The proposal swap: The new bait and switch scam
By Steve Savant
There are con artists in every industry, carnival barkers pitching their pithy one-liners to the naïve and gullible. PT Barnum is often quoted as saying, “There’s a sucker born every minute.” But the first time the quip actually appears in a publication, it’s assigned to a confidence man named Hungry Joe. PT’s friends say he actually said, “There’s a customer born every minute.” I’ll leave it to the historians to continue the debate.
Almost every confidence man started out on a street corner scamming the crowd with the shell game, the archetype of the bait and switch. But when con men don the dignity of a suit and tie, the ruse takes on an air of dignity that’s tough to discern. Gamers in suits are gamers still. And the new bait and switch scam, currently being perpetrated in our industry, is just a knock off of the old shell game. Here’s how it works.
The producer calls an independent marketing organization (IMO) to order a proposal illustrating an income scenario using one of the four permanent forms of life insurance: participating whole life or current assumption, indexed or variable universal life. The specifications for the proposal input require the lowest non-modified endowment death benefit (cost of insurance) option that produces the best accumulation and distribution results. In this illustrative scenario, the target premium generally represents less than one-third of the annual contributions and is directly correlated to the writing agent’s compensation. Keep in mind that even at this lower level of compensation, it’s more than any mutual fund, limited partnership or annuity commission payout. But this illustration will never be attached to the application. This is the bait proposal.
Then the scam really begins. The producer calls another IMO to order a proposal with a death benefit amount designed to be at the full target premium, i.e. fully commissionable. The second IMO wins the case. The first IMO is out the running and was never in it from the get go. Sometimes the more knowledgeable the IMO, the more at-risk they are of being used, not only in this scam but simply as a clearing house for information. Now back to the gaming.
The proposal with the minimized death benefit is show as the bait proposal, but at the signing of the application, the fully commissionable proposal (the switch) is signed by the policy owner and insured. The difference in death benefit generally doesn’t require additional medical exams, nor will it be flagged by the carrier because a single life insurance policy can have dual purposes: supplemental income or indemnification planning scenarios.
In the past, permanent life insurance has had multiple planning solutions that can cover indemnification and income scenarios on the same policy. Back in the 1980s, life insurance began evolving beyond indemnification and developed a secondary use as a tax advantaged income product. It soon became apparent that you couldn’t have your cake and eat it too. Purchasing one policy to solve two diametrically opposed planning solutions created inefficiencies in both, so the economics didn’t work for either. A cult of premium purists, me included, developed the mantra that it was actuarial adultery and anathema to homogenize multiple planning solutions on one policy ... but forget about my psychosis. This is a carrier issue. And they may find themselves somewhat culpable for their inattentiveness to the use of their products in an ever-evolving financial climate that has inadvertently given support to the shenanigans of these charlatans. The more sophisticated form of this bait and switch scam is the misuse of IRC section 2035, the three-year look back period established for existing policies that are reassigned to an irrevocable life insurance trust. In response to regulation, carriers added a three-year death benefit rider in excess of the original death benefit in the event the policy reverted into the estate and was consequently taxed. It was a great provision for those who were at risk during the three-year assignment period. But the unscrupulous now use this rule in the name of protecting the customer from tax liabilities that may result in the estate inclusion of the policy.
So as a response to a non-existing problem, the death benefit is increased to the target premium for at least three years to mimic the three-year carrier rider. But in almost every case, the policy owner is not subject to estate taxation because their assets are below the current unified credit or even the old thresholds which could be reinstated if Congress doesn’t act before the end of the year.
And one noteworthy heads up: Almost all these convoluted designs are never reviewed to decrease the death benefit after the three years have expired. So the cost of the entire death benefit continues to be charged against the policy, even though the writing agent has already been paid on the full target premium three years previous.
The unethical among us game the system with impunity because the duality of planning purposes on a single policy is so embedded in home office culture and the sales practices of insurance professionals. And using the IRC 2035’s three-year rule to purchase unnecessary death benefit on a policy created for supplemental retirement income is using a law unlawfully.
Changing the process will require more than an editing tweak on the application. It will require an overhaul in the life insurance industry’s approach to their product use in financial planning. But if for no other reason than for consumer protection, the industry must police itself against such perpetrators, or the regulators will do it for us. We’ll be judged along with them as complicit in consumer fraud. And it is fraud most foul!
This is no white collar criminal making a misdemeanor mistake. This can never be reduced to an error in judgment covered by your E&O. These are premium prostitutes that have traded in the insurance industry’s version of the Hippocratic Oath, to do no harm, for the blatant hypocrisy of deliberate bait and switching. And why? For nothing more than personal gain at the expense of their customer’s retirement plans. These cheats are commission whores and nothing more. They’re premium pimps who are ruining our industry’s already sullied reputation. They salute “best practices” on one hand, and line their pockets with the other. They say that their aim is the welfare of the customer, but their sights are set on the target premium. Shouldn't these con artists be ratted out?
It has become a crisis of conscience. Not for them, for their conscience has been seared a long time ago and they can no longer feel the guilt of their trespasses. But it has become a crisis of conscience for me. Sometimes silence is golden, but in this case, it’s just plain yellow. It’s time to call these guys out.