l I
TESTIMONY
OF
MICHAEL
PERTSCHUK
CHAIRMAN
FEDERAL
TRADE
COMMISSION
ON
LIFE
INSURANCE
COST
DISCLOSURE
BEFORE
THE
SENATE
COMMITTEE
ON
COMMERCE,
SCIENCE,
AND
TRANSPORTATION
JULY
10,
1979
Mr.
Chairman,
Thank
you
for
the
opportunity
to
testify
before
you
today.
Our
topic
--
life
insurance
--
is
a
deadly
serious
one
for
millions
of
American
consumers.
Each
year
they
spend
over
30
billion
dollars
on
life
insurance
premium
payments.
And
yet,
despite
the
importance
and
expense
of
this
purchase,
the
average
consumer
buys
a
life
insurance
policy
without
ever
being
given
the
information
that
is
absolutely
essential
for
him
or
her
to
be
able
to
understand
what
that
policy
really
costs.
Indeed,
I
think
it
fair
to
say
that
no
other
product
in
our
economy
that
is
purchased
by
so
many
people
for
so
much
money
is
bought
with
so
little
understanding
of
its
actual
or
comparative
value.
A
person
who
buys
an
ordinary
whole
life
insurance
policy
--
the
most
popular
type
of
insurance
now
sold
--
is
in
reality
buying
both
protection
against
dying
soon,
and
protection
against
not
dying
soon.
This
latter
protection
takes
the
form
of
cash
values,
which
the
insured
may
obtain
at
will,
merely
by
surrendering
his
or
her
policy.
Building
up
cash
values
in
a
life
insurance
policy
is
little
different
from
saving
money
in
any
other
medium,
and
one
would
imagine
that
one
of
the
first
things
that
many
consumers
would
want
to
know
about
their
life
insurance,
like
any
other
savings
medium,
is
"what
interest
rate
will
I
be
getting."
In
fact,
however,
such
information
is
simply
not
now
available
either
to
consumers
or
to
life
insurance
agents,
except
perhaps
for
those
few
fortunate
enough
to
have
mastered
courses
in
both
actuarial
science
and
computer
programming.
I
will
elaborate
on
these
observations
in
a
moment,
but
I
would
first
like
to
point
out
that
very
little
of
what
I
have
just
said
or
have
yet
to
say
is
at
all
original.
This
committee
has
had
a
long
term
concern
about
the
fate
of
the
insurance
consumer,
as
its
arduous
work
on
no-fault
auto
insurance
attests.
Similarly,
the
inability
of
consumers
to
make
knowledgeable
decisions
when
purchasing
life
insurance
has
long
been
a
topic
of
serious
(if
not
sufficiently
widespread)
concern
among
insurance
industry
executives,
state
regulators
and,
not
least
of
all,
here
on
Capitol
Hill.
In
February,
1973,
the
late
Senator
Philip
Hart
held
extensive
hearings
on
the
life
insurance
industry,
with
emphasis
on
the
need
for
life
insurance
cost
disclosure.
In
Senator
Hart's
words,
the
thrust
of
those
hearings
was
that
"consumers
couldn't
make
rational
buying
decisions
at
the
time
of
purchase
of
life
insurance
because
detailed
information
on
costs
and
benefits
wasn't
available."
In
June,
1973,
the
National
Association
of
Insurance
Commissioners
adopted
an
interim
model
cost
disclosure
regulation,
and
a
final
NAIC
model
was
adopted
in
May,
1976.
The
NAIC
model
law
was
an
important
first
step
in
the
direction
of
promoting
consumer
awareness
of
insurance
costs.
However,
it
contained
several
major
flaws
that
have
since
been
recognized
by
other
Congressional
committees,
including
the
Senate
Committee
on
Veterans'
Affairs,
which,
in
June,
1977,
postponed
action
on
S.
718,
a
bill
to
require
adherence
to
the
NAIC
model
regulation
in
connection
with
the
sale
of
life
insurance
to
veterans.
On
the
House
side,
the
Subcommittee
on
Oversight
and
Investigation
of
the
House
Committee
on
Interstate
and
Foreign
Commerce,
chaired
by
Congressman
Moss,
held
hearings
on
life
insurance
cost
disclosure
last
August,
focusing
on
the
inadequacy
of
the
NAIC
model
regulation.
It
was
in
the
context
of
this
interest
among
congres-
sional,
state
and
industry
authorities
that
the
Commission
began
its
own
inquiry
into
the
problem
of
life
insurance
cost
disclosure.
