Financial Advisors Giving Advice on Life Insurance

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Sometimes you see or hear about rules and you might think “man I’d like to know the story that led to this.”  Within the financial services industry, we have lots of rules.  Rules that are intended to protect people from unscrupulous salespeople and also rules to help protect people from themselves.  We have rules about what people can and cannot call themselves.  We have rules about what’s suitable for someone given a list of various fact patterns.  We even have rules that prohibit giving advice on things we’re not “appropriately” trained (i.e. licensed) to talk about.

In fact, the investment industry worries so much about “investment advice” that it has lobbied Congress to extend its reach in an attempt to regulate various facets of financial-professionals who might sell competing products.  The industry established itself as the gatekeeper to many key marketing aspects of personal finance, chief among them is effectively owning and regulating the term “financial advisor.”

We discussed this notion in the past, and I’m not looking to fully relitigate it today, but it’s a key understanding to the story I’m about to tell.  Once that highlights the hypocrisy of current regulatory behavior and the hush hush conflict of interest that plagues the industry’s most heralded practitioners.

Can You Help Advise Him on This Policy?

About a year ago I was asked to help a “financial advisor” sort out a strategy for a life insurance policy.  The policy owner had bought the policy several years prior, made one large premium payment, and never made subsequent premiums.  This was not a single pay intended policy.  It’s a universal life policy that was designed with the intention to make many multiple payments, but the policyholder never followed through with that plan.

The policyholder, who asked me to help the advisor was vague on the motivation for the policy.  It was unclear to me if he intended to keep it or was looking for a way out.

After speaking with the advisor, it was clear that the advisor’s intentions were to cancel the policy and move its cash value to a new investment strategy he had concocted for the policyholder.

In any event, I agreed to be of assistance and scheduled a phone conference with the advisor.

The Phone Conference

I didn’t know much about the advisor and I have no idea what he knew about me prior to our call.  The conversation began cordially and he proceeded to tell me that the client bought this policy about a handful of years ago and had since decided he didn’t want it.   That decision, it appeared, came from the financial advisor’s recommendations on an investment plan for the policyholder and his spouse (i.e. the advisor showed him how much more money he could have if he took the planned premium and invested it in the market!)

My immediate recommendation was if the policyholder no longer wanted the policy and thought there were other options at his disposal with greater growth potential, he should immediately cancel the policy and do those things.

The advisor was silent for a bit.  He then somewhat timidly noted, but there’s a surrender charge.

My response was, “so what?”

I’ve argued this point countless times to a painfully large number of people, there’s no prize for keeping a life insurance policy you don’t want until you can walk away with cash totaling the premiums that you paid.  Now I hear your sarcastic reply saying “except for all of your money back.”  But if you really believed that there were better options out there, why on earth would you forgo them while you wait for your life insurance policy to “break-even?”

Nonetheless, it became obvious that the “financial advisor” lacked the confidence in his own recommendations to make that suggestion (we’ll revisit this in a bit).  So we turned our discussion towards some finer details regarding the policy.

The advisor was obviously clueless about the policy and its mechanics.  I answered some very basic questions anyone with an insurance license should know and then we dived into the elephant in the room…the surrender charge.  The policyholder didn’t want to cancel the policy because of the surrender charge, so now this financial advisor was left trying to craft a plan to “help” the client out of the policy as efficiently as possible in a way that was palatable to the client and insured he followed through with the investment plan recommended by the advisor.

So I suggested annual death benefit reductions to the surrender-free amount.  It felt like I could hear the advisor’s ears perk up.  “What’s that?”  He asked.

For those who aren’t well versed in universal life insurance, and therefore shouldn’t be making any recommendations to people about it current or prospective owners, the surrender free amount is a sum of cash value that a universal life insurance policy owner can withdraw from the policy free of the surrender charge.  The same principle is often found with annuities and it also applies to death benefit reductions on universal life insurance policies.  It allows the policy owner to make a death benefit reduction up to a certain amount without triggering a surrender charge on the policy.

The most common surrender-free amount on insurance contracts with surrender charges is 10% per year.  So, I let the advisor know, that he’d likely be able to work with the policyholder and the insurance company to make annual reductions of the death benefit of about 10%.  This would reduce the cost of insurance and it would also not be subject to a surrender charge.

Then the advisor asked me, “if we reduce the death benefit by 10%, how much will that reduce the fees on the policy.”  I wish I was making this up.

Stunned, I told him, “you should see a 10% reduction in fees.”

At the end of the call, I’m not sure the advisor was any more thrilled about the plan for the client than he was prior to the call, but we did our friendly goodbyes and that’s the last I’ve had to deal with the situation.

The Moral of the Story

This story underscores two critical failures of the investment industry’s regulatory efforts regarding consumer protection.  There’s an obvious one, giving advice about a financial product you are not licensed to sell nor know anything about.  But there’s also a more interesting and less obvious conflict of interest issue at play.  Let’s start with the more interesting issue.

The term financial advisor comes with several positive connotations about what you do for people.  It’s a friendly term that suggests you will provide advice about a given situation.  The investment industry has even suggested that you’ll give advice that serves only the best interest of the person seeking your advice.  It’s no wonder why so many people working in the financial services industry seek to call themselves financial advisors.

But sadly, very few advisors are actually advisors.  They are instead investment salespeople who seek to sell an investment plan that provides compensation to them in the form of a fee we used to call a commission but for some reason now single out as specifically a fee and totally not a commission…like for realsies.

This puts the financial “advisor” in an odd predicament.  Bob has come to me seeking my advice, but if I make Bob mad by giving him honest advice he might not choose to invest his money with me and therefore I’ll lose out on all the money I stand to make if Bob decides to invest his money with me.  So in the interest of keeping Bob happy and interested in investing his money with me, I need to figure out how to tell Bob what he wants to hear packaged as advice.

The advisor in this story should have told the client that he needed to cancel his policy if he didn’t want it.  Get over the money he thinks he’s keeping by keeping the policy (the money is obviously not his given the circumstances) and move on with a better plan.  But that conversation was highly unlikely to happen because the advisor was way too afraid of upsetting the client.

This leads to horrible advice that creates watered-down solutions.

Now let’s talk about providing advice on things you don’t understand.  I did look the advisor up after the call to see if he had an insurance license.  Not because I was planning to point out if he did or didn’t to anyone, I was curious.  Turns out he does not.

So here we have an “advisor” who holds that title due only to the fact that he passed a securities exam that permits him to use said title and no other barrier to entry.  He’s providing advice to people about life insurance policies they own (namely dump that and invest in this instead) despite having no idea how these policies work.


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