Insurance Investing and the $100,000.00 Challenge - The Outcome

After writing the column, "Why So Critical on Annuities," I got a particularly interesting email. It started off with:

I can blow away saving for retirement in any market fund, with an Indexed Life policy. How about a NET return of 8% that allows you to take out the gains Tax Free for retirement income, with NO downside market risk.

Will I be forking over $100,000 to buy this product? I had some surprises on this one. Read on.

The product - Indexed Universal Life (IUL) Policy
In the challenge, Mr. Anderson promised to bury me in analysis and, at the very least, he buried me in paper. The product features and timing of paying my $100,000 changed over the challenge. Initially, I would get 140% of the S&P 500 index return. Then it was changed to use an option giving me 100% of the index return but a higher cap. Ultimately, he ended up with an IUL from Minnesota Life. The product's name is Eclipse Indexed Life. I'd hand over the $100,000 up front and would be credited 100% of the S&P 500 index return, with no downside risk in bad years.

The first promise to go in the challenge was the claim that I could "take out the gains Tax Free for retirement income." That went out the door because paying the full $100,000 up front disqualified it from IRS rules letting me borrow gains against the policy, as this is technically called a Modified Endowment Contract (MEC). I didn't consider this a big deal, because I don't really want to pay to borrow my own money anyway.

The claims from the producer
In written correspondence, Mr. Anderson noted that this policy would give me 140% of the market return, later reduced to 100%. Mr. Anderson also started using the term "limited" downside risk in place of his original wording "NO" downside risk. Let's look at each claim vs. the actual policy.

Would the product meet the reduced claims of the producer?
Claim 1: Market returns
As I've done dozens of times before, I started pouring through the paperwork and the illustrations run by Mr. Anderson. One of the easiest to find illusions is the claim of 100% of the "market return." Mr. Anderson noted a possible market return of 7.4% annually and stated my crediting would be based on this. In actuality, the crediting is based on the S&P 500 index, which is only the return from appreciation and strips out the dividends paid by the market, currently about 2.2% annually. This may not seem like much but, over a thirty year period, that takes out well over half the return. Mr. Anderson noted that the illustration shows a historic return of 9.21% annually based on the results of the last thirty years of the market. Of course, this was the beginning of the great bull market. And he didn't mention that Minnesota life had the unilateral right to lower the maximum annual indexed credit to as low as three percent annually. Anderson's response was that they have never lowered these caps.
Claim 2: Limited downside risk
While his challenge was for "NO downside risk," I gave Mr. Anderson the benefit of the doubt here. I looked at the "guaranteed values" in the illustration as these are my minimum returns as long as Minnesota Life stays in business. In ten years, I was guaranteed to get back all but 5.5% of my initial cash outlay. How did this compare to a moderate second grader portfolio of 60% equities and 40% bonds for the ten years ending September 30, 2009? Well, the simple index portfolio gained 44.4%.

Now I asked Mr. Anderson to run a few illustrations. What was my guaranteed return in year 26 and beyond? The answer was zero -- nada! I could lose my entire amount!

Discussion with Minnesota Life - didn't go as I thought
Mr. Anderson was kind enough to put me in touch with Benjamin Roth (no relation), Actuary & Director of Life Products at Minnesota Life. When I typically speak to officers of the insurance companies selling these products, they compare their returns to stocks in bad stock market years and to bonds in good ones. It's part of the illusion.

This time was different, though, because Roth noted that this product would not be appropriate for someone like me who did not have an insurable need. He noted the insurance costs are part of what the policy holder is paying for and that my insurance costs were going up dramatically, as I aged. Hence the zero guaranteed value in year 26.

Roth and I discussed the importance of disclosing to the policy holder that only part of the market return is credited with this product and that Minnesota Life had, in fact, unilaterally lowered its cap from 17% to 16% in February. I noted that when insurance companies had the unilateral right to change credits and payments to the policy holders, the policy holders were in effect providing insurance to the insurance companies. Roth didn't agree with my statement here.

I then asked Roth why I shouldn't just buy a zero coupon bond and a couple of low cost index funds with my $100,000. It works out that I could get a guaranteed $100,000 in 26 years for forking over about $32,842 today. I then could take the remaining $67,158 of my hundred grand and put it in low cost index funds. Roth responded that this is similar to what Minnesota Life does with the premium left after paying commissions. I was floored at his candidness.

Bottom Line
Not only will Anderson not be receiving my check, Minnesota Life seems to agree that this is not appropriate for those without an insurable need. It's easier, more tax efficient and far cheaper to use the zero coupon bond strategy Minnesota Life uses without paying those high commissions and insurance that is not needed. Anderson's errors in his statements, as well as his omissions, are completely consistent with his web site, where one can read ridiculous, not sourced statements such as "The odds of a couple age 65 eventually needing to pay for one typical Nursing Home stay for 2 1/2 years, is 100%!" As you might expect, some of the more recent emails from Anderson haven't been quite as respectful.

While I won't be buying the product, Minnesota Life earned my respect with both its candidness and belief that insurance products are meant for those with an insurable need.

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Wisdom from Bogleheads VIII - Day Two
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