In
December,
1976,
the
Commission
announced
that
it
had
authorized
its
staff
to
investigate
four
questions:
(1)
whether
adequate
cost
information
is
being
provided
to
prospective
life
insurance
purchasers;
(2)
what
types
cf
information
would
be
most
accurate
and
most
likely
to
be
useful
to
consumers;
(3)
the
impact
such
disclosures
would
be
likely
to
have
upon
the
industry
and
upon
consumers;
and
(4)
what
would
be
the
most
appropriate
and
feasible
course
of
action
for
the
Commission
to
take
in
this
area
to
alleviate
any
problems
found
to
exist.
The
Commission
has
been,
of
course,
mindful
that
our
ultimate
authority
to
take
regulatory
action
with
respect
to
life
insurance
may
be
significantly
circumscribed
by
the
McCarran-Ferguson
Act.
On
the
other
hand,
the
Commission's
authority
to
investigate
the
existence
of
potential
consumer
problems,
and
to
report
the
results
of
its
investigations
where
they
reveal
substantial
consumer
problems,
is
unimpaired
by
this
Act.
With
this
in
mind,
our
staff
b~gan
their
inquiry
in
late
1976.
They
have
now
produced
a
report
which
is
being
released
today.
Based
on
their
findings
and
recommendations,
the
Commission
has
proposed
a
model
state
regulation
on
life
insurance
cost
disclosure.
The
staff
report
is
perhaps
the
best
and
most
comprehensive
exploration
of
the
problems
of
life
insurance
cost
disclosure
undertaken
to
date.
We
thus
believe
that
the
report
will
serve
an
important
educational
purpose.
By
releasing
it
we
hope
to
prompt
careful
scrutiny
and
evaluation
of
its
findings
by
the
expert
community.
-2-
'
'·
. '
,.
c:
[:
,_
..
..
'·
'·
'·
~
With
that
introduction,
then,
let
me
summarize
the
findings
of
the
staff
report
and
the
Commission's
own
recommendations:
1.
Saving
through
life
insurance.
The
first
major
conclusion
of
the
report,
as
I
noted,
is
that
ordinary
life
insurance
isn't
just
insurance.
For
most
consumers,
a
life
insurance
policy
is
also
a
type
of
savings
account.
Only
part
of
the
premiums
pay
for
death
protection.
'Another
large
portion
of
the
premiums
consumers
pay
each
year
goes
toward
the
policy's
"cash
value,"
which
grows
over
time
and
may
be
obtained
simply
by
surrendering
the
policy.
Industrywide,
this
savings
component
of
cash
value
life
insurance
is
extremely
significant.
Based
on
industry
estimates,
our
staff
puts
the
total
consumer
savings
held
by
life
insurance
companies
in
1977
at
140
billion
dollars.
In
other
words,
consumers
save
about
the
same
amount
through
life
insurance
as
through
savings
and
loan
passbook
accounts.
Let
me
illustrate
the
relative
importance
of
the
savings
component
of
cash
value
insurance
in
two
ways.
The
first
is
to
examine
the
cash
flow
of
the
life
insurance
industry
in
gross
dollar
terms.
Our
staff
analysis
shows
that
almost
34
billion
dollars
flowed
into
life
insurance
companies
in
1977
from
premiums
and
investment
earnings.
On
the
other
side
of
this
rough
balance
sheet,
only
5
billion
dollars
were
paid
out
in
death
benefits.
The
rest
of
the
revenue
went
toward
savings-related
benefits
such
as
dividends,
surrender
values,
and
increased
holdings,
as
well
as
to
the
cost
of
doing
business.
The
other
way
to
look
at
the
savings
element
of
life
insurance
is
to
break
down
each
premium
dollar
into
its
end
uses.
How
much
is
used
to
pay
death
benefits?
About
15
cents.
What
portion
is
charged
to
overhead?
Just
over
30
cents.
And
the
remaining
55
cents
--
over
half
of
every
dollar
paid
in
premiums?
It
goes
into
the
savings
component,
to
be
used
to
fund
withdrawals
and
to
increase
the
consumer
savings
held
by
the
companies.
2.
Industrywide
rate
of
return
Once
we
recognize
that
cash
value
life
insurance
is
both
death
protection
plus
savings,
the
logical
next
question
is:
What
interest
rate
are
consumers
receiving
on
their
money?
The
answer
is
that,
in
almost
all
cases,
the
average
annual
rate
of
return
on
the
savings
component
of
life
insurance
policies
is
far
below
the
market
value
of
money.
-3-
As
one
measure
of
the
interest
rates
paid
by
life
insurance
companies,
our
staff
computed
the
average
industry-
wide
rate
of
return
paid
on
all
cash
value
policies
in
1977.
