By John Blocher
How do we provision a small amount life insurance policy
as efficiently as possible to a person with low and highly variable income?
Step to the dry-erase board and suspend disbelief to think about the best way
to do this.
Over the last century there have been two main approaches: 1) offering permanent life with lifetime premiums for the lowest level of premium, and 2) offering term life with premiums for the term period. Neither of these approaches meshes well with low and highly variable income. Demanding a set amount of premium—frequently monthly—that a person may or may not have in hand when it is due is a recipe for lapses. Unlike utility bills, where there are massive fees for late or missed payments along with a potential service disconnection, the only consequence for not paying life insurance premium is the coverage is lost. A high lapse rate is the result. And a lapsed life policy doesn’t cover anyone.
At the dry-erase board, let’s see what this underserved market needs. The person might start with any group term life coverage from their employer forming a base level of life insurance coverage that can be built upon. Some employers might offer optional worksite permanent life insurance coverage paid with some form of payroll deduction. We will assume there is no group term life and no worksite permanent life available, though neither of these would preclude a person from purchasing an individual life policy.
What is a small amount life insurance? “Small amount” might be considered a face amount range up to $25,000 and specifically $1–$15,000 of death benefit. This is a continuum where at one end it is all taxable accumulated savings in an account, and at the other end it is a life insurance policy. That continuum changes over time, with accumulated savings as the more economically viable option slowly increasing proportionately.
The base issue remains whether insurance is offered at a given face amount, and that is how that person will soften financial costs upon their death. This may sound like a “final expense” concept; however, that is a limited version with a specific purchase of goods and services upon death in mind, typically involving a life policy purchased toward the end of working or after retirement at a location where those expenses might happen. What is being discussed here is what someone might do while relatively young and just starting to accumulate capital.
The first step is to accumulate savings, preferably in accounts that may pay some interest but certainly don’t charge fees. Most savings will start in a container in the living quarters and quickly move to savings and checking accounts at a local credit union or bank. It was simple for a long time to run a household primarily on cash and sweep excess into accounts after all the monthly expenses have been deducted. For a long time, budgeting involved allocating cash to envelopes labeled for specific expenses with the emphasis on making sure there is some cash for savings. More recently, a household has had a higher need for official savings and checking accounts for some expense deductions directly from the accounts. Budgeting has moved from cash in envelopes to also categorizing electronic transactions; however, the same allocation concept is still active, and savings is still emphasized.
There is no faster way to start saving for someone unbanked than to open an account. In the right locations, the single payroll check otherwise processed at a check cashing establishment for a fee is enough to open at least a savings account where there would be no fee to cash a check ever again, and no monthly fee. Savings accounts can be opened with as little as a $5 minimum balance in them where there are no monthly fees, though not every random location a person walks into will make this offer.
Still at the dry-erase board, the person with low and highly variable income now is generating a little accumulated savings. While that process continues, the person may start to think about something beyond credit union or bank accounts. This is the actual interface between accumulated savings and life insurance, not an artificial dollar amount of life insurance coverage. The amount varies considerably and typically the person already has an emergency fund of up to six months of expenses. No one is suggesting spending any part of any emergency fund on life insurance. Aside from regular accumulated savings, the person might have received bonuses or gifts; tax refunds or other refunds; or earned extra income from temporary or seasonal jobs, gigs, or side hustles. These additional sources all add to accumulated savings.
Let’s say for the sake of concreteness that the person has excess accumulated savings of $700 and wants to consider buying life insurance. The person also thinks they can maybe generate $100 a year reliably. Eventual contact with a life insurance agent will likely result in a discussion of term vs. permanent life coverage and some expression of financial aspirations. The person interested in capital accumulation will want nothing to do with term as it is death benefit only with no cash value and no investment component. Term is a lot cheaper than permanent for the coverage amount, but it only pays during the term and is prohibitively expensive later in life. The person interested in capital accumulation will want some form of permanent coverage.
If the person expresses themselves well, they will say they have $700 for a life policy. The agent will likely run an illustration for $100 a year in premium paid for life and see what that would buy in life coverage. That isn’t what the person asked for and has built their entire financial management around. What the person wants is a life insurance policy where the entire amount of premium is paid up front, nothing is ever due in the future, and the amount of initial life insurance coverage exceeds the amount of premium paid. The desire is for a single premium life insurance policy.
