Gambling with Insurance

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I will explain how insurance plays on people’s fears or guilt, but does not necessarily improve their financial situation.

When I became an Investment Advisor (IA), I had to take several courses and exams on insurance.  I was never a big fan of insurance but I went through the grind and got licensed to sell insurance, as this was a pre-requisite by the firm.

The job of an Investment Advisor is to manage people’s wealth.  Part of wealth management is to help clients plan for retirement. If you watch or read business media, you will see many commercials or ads that talk about retirement.  They ask questions like “Will I outlive my money in retirement?”  or “Do you have enough to retire?”

We were trained to provide retirement planning.  We had special software that churned out financial plans.  At first, I thought this was a loss leader to sell stocks as we did not charge for the financial plans.  But then, how would a retirement plan sell more stocks?  If the client is already fully invested, even with a 60/40 split in asset allocation, we were not going to change that. The firm explained that retirement planning provides value-add in our service and keeps the clients invested instead of cashing out prematurely. However, retirement planning also provided another benefit to the firm.  It was a way to sell insurance.

The retirement plan will show the amount of money that is needed to survive and live comfortably until your death-bed.  Well, what happens if you lose your job early?  What happens if you become disabled?  What happens if the stock market crashes?  What happens if you die early?  Well then, you need insurance.

Even before becoming an IA, I knew that pushing fear is an easy way to sell things.  Nobody does this better than the insurance industry.  Actually, the U.S. government might be even better at it.

Each of our wealth management branches had a specialist in insurance.  Ours was a good-looking, man’s man.  He was a really nice guy. Not only did I get along well with him, it was his job to get along with all of the IAs.  This is because his compensation depended on how much insurance the IAs sold in his branch.  Hence, he was there to help market insurance to the IAs and the IAs’ clients.

As a gambling lawyer will concur, insurance is one type of gambling activity.  When you buy life insurance, you are making a bet with the insurance company.  You are betting that you will die early.  They are betting that you will die late.  When you buy car insurance, you are making a bet that you will have an accident.  They are betting that you will not.  However, note that the insurance company has hundreds of actuaries and mathematicians, who have calculated the odds on the bet and they are making sure that the insurance company has the better odds.  If you can do a better job of calculating the odds and can determine that you have a higher probability of coming out ahead in the bet, then you should take that bet.  However, most people cannot compete against a team of actuaries and mathematicians.  When you buy insurance, you are making a bet where you will lose most of the time.

Please note that I am not against gambling. According to the three top dictionaries (Websters, Oxford and Reference), any activity that involves risk or chance is gambling, even if the activity involves skill as well which most do.  They give “investing” or “starting a business” as examples of gambling activities.  As every one knows, these are crucial activities for the economy. Boston University Law Review explains that investing and gambling are identical activities in speculation.

I agree that certain types of insurance are very valuable, such as medical, car or disability insurance.  This is because if you do not have them, your finances can suffer immensely and more so than you can handle.  In other words, you do not want to win these bets against the insurance company.  Or worse, you do not want to be right that you will get cancer, have a car accident or become disabled and not have made bets with an insurance company.  These types of insurance give you peace of mind.

However, most insurance is analogous to casino operators where the house (insurance company) will win in the long-run.  Yes, there are rare occasions where insurance companies, such as AIG, screw up and lose on some big bets.  For the most part, they do not.  The customers lose the bets most of the time, otherwise there would not be so many big insurance companies.

When I was an IA, I could not get myself to push life insurance.  I think life insurance plays on people’s fear or guilt.  Make people feel fearful of dying early or guilty for not leaving lots of money for their loved ones and they will buy life insurance.  There is one situation where life insurance makes sense.  That is with parents who are still raising their children.  Other than that, most people have saved or built up sufficient net worth that they should not feel guilty when they leave this to their loved ones. Most people will survive on the household net worth if the spouse dies without life insurance. People should not feel obligated to pass on so much wealth that their children never have to work.  As far as I know, most of my friends and I will do just fine financially if our parents died with no life insurance.

When I was an IA, my job was to maximize people’s wealth.  I did not feel that I would be maximizing clients’ wealth by pushing insurance.  To me, life insurance reduces people’s wealth and increases insurance companies’ wealth. Yes, some clients will win their bets against the insurance companies, but most will lose.  Insurance companies have to make a profit on these bets.  Therefore, most people will end up with less money by buying life insurance.

Many Wealth Management firms will also push Annuities (and Segregated Funds in Canada), which can be thought of as a mutual fund mixed with life insurance.  This is another wealth reducer for clients.

In summary, annuities work like this:  You give a sum of money to the insurance company which provides you with guaranteed monthly income, usually for the rest of your life.  After you give the money to the insurance company, they invest it and make returns.  As with any insurance, you are making a bet with them.  You are betting that you will die late.  They are betting that you will die early.  Or put in another way, they are betting that the value of all of the monthly payments to you will be less than the initial sum that you paid them plus investment returns.

Most people cannot outperform the stock market index, including insurance companies.  If an individual puts all of their money into an ETF that tracks the index instead of buying an annuity, that person will likely make as much or more return than the insurance company.  However, the person will be further ahead because the person did not pay fees for the insurance aspect of an annuity.

However, annuities can provide peace of mind for the insecure.  It is also one of those insurances, such as car or medical insurance, where you do not want to be right without having made a bet with an insurance company.

Segregated funds work like this:  The fund guarantees that upon death, you will get no less than a certain percentage of the initial investment. Let us say that the percentage is 75%.  If upon death, the fund has grown to 110% of your initial investment, you will get 110% less the fees.  If it dropped in value to 70% of your initial investment, you will still get 75%. To get this guarantee, you may a much higher fee than the fees that a regular mutual fund charges.  This is to pay for the insurance.  The fund also provides creditor and probate protection.

To me, unless you REALLY need creditor or probate protection, buying Segregated Funds is one of the worst bets that clients can make.  It totally plays on clients’ fear of a stock market crash.  As shown in Top 4 Reasons to Invest in Stocks, since 2000 we had two of the biggest bear markets in a lifetime.  Yet, both of them have recovered in 7 years or less.  If one has more than 7 years to live, one is making a bet that another stock market crash will not recover in his/her lifetime.  To me, that’s a low probability bet.  Most people lose their bets on Segregated Funds to the insurance companies.

In conclusion, if you ever deal with a wealth management firm, be cognizant that some services or products may play on your fears or conscience, but they will not necessarily maximize your wealth.

Again, please read my disclaimer below before you make any financial decisions.