After
conservatively
estimating
the
portion
of
the
premiums
needed
to
provide
death
protection,
they
found
that
the
insurance
industry
paid
consumers
an
average
of
between
1
and
2
percent
on
savings,
with
the
best
estimate
being
1.3
percent.
This
industrywide
return
rate
is
a
summation
of
all
the
rates
of
return
on
individual
policies.
Thus
it
reflects
the
fact
that
the
rates
vary
widely
depending
on
the
policy
type,
and
more
importantly,
on
the
age
of
the
policy.
Because
of
the
uneven
way
in
which
cash
values
grow
over
the
life
of
a
policy,
the
return
rate
realized
by
a
consumer
is
largely
dependent
on
how
long
the
policy
is
held.
3.
Penalties
for
early
termination
In
the
early
years,
there
is
actually
a
negative
rate
of
return
--
the
cash
value
is
less
than
that
part
of
the
premium
attributable
to
the
savings
element.
Most
policies
have
no
cash
value
for
the
first
year,
so
if
the
policy
is
allowed
to
lapse
afte
only
one
annual
payment,
the
entire
savings
is
lost,
and
the
rate
of
return
is
minus
100
percent.
And
the
fact
is
that
about
one
in
every
five
new
policyholders
drops
his
or
her
policy
in
the
first
thirteen
n1onths.
Using
the
data
gathered
in
1973
by
the
Hart
committee,
we
have
estimated
total
consumer
loss
from
first
year
lapses
to
be
in
excess
of
$200
million
annually.
Due
to
the
slow
cash
value
buildup,
whole
life
policies
are
rarely
a
desirable
purchase
unless
held
for
more
than
10
years.
When
our
staff
analyzed
policies
issued
in
1973
and
1977,
they
foun
that
policies
terminated
in
the
fifth
year
had
an
average
return
rate
of
minus
10
percent.
At
the
end
of
10
years,
those
policies
would
pay
approximately
one
percent.
4.
Insurance
vs.
other
investments
From
these
findings,
it
is
clear
that
many
cash
value
insur-
ance
policies
offer
rates
of
return
several
percentage
points
below
alternatives
readily
available
in
the
marketplace,
even
taking
into
account
the
fact
that
interest
earnings
from
insurance
are
essentia
tax-free.
For
example,
passbook
savings
accounts
pay
5
percent
or
more.
Time
deposit
rates
for
small
savers
are
between
6
and
8
percent.
And
there
have
recently
been
complaints
that
these
rates
are
artificially
low,
that
they
prevent
small
savers
from
keeping
pace
with
inflation.
-4-
The
potential
consumer
loss
makes
these
rate
of
return
differentials
extremely
significant.
A
person
who
invests
$1000
each
year
at
3
percent
--
a
rate
of
return
yielded
by
many
whole
life
policies
if
they
are
held
for
20
years
--
will
have
roughly
$47,000
at
the
end
of
30
years.
The
same
amount
invested
for
the
same
period
at
6
percent
will
yield
almost
twice
as
much,
about
$84,000.
To
give
us
an
idea
of
the
aggregate
impact,
the
staff
esti-
mated
that
if
the
industrywide
average
return
rate
in
1977
had
been
4
percent
rather
than
1.3,
policyholders
would
have
received
an
additional
3.7
billion
dollars
in
that
year
alone.
I
should
emphasize
here
that
neither
the
Commission
nor
our
staff
is
opposed
to
saving
through
life
insurance.
Neither
do
we
favor
the
purchase
of
one
form
of
insurance
over
another.
Some
available
whole
life
policies
offer
return
rates
which
are
competitive
with
other
savings
media.
And
there
are
reasons
for
saving
through
insurance:
it
is
convenient,
some
people
prefer
the
forced
savings
aspect,
and
tax
advantages
may
exist.
In
addition,
whole
life
policies
have
certain
attractive
features
which
may
not
be
available
through
term
insurance.
5.
The
need
for
rate
of
return
disclosure
But
we
are
convinced
that
consumers
cannot
make
an
intelligent
judgment
about
the
merits
of
different
insurance
and
investment
packages
without
rate
of
return
information,
because
the
true
cost
of
a
life
insurance
policy
can
only
be
evaluated
if
one
considers
the
interest
rate
paid
on
the
savings
component.
A
sizeable
portion
of
the
premium
goes
toward
savings.
If
consumers
are
receiving
a
lower
interest
rate
on
those
savings
than
they
could
get
from
other
investments,
then,
in
effect,
they
are
paying
more
for
the
insurance,
something
any
informed
buyer
should
certainly
know.
