(MONEY Magazine) – When Metropolitan Life was slapped with $20 million in fines in March 1994 for possibly deceiving tens of thousands of customers into purchasing policies that were disguised as retirement plans or other investments, all of the nation's 156 million policyholders had reason to get the shakes. After all, if you could be bitten by Snoopy--the lovable Peanuts character who stars in MetLife's ad campaign--how could you trust any of the other nearly 2,000 life insurers?

Well, maybe you can't. A two-month Money examination of insurers' sales practices reveals that the industry too often preys on consumers' lack of knowledge of how life insurance policies work--an ignorance documented by our exclusive national poll (see page 120). The result: Trusting customers can become easy pickings for predatory agents. For a look at the plight of seven aggrieved policyholders, see the profiles throughout this story. Of course, there are plenty of honest insurance agents who would never knowingly betray their clients. And in the wake of the scandal involving MetLife--the nation's second largest life insurer with $163 billion in assets--many insurers have begun efforts to stem some of the most egregious abuses. Still, our interviews with more than 50 regulators, current and former agents and other insurance experts suggest that a wide variety of gimmicks, sleight of hand and many other deceptions are so endemic that there must be nothing less than a complete overhaul of the way insurance is sold in the U.S. to restore the industry's tarnished reputation. The lowlights of our investigation:

Deceptive sales practices are far more prevalent than the industry admits. Publicly, the industry's stance is that abusive sales techniques are aberrations--"the acts of a handful of bad agents in a few companies," according to Guardian Life chief executive officer Arthur V. Ferrara. The abuses look more like a pattern to us. Consider the following: In October, New York State's Department of Insurance levied a $500,000 fine against $430 million National Benefit Life, a subsidiary of $116 billion Travelers, in the wake of objections concerning sales materials that could mislead customers. In addition, the Texas Department of Insurance is considering hitting $710 million Banner Life with an $8.75 million fine for allegedly misrepresenting universal life and other policies as tax-free investments, savings plans and annuities. Spokesmen for both insurers deny that their firms violated any laws or regulations.

And more crackdowns are on the way. "I think this year you will see some major companies that have very large market conduct problems," predicts Salvatore Curiale, New York State's superintendent of insurance. Indeed, Money has learned that regulators in Maryland, New York, Ohio, Pennsylvania and Texas--home to 25% of the U.S. population--are investigating numerous insurers for a variety of deceptive sales practices.

Insurers are increasingly being sued by irate policyholders who charge that agents deceived them by siphoning off the cash values in their policies. MetLife, Prudential, New York Life and John Hancock: All on this list of who's who of insurance have recently been hit with class-action suits alleging that they and their agents bilked customers for big commissions by transferring cash value from existing policies into new ones. The industry calls the practice churning.

Suits also are piling up for possibly misrepresenting life insurance policies as investments. Equitable Life, New York Life and Life of Georgia face class-action suits for allegedly selling life insurance policies that their agents pushed as retirement plans. Meanwhile, MetLife, which recently settled a class-action suit related to its $20 million in fines, faces yet another class-action suit for allegedly marketing policies as college-savings plans.

Attorneys representing the consumers in all the class-action suits estimate that the number of victims nationwide could exceed 100,000. Prudential and MetLife would not comment on pending lawsuits. All of the other insurers involved in litigation vehemently denied to Money the allegations against them.

How is it that one of the largest financial service industries in the U.S., with more than $1.8 trillion in assets, has built a reputation for taking advantage of its clients? There are three reasons:

First and foremost, you can blame the flawed life insurance compensation system that puts the agents' interests ahead of the consumers'. Agents are richly rewarded--but only if they sell you a policy. Life insurance policy commissions are typically 55% to 80% of the first year's premium. Life insurance agents typically get nothing for merely reviewing your coverage and ruling it sufficient. Thus an agent's livelihood and career advancement hinges almost exclusively on his ability to sell, sell and sell. "Agents are under stress to meet quotas every week," says Richard Sabo, a former MetLife agent now suing the company.

The second reason life insurance customers are ripe for the plucking is the lack of clear, detailed financial disclosure in most agents' sales presentations. Just compare the way mutual funds and life insurance policies are sold: The Securities and Exchange Commission requires fund companies to give detailed information about sales charges, annual management fees and the risks of investing in the funds. But insurers generally face no comparable disclosure requirements. So insurance companies rarely provide policyholders with documentation like the kind fund investors get. "People don't know how much commission they're paying or how much they're paying in expenses," says Pennsylvania insurance commissioner Cynthia Maleski. Joseph Belth, editor of the Insurance Forum newsletter, points out that most owners of cash-value policies can't even get basics like the rate the policies' savings components earned in a given year.