At the dry-erase board, we are almost to the end. The person asked, possibly without knowing they did, for a single premium life insurance policy. We are still talking about amounts considerably below $25,000 and likely less than $15,000 in life coverage. There are single premium policies available down to a certain amount, and most likely at this size it will be Single Premium Whole Life (SPWL). The person may not know enough to express it—they want a participating SPWL where the dividends are set to purchase paid-up additions because that kind of policy has a potential for growth in death benefit over time by participating in the good fortunes of the insurer through the dividends received.
At this point, reality sets that the one life product that might help the low and highly variable income person, namely SPWL, has been severely harmed by the tax code in labeling it a Modified Endowment Contract (MEC). The tax code designed to prevent abuse at high amounts effectively prohibits a life product that would help the person with low and highly variable income from taking a basic step toward capital accumulation.
The objective over time is that what was originally a small amount life insurance policy will grow by its own internal workings and by any additional amounts the person finds they can afford to add from time to time.
To avoid MEC status, an insurer may be able to offer to collect the $700 as a single payment and then internally handle it as if the person is making seven annual premium payments for $100 each year. Interest on the declining balance fund converts into paid-up additions when it is paid each year. It looks like a single premium to the person, it looks like a regular 7-pay to the tax authority, and the policy behaves like any other life insurance policy with a small and declining fund where future premiums are held until needed. This process would cover all the premiums due without ever going back to the person for more.
Certain provisions would help this concept work optimally. The first is to allow additional amounts to be added later as more single premium to the policy bought because the maintenance expense has already been paid when the policy was originally purchased. It will be considerably more efficient to keep all the coverage within one policy than to have multiple policies. This is not quite traditional guaranteed insurability, just the ability to increase the same policy when later cash is available according to some premium schedule by age. There can be limits on additional amounts and timing to avoid someone abusing the tax code or the underwriting. The objective over time is that what was originally a small amount life insurance policy will grow by its own internal workings and by any additional amounts the person finds they can afford to add from time to time.
The second is allow any MEC to have a priority policy loan without it being labeled a taxable distribution potentially with a tax penalty. A person with low and highly variable income is exposed to predatory lending due to sudden cash demands and limited means to manage emergency expenses. Currently, premium paid into a MEC is unavailable in the sense nothing can be recovered without canceling the life coverage or without MEC tax consequences. The ability to borrow perhaps as much as 50% of the cash value up to perhaps a maximum of $1,000 without MEC tax consequences would reduce predatory lending as the person has a reasonable option to borrow and repay over time, avoiding predatory lending fees and excessively high interest rates. Loan availability at the level suggested should not disturb the tax authority goal of not allowing tax abuse while simultaneously reducing predatory lending.
This priority policy loan could have an accelerated repayment schedule compared to regular policy loans as this loan is for emergencies only and not expected to remain in existence for a long time. Perhaps a loan payment amount of 1/20 of the original loaned balance each month ($50 a month for a maximum loan of $1,000) might work, which ensures the loan is repaid well within two years after it occurred (many would accelerate repayment as accumulated savings become available). While dividends would normally be used to purchase paid-up additions, any dividend paid would be applied toward the loan balance first. If the person wanted to pay premium while there is an outstanding loan balance, the loan balance would be repaid first. This is called a priority policy loan because all available amounts in addition to any loan payments apply to extinguish the loan first. For any non-MEC, the regular policy loan provision is sufficient.
We do want to keep any repurposed life product to be available for more general use. Industrial life insurance was a life product created for lower-income people well over a century ago. Industrial life lacks many of the pro-consumer aspects of Ordinary life that is nearly universally sold today. Industrial life cash value develops more slowly than for Ordinary life, it is nearly always non-participating, it generally has no policy loans available, there is usually no ability to add coverage requiring a person to buy multiple policies for additional coverage, high collection fees exist for the weekly premium, and modal factors are frequently not available to reduce total premium when premium is collected less frequently.
While Industrial life is largely running off, only two states have ended new issues of Industrial life policies: New York (1980) and Arkansas (1988). Other states have various restrictions affecting availability. One state, Mississippi, has a noticeable number of new Industrial life issues currently.[1] While it would be appropriate for any state to end new issues of Industrial life policies going forward, that effort only needs to be considered where new issues occur in any noticeable amount. Weekly premium Ordinary life is very similar to Industrial life. While it is slightly better than Industrial life from a consumer perspective, it still has high fees for the weekly premium collection. Industrial life and weekly premium Ordinary life are cautionary tales and traps to avoid when trying to provision life insurance for people with low and highly variable income.
Purchasing the participating life policy from one of the appropriate companies is key to this concept working, as it only works if dividends are paid that increase the original coverage far beyond the original amount.
