Market Recovery Program
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Chapter 11
UPSIDE-DOWN LIFE INSURANCE FOR THE LIVING
In this era of low interest rates, how can the insurance company give a guaranteed 8% return on the funds in the income account?
Outside the context of the income rider, the insurance company wouldn’t be able to offer anywhere near 8% annual interest.
The first time I saw the amazing numbers generated by the income rider, I asked myself the same question: How can they do this? How can the insurance company guarantee an 8% rate of return when the rest of the financial industry can only promise about 1-3%?
The best way to explain why they are able to do it is to describe the income rider as upside-down life insurance.
Take a typical 35-year-old father of two, married, who earns $75,000 a year, which pays the mortgage, buys the food and clothing, etc. for his family. If that father unexpectedly dies, this would no doubt be emotionally devastating to his family. But from a purely cold, hard economic perspective, his death would trigger an economic loss for that family because the $75,000 a year is no longer available. So what do tens of thousands of 35-year-olds in the same position across the United States do?
They buy term life insurance.
Yes. Thousands upon thousands of 35-year-olds are pooling their funds in order to minimize the economic loss that would be triggered by death.
Let’s suppose that each of those 35-year-olds buys a 20-year term life insurance policy, with a million dollar death benefit, costing each one $40.00 a month in premiums. Thus, if one of them were to die within the 20 year period, the insurance company would pay the beneficiary (usually the surviving spouse) the death benefit, the idea being that the million dollars would replace the $75,000 per year lost when the father died.
However, even if the deceased may have only had the policy for 3 months and paid in a total of $120.00 his family will nevertheless get the $1 million.
That’s a pretty good return on investment; pay in $120.00 and get back a million!
…and term insurance only works because not everyone participating is going to die within the 20 year period. But the pooling of funds through the monthly premiums creates enough to pay off when the rare insured participant does die.
The income rider works on the same principle albeit the mirror opposite of life insurance: not everyone participating in the income rider is going to live. Here, too, there is a pooling of funds through the paying of premiums which enables the higher 8% return as well as the large payouts in the Guaranteed Annual Payment schedule. But you’ve got to live in order to benefit.
With term insurance, the benefit goes to your survivors, not you. With the Income Rider, the benefits are for you, not your survivors.
Correct…and yet another example why the income rider is “upside-down”.
From a strictly economic perspective who benefits from the term insurance scenario above? Not the 35-year old insured father. He has to die in order for the million dollars to be paid out…and he doesn’t see a cent of that because he’s dead. Certainly, while he’s alive, he benefits emotionally from piece of mind knowing that his family will be taken care of. But, monetarily, having life insurance is a loss for him: he has to pay out 40 bucks a month for a benefit he will, by definition, never see.
The income rider is the opposite of life insurance in this sense as well. Life insurance pays off when someone dies; income rider pays off when you live. And it only benefits you while you’re living.
For those that don’t live long enough, there’s no benefit -- or, at least, not the full benefit -- but they still paid in and it benefited those that did live long. See how that works?
Yes, I do. With term insurance, if every 35-year-old participant died and the insurance company had to pay out a million dollars to each widow, they’d be out of business in a week. But 99.9% of all 35-years don’t die in any one year…it’s just a few.
And it’s the same with the income rider…but in the opposite direction and with much different numbers and probabilities coming into play: not every 50-year-old who participates in the Income Rider is going to live to be 70; and not every 50-year-old that reaches age 70 is going to then go on to live to be 95 years old. See Figure 12 from the previous chapter.
The success of the program appears to rely heavily on the fact that not all participants will live long enough to receive the annual payouts.
From a hard, cold, objective perspective, death is key to the success of the Income Rider. If everyone lived a long and healthy life, the insurance company could not afford the 8% interest rate for the funds that accumulate in the Income Rider. It is a sad fact to observe that we all die at different actuarial ages. But in this case it provides a benefit for the living.
Is it fair to say that those Income Rider participants who die early are the “losers” and those that live longer the “winners”?
No, I don’t think so.
With the exception of those intent upon suicide, we all set out to live the longest and healthiest life we can. This is the attitude with which we should, I believe, participate in the Income Rider. If we die prematurely, we can’t take “it” -- material possessions, such as investment funds -- with us.
The expectation to live as long as possible and to enjoy the benefits of a long run of distributions from the Income Rider regardless of what eventually transpires is the best retirement planning I can think of.
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