We take a break from our vacation to bring you our first ever post on a life insurance topic.  I.I.I.  senior vice president and chief economist Dr. Steven Weisbart  offers an  insightful perspective on an established  life insurance industry practice that is coming under fire.

A life insurance industry practice that has served beneficiaries well for a quarter century and has generated few if any complaints to state insurance departments came under withering fire last week via an article published online and scheduled to appear in the September issue of Bloomberg Markets magazine. The article focused on how the industry practice affected the beneficiary of a $400,000 life insurance policy  Ã¢â‚¬“ the mother of an army sergeant who died in Afghanistan while saving the lives of three others.

Seemingly within minutes of the article’s appearance, the acting under secretary for benefits at the U.S. Department of Veterans Affairs, Michael Walcoff, announced an investigation, and New York Attorney General (and candidate for New York Governor) Andrew Cuomo subpoenaed a half dozen life insurers as part of another investigation. A few days later, U.S. Representative Debbie Halvorson (D-IL) introduced a bill that would set new rules for life insurers using this practice.

What practice caused this furor? In the absence of any other selected settlement option, life insurers place death benefits in the equivalent of an interest-paying checking account. Beneficiaries get checks with which to withdraw/spend the money, which stays in the life insurer’s general account until it’s withdrawn. Materials provided to beneficiaries make clear that the account is not FDIC-insured and periodically report on interest credited and the remaining balance.

So what’s wrong with this? According to the Bloomberg article, virtually everything. The article suggests the practice cheats the families of those who die, stealing money from the families of our fallen servicemen. This unregulated quasi-banking system operated by insurers has none of the protections of the actual banking system, the article reports. Next, life insurers are accused of not disclosing that the funds aren’t FDIC-insured, so beneficiaries are misled into thinking the funds are in an FDIC-insured bank. The industry does this to hold onto death benefits that they’re not entitled to. The article notes that life insurers earn interest on the funds at their corporate rate yet credit uncompetitive rates on death benefit balances, resulting in secret profits for insurers. And so on.

The article is such a one-sided diatribe that it’s hard to know where to start. It treats an FDIC-insured bank account as safer for death benefits than the general account of a life insurer, ignoring the state guaranty laws that insure death benefits for $300,000 to $500,000, depending on the state (vs. FDIC’s $250,000 limit, which was $100,000 at the time the death of the army sergeant occurred). It ignores the bank failure rate of the past few years vs. the superior rate of almost no life insurer failures. It says life insurers shouldn’t earn a higher rate on the funds and credit a lower rate, but says the money should go into a bank account (where it ignores the fact that the bank would do the same thing). It says the insurer should send the beneficiary a check for the entire amount instead of holding onto the money, ignoring the likelihood, based on long insurer experience, that when insurers did that the checks often either went uncashed for long periods of time or were spent/invested unwisely and effectively lost. This practice, at least, credits interest uninterruptedly at a rate that is comparable to accounts with instant liquidity.”

If you have questions or comments, please email Dr. Weisbart at stevenw@iii.org.