Imagine that a man walks up to you with a proposal. He’d like you to lend him a large sum of money, possibly most of your worldly wealth, at an interest rate of less than 1 per cent.
And then he says yes on your behalf.
In an excellent piece of reporting by David Evans, Bloomberg Markets magazine last week drew attention to the fact that many insurance companies are effectively doing just that. Instead of sending checks to the beneficiaries of life insurance policies, including relatives of soldiers killed on the battlefield, companies like Prudential and MetLife are sending IOUs in the form of “checkbooks.” The money from the death benefit has been placed in a special account for safekeeping, the companies tell the beneficiaries. There is a bank name on the “checks,” but the bank simply processes the transaction. The money itself stays with the insurance company.
In effect, these companies are electing to lend themselves money that belongs to the beneficiaries.
In the midst of their bereavement, many family members are too distraught to pay much attention to financial arrangements, leaving the insurance company to make interest off the money that remains in its hands until the family withdraws the sum. In many cases, this may translate into years of inadvertent loans on the part of the beneficiaries.
What’s worse, the money is not backed by the government, as it would be in a bank. The FDIC does not cover funds held by insurance companies.
Insurers should be in the business of assuming risks in exchange for premiums. Instead, this practice directly creates risk for people at a time when they are most vulnerable. A lump sum benefit that often represents a family’s biggest asset is invested in a low-interest loan to a single company, which violates the cardinal rule of prudent money management: diversification.
MetLife, in its standard beneficiary letter, says that the account into which it places the benefits is guaranteed by the company. Almost parenthetically, it adds, “All guarantees are subject to the financial strength and claims-paying ability of MetLife.”
It is hard to imagine that many beneficiaries would actively choose to invest their money at a rate of less than 1 per cent (a typical rate, though insurers may pay some beneficiaries a little more), and that they would sink all of it into one company with no safety net at all. Yet the insurance companies claim that these accounts are convenient and designed for customers’ needs. Pennsylvania Insurance Commissioner Joel Ario told Evans, “I haven’t heard a plausible argument about why these accounts are better for the consumer.”
The financial reform bill recently signed by President Obama created the Consumer Financial Protection Bureau. That office may or may not find this matter within its purview. If it does, the bureau should outlaw this practice immediately, and should require insurance companies to send actual checks to beneficiaries who are due payments.
If the companies wished, they could enclose a form advising beneficiaries that they could send the money back if they wanted to. The form would need to make it clear that returning the money would constitute a loan and not a deposit. Of course, if I were an insurance company in that case, I would hardly sit by the mailbox waiting for the checks to roll in.
If the Consumer Financial Protection Bureau does not take action on the matter, states can outlaw the practice themselves, as Ario is already attempting to do in Pennsylvania. New York Attorney General Andrew Cuomo announced last week that he is investigating whether the insurers’ current practices violate state laws. At minimum, states should strongly consider creating a requirement that such accounts cannot be used as the default method of payment.
States also could require insurers to pay a reasonably high rate of interest from the date of an insured’s death until the day the benefit is withdrawn. Such an interest rate, for example, might be equal to the floating rate that the Internal Revenue Service charges individuals who underpay their taxes. This would make companies much more eager to encourage beneficiaries to withdraw their funds.
Insurers seem to have taken a page from the playbook recently copyrighted by bankers: Take advantage of your customers at every turn, and then wonder why no one likes you. If insurers don’t see it in their own interest to deal with bereaved families in an open, above-board way, state and federal regulators should waste no time showing them the light.