arguments used by those who opposed life settlements, do this make life settlements right? The answer is no but it provides us with an idea.
Let’s go back to our disable man. He has a Universal Life policy with a death benefit of $500,000 and a cash value of $50,000. Under the disability benefit he will be able to withdraw the $50,000 on a tax-free basis. Great he thinks but someone forgot to inform me about a little detail. In 30 days, he will receive a premium and lapse notice. Surprise! Surprise! There are no more cash values to support the policy. In his condition he can’t resume payment of the policy and like most people who have bought a Universal life he has not bought the premium waiver option. So this means the policy will lapse at a time when he is probably uninsurable. Also he can’t request an advance on the death benefit since he is not terminally ill. So truly under this condition, it is the insurance company that benefits from this situation and lapse. However let’s assume that the Fair Market Value of the $500,000 death benefit is $100,000. Someone is willing to offer him a life settlement either through a buyout or loan at 25% of that value. So this is an additional $25,000 in his pocket. Is that wrong? The one that should benefit from the asset is the one that owns the asset and certainly the one that is in the greatest need.
Second situation is more obvious. The fact is that Life Insurance Companies have marketed heavily the concept of life settlements. It one of their main concept and sale strategy and it’s called leveraging. Leveraging, a concept used by all insurance companies is a form of life settlements. I call this a life settlement at the Liquidation Value of a life policy instead of at its Fair Market Value. Leveraging is also a Zero Lapse Strategy. If you leverage a policy, the only way to get out and repay the loan is to die. This means the policy owner will not lapse the policy. To illustrate this let’s look at a client who has a Universal Life with a death benefit of $500,000 and cash value of $100,000. He goes to bank A and he is offered a leveraged deal and settlement of 75% of cash value. For this case insurance companies state this is legal and heavily promotes this concept. The client goes to bank B and the bank is also willing to offer a leveraged deal of 75% of cash value. However this bank has done a market value evaluation of the death benefit/cash value and the value (FMV) of the policy has been established at $150,000. The bank B is willing to offer a 75% leverage deal on this value. Suddenly for the detractors of life settlements, this would be illegal and trading in life insurance. I think not…
Finally detractors of life settlements state that there is no need for a life settlement industry in Canada because insurers offer advances on the death benefit if you are terminally ill. First this statement constitutes an illegal restraint on trade and is therefore illegal under the Competition Act of Canada. Already there has been complaints made and it is just a question of time before the matters is investigated. The terminal illness clause is very restrictive and the client is left at the whim of the insurer. The client should have the right to shop for the most advantageous terms for this type of advance. Also demographic changes in our society have created needs that cannot be ignored. Already the family house that used to be part of the estate is now shifting to retirement because people do not have enough money to retire. It is only normal that these people should view their insurance as an asset. For the sandwich generation who must take care of their parents, there is also a financial struggle. Is it wrong for a daughter who feels guilty of not having been there to care for her mother before her death of wanting to be there to take care of her father? However she will have to stop working and therefore how can she afford this. A life settlement on the policy would have solved the situation. We have not yet even discuss long term care situations and cost.
Life settlements in Canada is not only right but it is inevitable. However as I have discussed with the proponents of life settlements such as Daniel Kahan it does not mean we just start considering life insurance as just another asset. We must study what has been done abroad to avoid repeating costly mistakes. The market must be regulated and I worried that the provincial regulators are not up to the challenge. This is why I believe this should be a federally regulated market even if insurance falls under the provincial responsibilities. I certainly prefer the mortgage type of life settlements as there are no changes of ownership and the mortgagee profits are not linked to how fast the insured will die but how long he will live since the profits are earned on the interest paid for the loan. Finally unlike any other asset, insurance is made of many interests such as the beneficiary interest. Personally I would not get involved in any life settlements where disclosure of the settlement has not been made to the beneficiaries and the person who will take care of the estate. Buy-in from the beneficiaries I believe is not a requirement but disclosure is.