Life Insurance Payouts: Are You Earning Enough on the Money?

Did you get a payout from a life insurance policy? Is it sitting in a special checking account provided by the insurance company?

A class action lawsuit, filed recently and amended today, slams the Prudential Insurance Company of America for taking financial advantage of beneficiaries. Pru earns 5 to 6 percent on that money, the complaint says, while crediting the accounts with an interest rate of only 0.5 to 1.2 percent. The families think that all the earnings should belong to them.

Whether Pru owes more money is up to a judge and jury to decide. At present, these accounts provide the same service that you'd get from a bank money market account and are paying about the same amount of interest. They make sense as a way of managing large lump sums, short term.

What I question is whether families are unfairly steered into this insurance-company deal when it might have been better to ask for a check in the mail.

But first, a word about the lawsuit. It got a lot of press because the policies were issued under the Servicemembers' Group Life Insurance program, available to military men and women and administered by Prudential. Jeffrey M. Lucey, who died in 2004, named his parents, Joyce and Kevin, as beneficiaries of his $250,000 policy. Scott W. Eiswert, who died in 2008, left his wife, Tracy, $400,000. They could choose a lump-sum payout or spread it out over many months. Four other military families have joined the complaint.

Pru, like most insurance companies, automatically put the lump-sum payouts into what's known as a retained-asset account. It's a holding pen for cash -- for military and nonmilitary families alike. Beneficiaries get checkbooks and can write checks or ("drafts") on those accounts at any time and for any amount, including the lump sum. The Luceys took out their money gradually, over five years. Ms. Eiswert took hers within eight months.

Retained-asset accounts are invested along with the insurers' general pool of money. The company fixes your interest rate and can change it at any time.

Currently, Pru pays 0.5 percent. That's the same as my bank pays on money market accounts of at least $50,000. Some banks and credit unions pay more (yes, I should change my bank). Money market mutual funds yield about 0.2 percent today. So for cash you can tap at any time, the insurance company looks okay. If you die while holding a retained asset account, the interest as well as the principal goes to heirs untaxed.

The advantage of a retained-asset account is that it saves you from thinking about money at an emotionally difficult time. It also saves mistakes. "We don't think that a check in the mail is the best settlement option for beneficiaries," says Pru spokesperson Bob DeFillippo. "It might be dropped into a drawer and forgotten, or mislaid." It's also convenient for paying current expenses.

On the other hand, you might want that lump sum immediately, to invest in a higher paying certificate of deposit.

The claim form for military policies tells the families that lump sums are paid through retained-asset accounts. It doesn't mention putting checks directly into the mail. DeFillippo says that Pru will send checks but families have to call and ask about it.

"The client decides on the options," DeFillippo says. "The Department of Veterans Affairs tells us what to do." Questions left with the DVA weren't answered by the time I filed this column. Pru and the department are currently in discussions about handling these accounts.

On nonmilitary payouts, you might or might not be told about direct pay. In the past two years, Pru has disclosed this option when beneficiaries make a claim, but only in a separate brochure. The simple, one-stop and recommended choice is the insurance account.

There are two potential drawbacks to retained-asset accounts compared with bank options. They aren't insured by the Federal Deposit Insurance Company. If the insurance company failed, you'd be covered for $300,000 in most states ($500,000 in some) by the industry-backed State Guaranty Funds. Bank and credit union accounts are insured for up to $250,000, but you can multiply your coverage by using different types of accounts or dividing your money among different banks.

Also, liability isn't clear if someone forges your name on the check. In two lawsuits against MetLife, reported by Bloomberg magazine, the insurance company and the bank that administered the accounts pointed fingers at each other and both declined to pay. (Eventually, judges ruled that banks might have liability and the parties settled). If you had your own account, the bank would be liable for cashing a forged check.

Regardless of the new lawsuit's merits, it's stirring up some state insurance regulators. Kentucky prohibited insurance companies from putting money into retained-asset accounts automatically. They first have to first disclose the terms and get the beneficiary's consent. If there's no reply, the check is mailed out. A number of other states are considering similar proposals.

Retained-asset accounts are a reasonable and convenient choice, and will be better if better disclosed. But don't leave the money there long. For long-term support, you want the payout invested for higher income and growth.

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