But
of
course
most
consumers
are
not
aware
of
this,
so
we
come
to
the
pervasive
problem
with
the
way
ordinary
life
insurance
is
marketed
today:
inadequate
cost
information.
No
life
insurance
company
in
this
country
currently
discloses
a
standardized
rate
of
return
to
its
customers.
Yet,
without
such
cost
information,
consumers
cannot
shop
comparatively
for
the
most
suitable
insurance
product
at
the
lowest
price.
Comparisons
between
insurance
and
other
types
of
savings
are
also
impossible.
And,
where
buyers
have
no
way
to
distinguish
competing
products
on
the
basis
of
their
true
cost,
the
forces
of
competition
--
which
we
rely
on
to
eliminate
inefficiencies
and
reward
low
cost
products
with
larger
market
shares
--
cannot
operate
effectively.
-5-
Under
the
NAIC
model,
the
only
information
consumers
receive
concerning
cash
values
is
a
schedule
showing
what
the
value
will
be
at
the
end
of
selected
years.
In
other
words,
they
are
told
that
after
5
years,
the
cash
value
of
the
policy
is,
say,
$1,000;
after
10
years,
it
is
$8,500;
and
so
on.
But
they
are
not
told
whether
this
sum
represents
a 1%, a
5%
or
some
other
rate
of
return
on
their
investment.
Let
me
reiterate
the
serious
consequences
of
this
informational
void.
Without
rate
of
return
information,
consumers
cannot
compare
the
relative
merits
of
saving
through
the
whole
life
policy
with
other
alternatives
such
as
buying
a
term
policy
and
investing
the
difference
in
another
savings
medium.
Nor
are
they
able
to
compare
the
whole
life
policy's
rate
of
return
with
anticipated
rates
of
inflation
to
judge
whether
their
"investment"
is
likely
to
stay
ahead
or
fall
behind
inflation
rates.
We
know
that
many
industry
spokespersons
object
to
rate
of
return
disclosure
because
it
requires
what
to
them
is
an
improper
separation
of
whole
life
insurance
into
two
elements:
savings
and
protection.
They
assert
that
life
insurance
is
a
unitary
contract
that,
like
the
law,
must
be
viewed
as
a
"seamless
web."
Cash
values
are
said
to
be
only
an
incidental
by-product
of
the
level
premium
nature
of
whole
life
policies.
Whether
the
whole
life
insurance
contract
should
be
characterized
as
an
"indivisible
whole,"
"insurance
purchased
on
the
installment
j
plan"
or
a
"combination
of
death
protection
and
savings"
is
largely
l
a
matter
of
semantics.
The
indisputable
fact
of
the
matter
is
that,
.
regardless
of
how
the
savings
element
is
described,
it
is
hardly
~incidental.
The
savings
element
accounts
for
three
or
four.times
t
as
much
of
the
premium
dollar
as
does
the
insurance
protect~on,
and
1
this
has
made
the
life
insurance
industry
a
major
repository
of
consumer
savings.
The
argument
is
simply
not
a
persuasive
response
to
the
call
for
rate
of
return
disclosure.
The
Moss
committee
recently
considered
this
same
issue
and
concluded
as
follows:
"We
regard
the
'inseparable'
whole
life
policy
argument
as
a
diversionary
ploy.
In
our
view,
reliance
on
it
in
the
future
as
a
defense
to
rate
of
return
disclosure
will
cross
the
line
into
irresponsibility."
The
Commission
recognizes
that
there
is
more
than
one
disclosure
method
which
can
be
used
to
compare
different
type
insurance
policies.
Based
on
the
available
evidence,
we
selected
the
rate
of
return
as
the
one
most
likely
to
aid
consumers
in
making
informed
purchases.
The
staff
report
contains
a
detailed
description
of
the
advantages
and
disadvantages
of
this
and
other
systems.
-7-
b.
An
appropriate
index
number
As
I
have
just
described,
rate
of
return
information
is
necessa
for
comparing
dissimilar
policies
and
alternate
savings
mechanisms.
Another
important
part
of
any
cost
disclosure
system
is
an
index
that
will
enable
prospective
purchasers
to
identify
and
select
low
cost
policies
from
among
an
array
of
similar
policies.
This
need
is
particularly
acute
in
the
case
of
cash
value
insurance.
For
these
policies,
it
is
often
impossible
to
ascertain
their
true
cost
simply
by
looking
at
premiums
because,
in
addition
to
providing
death
benefits,
whole
life
policies
accumulate
cash
values
and,
in
many
cases,
pay
dividends.
The
NAIC
model
regulation
recognizes
this
problem
and
requires
the
provision
of
three
different
indices
--
the
surrender
index,
the
payment
index
and
the
equivalent
level
annual
dividend.