Let’s address potential pitfalls of the concept of someone purchasing a participating single premium whole life insurance policy where the dividends are set to purchase paid-up additions.
First, the person is not necessarily buying life insurance the moment of deciding they might want some life insurance; rather, they will start accumulating savings and then aspire to purchase life insurance later. During that time, the person is exposed to the expense of needing to cover their own death and will only have any accumulated savings. This was the normal state of the world for several millennia prior to life insurance existing and is managed by decreasing the expense and accepting contributions from family, friends, or anyone else for any funding shortfall. Disposition (burial, cremation, donation, abandonment) and service (funeral, graveside only, memorial, wake, informal) can be managed down to minimal levels if required. That reduction might not be desirable by survivors who may want to do the best they can for the person who died, but it can be done if necessary. The amount provided for any survivors to continue without severe economic disruption is dependent on the remainder after the amount spent on disposition and service compared to any other debts/expenses the person who died had that continue after their death. Accepting contributions used to be entirely in-person and has evolved to sometimes online efforts. Mitigation involves a person working revenues and expenses to generate enough excess accumulated savings as quickly as possible to be able to purchase a life policy with the remaining accumulated savings also available upon death. Most likely this period can be limited to under four years, and much shorter in some circumstances.
Second, the person must be careful that account(s) where savings are accumulated offer some interest or return with no monthly or recurring fees or any other unavoidable fees other than perhaps physical checks for a checking account. This can be difficult as any branch a person considers may or may not have an appropriate account for this purpose. Fees destroy savings at any level of savings, but they are especially devastating for a person with low and highly variable income. The person trying very hard to sweep small amounts throughout a month into an account can’t afford any monthly fee and will need to search until the right account is found with no fees. As always, if fees occur, the person will talk to the people at the branch and then determine if a different account will work better. If not, move accounts elsewhere. An amount of accumulated savings remains after the life policy purchase and these accounts continues to operate.
Third, the person must be careful that the insurer is sound and a strong reputation and commitment to pay quality dividends. This means purchasing a participating life policy from a mutual or fraternal insurer. There are not an excessive number of appropriate companies, as not just any mutual or any fraternal will do, either. Purchasing the participating life policy from one of the appropriate companies is key to this concept working, as it only works if dividends are paid that increase the original coverage far beyond the original amount. Dividends are never guaranteed, but there is no other concept more dependent on quality dividends being consistently paid over a long time. To lose that growth through buying from a company not treating participating policyholders well or by mistakenly purchasing a non-participating policy makes this concept unworkable. Avoiding MEC status as mentioned previously also adds value to the concept.
This may all seem daunting—where a person must have accumulated savings in account(s) beyond what might be needed for emergencies, then think about purchasing life insurance, then actually purchase a participating single premium whole life policy (or single pay where company makes the 7-pay premium payments in the background) where dividends are set to purchase paid-up additions from a quality insurer. If all of this happens, then the person will have a small amount life insurance policy that should grow over time by both the internal workings and by any additional premium that can be added later (if allowed). It is doable on a step-by-step basis. In a sense, this is a hybrid process, with the interplay of accumulated savings and a life insurance policy working together in tandem to provide more financial security for a person with low and highly variable income than either alone.
For sake of discussion, let’s say the person with $700 buys a participating SPWL with dividends set to purchase paid-up additions that starts with a $2,000 life coverage amount. The person never adds any additional premium later, receives statements and the policy works year after year. Let’s say 50 years later the policy now has a total life coverage amount including paid-up additions of $10,000 when the person dies. This is still not a lot of life coverage, but it likely is much better than leaving the $700 in accumulated savings or all kinds of other alternatives that don’t add anything to financial security, and it is vastly superior to a non-participating policy of the same initial face amount.
The life insurance industry has tried lifetime premiums for small amounts of coverage with the consumer issues related to premiums exceeding death benefits in some fashion and has tried to provide term coverage that ends eventually with no capital accumulation with high lapses in both. This concept is limiting the premium payment period to a single premium, which is the most efficient possible use of premium dollars, for a small amount life insurance policy. With nothing due in the future, the person will be more likely to keep the policy.
To the extent insurers are able, have this available in as small face amounts as practical. This concept seems to be the best possibility remaining to provision a small amount life insurance policy as efficiently as possible to a person with low and highly variable income.
John Blocher a senior actuary, financial reporting, at Great American Life Insurance Company.
Reference
[1] NAIC publication “Statistical Compilation of Annual Statement Information,” STA-LS; 2019 is the most recent available year currently.