The final reason insurers can so easily take advantage of consumers is that the current system of state regulation simply can't control them. One explanation: a potential conflict between consumers' and regulators' interests. Only 12 of the 50 state insurance commissioners are elected by popular vote; the others are appointed, typically by the governor. "The appointees usually come from the industry and return to the industry after serving," says John Garamendi, who did not seek re-election and thus steps down as California insurance commissioner this month after failing to win the Democratic nomination for governor. In October, Rep. John Dingell (D-Mich.), then the chairman of the House Energy and Commerce Committee, issued a report titled "Wishful Thinking" that questioned whether state regulators were up to the task of overseeing the insurance industry.

If anything, the Republican sweep of the November elections dims the prospects for tougher regulation of insurers. According to Steven Goldstein, a spokesman for the Insurance Information Institute, the G.O.P. rout means that several activist commissioners, such as those in California, Georgia, Pennsylvania and Texas, will likely be replaced with ones more sympathetic to the industry. Similarly, the switch in Capitol Hill leadership to Republicans makes it unlikely that Congress will supplement state regulation with federal controls.

Even if lax state insurance departments wanted to more effectively protect consumers, they would have difficulty doing so with their present staffs and budgets. A 1992 review of staffing levels by the National Association of Insurance Commissioners--the NAIC's most recent figures--suggests many of the regulators can afford only the skimpiest oversight. Furthermore, 22 of 50 state insurance departments have only one or no examiners on staff to conduct the kind of on-site audits of insurers that sometimes expose misleading sales practices in their early stages.

It's little wonder then that some insurers and agents can bamboozle consumers repeatedly with a wide array of tactics. Our reporting suggests that insurance customers are especially vulnerable to three pervasive and troubling games:


Agents routinely sell cash-value insurance with policy illustrations, or documents that chart the annual projected growth of the policy's cash value based on the company's investment strategy. Yet the overwhelming majority of illustrations omit crucial information, such as how much of the premium is siphoned off in sales and marketing expenses each year and how much goes to pay for the basic death benefit.

Insurers can also tailor their illustrations creatively to keep current premiums low. For example, American General sells a universal life policy whose annual premium can be roughly 25% lower than a comparable policy sold by John Alden Life. Although American General doesn't disclose this in its policy illustration, the company is projecting a 56% decrease in insurance charges beginning in the policy's 15th year. American General chief financial officer Zafar Rashid told Money that the company will have no trouble meeting the projection, because the policy was designed to recoup virtually all its marketing expenses and other costs in the first 15 years. Rashid said the decline "is not a projection. It's a certainty." Perhaps. But those lower charges are not guaranteed in the policy contract, so the company is under no legal obligation to drop its expenses one penny, let alone by the 50% or so that's needed to keep its alluringly low premium.

Consider what happened to Edward and Carol Benn of Remsen, N.Y. In 1988, Edward, a 62-year-old part-time real estate agent, purchased two $70,000 whole life policies from The New England through the insurance subsidiary of a local savings bank for himself and Carol, now 58. The idea was to provide extra income for whichever spouse outlived the other. In the illustration provided by the agent, the couple would pay $33,110 in premiums over nine years, after which they would no longer have to shell out cash for coverage. Instead, the premium would be paid by the policies' dividends. Last August, however, during the policy's seventh year, the agent informed Edward that because the insurer's investments hadn't done as well as projected, the couple would have to pay additional premiums totaling a whopping $21,408 in order to keep the policies in force. The New England spokesperson Susan Bumstead told Money that Edward Benn "clearly understood the nonguaranteed nature of dividends and therefore of vanishing premiums as well." Benn admits that he knew dividends could vary from the projections. But he insists the salesman never explained that lower dividends could mean that he might be forced to increase his projected out-of-pocket payments by 65% to keep the policy in force. "The fact that the projection could go so far off in such a short time boggles my mind," he says. "For all I know, they could come back to me again and say I have to pay premiums for another 10 years."


On rare occasions--for example, if the insurer's financial condition is deteriorating--it may make sense for you to replace an existing cash-value policy with a new one. Usually, however, agents suggest replacements because they can use the cash value in the existing policy to generate new commissions. As we noted above, this common ploy is known as churning-or twisting. Typically, agents play this game by convincing customers that because of inflation, the existing policy's death benefit is no longer adequate or by saying that the insurer has recently introduced a new and improved policy that will build cash value better. "Replacing and churning is an easy sale," says Rick Nelson, an insurance broker in Lake Forest, Ill. "The customer doesn't have to put up any money for it."

Sabo and other former MetLife agents say that some MetLife agents in many states, including California, Ohio, Pennsylvania and West Virginia, have targeted potential churning candidates with computerized statements of customer's policies called EARS, for Electronic Annual Review Service. These documents, several of which were obtained by Money, list such information as the customer's name, address and the amount of cash value (or "juice") currently in the policy. MetLife says these reports were designed so agents could review their clients' accounts. But, according to Sabo and others, EARS reports with juice were also used by some agents to churn policies with cash value. "That's the way the industry operates," says Sabo. "If a policy has juice, it's gonna get worked."