It
also
requires
that
each
of
these
indices
be
given
for
the
tenth
and
twentieth
years.
Providing
three
different
indices,
each
for
two
different
years,
for
a
total
of
six
numbers,
has
the
potential,
we
believe,
to
confuse
consumers
and
to
defeat
the
purpose
of
cost
disclosure.
The
life
insurance
industry's
own
Joint
Special
Committee
on
Life
Insurance
Costs
recognized
this
fact
in
recommending
the
use
of
only
the
surrender
index.
The
Committee
warned
in
its
1970
report,
that
"to
do
[otherwise]
would
inevitably
complicate
a
subject
that
greatly
needs
to
be
kept
straight-forward."
Based
on
the
staff's
study,
we
have
concluded
that
the
industry
Joint
Special
Committee's
early
judgment
that
only
the
surrender
index
should
be
used,
was
right
on
target.
We
believe
that
the
other
two
NAIC
indices
provide
little,
if
any,
useful
information
to
consumers.
And
because
the
assumptions
on
which
these
other
indices
are
based
are
extremely
unlikely
to
occur,
these
two
indices
are
potentially
misleading.
In
addition,
to
further
streamline
the
disclosure
statement,
the
Commission
recommends
omitting
the
tenth
year
surrender
index.
Whole
life
policies
are
rarely
a
desirable
purchase
unless
they
are
held
for
substantially
longer
than
10
years.
As
a
consequence,
the
tenth
year
indices
are
of
little
use
to
the
prospective
purchaser.
The
focus
of
the
industry
Joint
Committee
and
our
own
recommen-
;:
dations
are
consistent
with
the
various
studies
that
have
been
conducted
since
1970.
These
studies,
some
of
which
were
done
by
the
industry
and
some
at
the
FTC
staff's
request,
indicate
that
consumers
have
difficulty
using
and
understanding
the
NAIC
six
number
system.
-8-
For
this
reason,
the
Commission's
suggested
regulation
would
require
that
consumers
be
provided
with
but
one
index
number:
the
surrender
index
computed
for
the
twentieth
year.
c.
Timing
of
disclosure
Finally,
the
Commission
was
concerned
about
the
timing
of
the
disclosure.
Under
the
NAIC
model
regulation,
consumers
generally
received
the
buyer's
guide
and
policy
summary
only
when
the
policy
is
actually
delivered,
often
a
week
to
ten
days
after
purchase.
Our
experience
indicates
that
if
cost
disclosure
1s
to
be
effective,
it
must
take
place
before
the
purchase
decision.
Consumers
are
very
unlikely
to
read
and
use
a
disclosure
package
provided
after
the
transaction
has
been
completed.
For
this
reason,
we
recommend
that
a
buyer's
guide
be
given
at
the
beginning
of
the
sales
presentation
and
that
a
preliminary
policy
summary
be
given
prior
to
the
time
prospective
purchasers
are
provided
an
application
for
a
policy.
The
preliminary
policy
summary
would
contain
the
basic
information
concerning
the
policy,
such
as
the
policy
type,
premium,
surrender
index
and
the
rate
of
return.
The
proposed
preliminary
policy
summary
contains
only
those
limited
items
of
information
essential
to
an
informed
purchase
decision.
It
would
not
be
impractical
for
agents
to
have
all
of
the
information
needed
to
fill
out
the
preliminary
policy
summary
with
them
during
the
sales
presentation.
However,
we
concur
in
the
NAIC's
recommendation
that
a
full
policy
summary
be
delivered
with
the
policy.
That
summary
contains
more
detailed
information
concerning
the
cash
flow
elements
of
the
policy.
The
Commission
believes
that
this
information
is
important
and
useful
to
the
consumer.
Because
the
information
is
more
detailed
it
may
not
be
readily
available
to
the
agent
during
the
sales
presentation,
but
it
can
easily
be
provided
with
the
policy,
as
is
currently
the
practice
of
companies
which
comply
with
the
NAIC
model.
7.
Conclusion
Submitted
with
this
statement
are
the
staff
report,
the
Commission's
suggested
regulation,
and
a
model
buyer's
guide
and
disclosure
statement
recommended
by
our
staff.
While
the
Commission
firmly
believes
that
disclosures
of
this
type
are
necessary,
these
latter
two
documents
are
not
meant
to
be
the
definitive
solution.
Rather,
they
are
provided
to
illustrate
how
the
necessary
elements
of
a
disclosure
system
can
be
incorporated
into
an
effective
cost
disclosure
regulation.
-9-