The Right Blend

Published on 04/22/2008 via Financial Advisor

Life insurance industry critics like to say that the industry will never change, that it completely deceives consumers and should be junked for a fresh start.


Life insurance industry apologists like to say that agents perform a crucial service and deserve every penny of their commissions, which eat up most of the first year’s premium paid by the policyholder. After all, don’t agents force people to buy life insurance, which they need but probably wouldn’t buy on their own?


And finally, we have a third group, which is, happily, growing. These critics acknowledge that life insurance is an essential part of financial planning and risk management. But, they add, the way that it works benefits the agent more than the customer.


Many of the folks in this last group, a knowledgeable crew, are actually doing something about it, trying to make certain that life insurance buyers get a fair shake. Financial planners should be very interested in what is going on here and how it might impact their own fiduciary responsibility if they are just handing off clients to a life insurance agent.


One of the favorite tools of this group is “blending,” an exercise that mixes term insurance and whole life in a way that both decreases the agent’s commission and enhances the policy’s value. These consultants have carved out a niche for themselves. Many of them are fee-only insurance consultants or agents who made the decision to put the interest of the insured first. They offer blended policies with lower commissions and with a substantial cash value at the end of the first policy year, as opposed to nothing.


Interestingly, many—but not all—are Northwestern Mutual Life Insurance Co. agents like Chuck Hinners in Middleton, Wis., and BrianFechtel in Port Chester, N.Y. Others are former Northwestern agents like David Barkhausen in Lake Bluff , Ill. One, Scott Witt, inMilwaukee , is a former pricing actuary at Northwestern Mutual. He, too, works as a fee-only consultant, building custom policies for each client. And, of course, I must mention Peter Katt in Mattawan , Mich. , who has trained many of these people in his consulting business, and James H. Hunt, an actuary and former insurance commissioner of Vermont , who evaluates policies for consumers from Concord , N.H.


Actually, perhaps it’s not so surprising that many come from Northwestern Mutual Life, which is considered to be the gold standard in life insurance. Many people trained by Northwestern are bright and creative. Indeed, they sound a lot more like fiduciary financial planners, always putting the client’s interest first, than like life insurance agents, always selling a product.


Blending is a method of rejiggering a whole life insurance policy to reduce the amount of whole life, which gets maximum commissions, and increasing the amount of term insurance, which carries very low commissions. The policy is then set up to use term and paid-up additions riders that can be added to the base policy.


Blending is not new. Chuck Hinners, who’s been a life insurance agent since 1974, says blending emerged from the competition with variable life policies in the mid-1980s. Because variable policies offered the policyholder so much flexibility, the whole-life companies agreed to “allow agents to dial in the amount of their commissions so they could be competitive,” Hinners says. “That’s how the secret leaked out,” the secret being that a policy could be dismantled in this way to reduce the agent’s commission and increase value for the customer.


But for the most part the secret is back in the bag. Why? Maybe it’s tough for agents to stomach the idea that they should make less so the customer can profit. “The young agents are not taught anything about blending,” Hinners says. “If someone asks, they’re told: ‘Oh, that’s advanced stuff. You don’t need to worry about that.’” What do new agents learn? “They go to a six-week boot camp to learn how to ingratiate themselves with people and how to sell,” he says.


Any agent could offer a blended policy, says Witt. But “agents are in a perpetual conflict of interest where they have to choose between their own best interest and clients.” If the customer gets a better deal, the agent gets a worse deal.


Hinners has been a Northwestern Mutual agent since 1984, which is the year he went to his last agents’ meeting. “It’s difficult for me to sit there and listen to the B.S. spewed out like, ‘Here’s how you can steal some business from someone else.’ Or, ‘Here’s how you can make a lot of money from 401(k) plans,’” he says.


Like many of his colleagues who put value for customers first, Hinners was considered a renegade by the industry. “What I try to do is to save people as much money as possible,” he says. Some companies are becoming stricter about permitting practices like blending that favor the consumer, Hinners says. “Maybe they’re waiting for old dinosaurs like me to die off.”


Barkhausen, now a fee-only consultant, says, “The agent’s typical illustration has no or only a negligible amount of cash value in the first year in relation to the premium paid.” However, with an “efficiently designed product, the first-year cash value may be a high percentage—perhaps 80% or more—of the premium. The extra cash value in the early years compounds over time and can produce significantly more long-term cash value and death benefit.”


Glenn Daily, a fee-only insurance consultant in New York , says he’s had a number of clients come to him with very large whole-life policies in which the part of the policy with the largest commission makes up most of the policy. Daily defines blending as “taking money from the agent’s pocket and putting it back into the policy.” Daily says he “can’t believe there haven’t been lawsuits about this,” because the option of giving the customer a better deal is right there, whether the agent chooses to use it or not.


A blended policy could result in a much lower premium. However, most consultants, like Daily, pump the savings from commissions back into the policy to increase cash values. “The goal is to use blending to reduce commissions and improve policy values, not to reduce the outlay,” Daily says. Likewise, Scott Witt, who custom designs policies for each client says, “My fiduciary loyalty is to whoever hires me.”


The desire to reduce the load or the commission and enhance cash value sometimes leads consumers or their advisors to consider a no-load insurance product. Daily would certainly consider that option. Others, like Barkhausen, say that although “the sales load or its relative size has a very substantial impact on the performance of a life insurance policy, it is by no means the only factor.”  Other crucial factors include the mortality charges or cost of insurance and the investment performance of the portfolio.


Blending the policy provides an insurance consultant with a much broader array of options than just no-load products. But secrecy prevents many consumers from learning about it. “In my work, I find that agents don’t know of or don’t disclose the extent to which these opportunities exist,” Barkhausen says. “This lack of disclosure is a “sin of omission” by agents and brokers but is really a “sin of commission” on the part of the carriers and, indeed, the state regulators.”


So what’s holding everyone back? Why not let the secret out? Some consultants say that life agents need to be pampered; they need to be told that they are adding value to America and to the lives of American families. Whenever I question the work of life insurance agents, I get a ton of letters saying things like, “You don’t know how hard we work!” or “Have you ever tried to sell a life insurance policy?”


Well, no. But providing disclosure of commissions to consumers seems like a step in the right direction. Providing a better deal for consumers also has its rewards. “I haven’t prospected for the life insurance business for 15 years,” Hinners says. “I get all my business from existing clientele.”