Insurance company officials like to say that only a few zealous agents churn and burn clients. But industry critics contend that many companies foster the hustle. In pending class-action lawsuits filed against John Hancock, MetLife, New York Life and Prudential, the plaintiffs allege that these companies either encouraged agents to replace clients' policies or looked the other way as they did so. And in a lawsuit filed in November, former MetLife executive Charles Kavitsky alleges that some top MetLife managers, including president Ted Athanassiades, knew MetLife records showed that approximately 40,000 policies nationwide had been improperly replaced to generate commissions. MetLife told Money that the suit is without merit.


While some MetLife agents' peddling of whole life policies as retirement investments received tremendous publicity, it is not unique. Insurers regularly push policies dressed up as investments. That's perfectly legal, as long as customers are adequately informed that they are indeed buying insurance. But insurers and agents may not always be explaining the litany of risks and uncertainties customers face when using life insurance as an investment. The agents' tendency to gloss over potential pitfalls is most evident in the so-called private pension plans now being widely touted.

In a putative private pension, agents typically convince customers to stash premiums of $1,000 or more a month into a universal or variable universal life policy for 10 to 20 years. Armed with illustrations that show the policy's cash value growing at 8% to 12% a year unfettered by taxes, agents then explain that upon retiring you'll first withdraw what you've paid in. Then, as you need additional income, you can borrow against the policy's cash value via low- or no-interest-rate loans. The pitch goes on to state that the policy loan proceeds aren't taxable and don't have to be repaid; they can instead be subtracted from the policy's death benefit. Voile! Through the magic of life insurance, the insurer has seemingly created a retirement savings plan that generates returns that are absolutely tax-free.

Sounds great. But customers are rarely warned adequately that those cash values might not pan out so neatly--if, say, interest rates tumble or the stock market swoons. The insurer could even cut into your returns by raising its administrative and marketing charges or by boosting the cost of basic protection. Whatever the cause, you might then have to funnel cash back into the policy to keep it in force. If you don't have the money to do that--remember, you may be retired by then--the policy could lapse. If that happens, all outstanding loan amounts in excess of the premiums you've paid become immediately taxable as ordinary income, at a rate now as high as 39.6%.

Clearly, the life insurance industry needs massive reform. Here are Money's three recommendations:

Require life insurers to disclose agents' commissions as well as other policy costs and risks. Joseph Belth thinks insurers should be required to provide a prospectus that would disclose the agent's commissions and tell consumers how they can find out more about the assumptions insurers make to arrive at policy values. He also believes insurers ought to be required to provide customers with annual reports that disclose a rate of return on the policy's savings component, if any, after all expenses--and show how that return was calculated.

Make agents more accountable for their recommendations and insurers more responsible for their agents' actions. Insurers should adopt the securities industry's principle of suitability, which makes it illegal for brokers and financial planners to sell investments that are inappropriate for a client's financial needs. Also, life insurance managers, like those in the securities business, ought to be held liable for the sales practices of their supervised agents.

Strengthen regulators' oversight of life insurers' sales practices. Ideally, the federal government should take a larger role in overseeing insurers. But in the new Republican order, that's about as likely as a Clinton-Gingrich ticket in '96. State insurance departments ought to get more staffing to perform more audits, though. The states could give them the funding by allowing state insurance departments to keep a larger percentage (now only 6% on average) of the taxes and fees they collect from insurers and pass on to the state treasury.

In the meantime, you have to guard against getting sucked into your own insurance mess when you shop for coverage. Here are three tips:

Look into low-load life insurance. About 15 companies sell their policies directly to consumers using salaried telephone reps or fee-only financial planners. The advantage: Only 10% to 25% of the first year's premiums as opposed to 90% to 125% on typical agent- peddled policies, gets chewed up by sales and marketing expenses. Two low-load companies that sell universal life policies by phone are Ameritas (800-552-3553) and USAA (800-531-8000). The catch: You'll have to figure out how much insurance you need and decide what type of policy is best for you. If you need advice, you can get the name of a fee-only planner or insurance consultant through Fee for Service (800-874-5662) or the National Association of Personal Financial Advisers (800-366-2732). You'll typically pay $250 to $1,000 to see how much coverage you need.

Avoid anyone hawking insurance as an investment, rather than as basic death protection. Remember that unlike with mutual funds, an insurer can seriously erode your return--and increase its profits--by sharply increasing the policy's expenses without first informing you. "Life insurance works well as a way to guarantee a death benefit that can be used to replace income when someone dies," sums up Mark White, president of San Diego-based Direct Insurance Services. "But using it as an investment is very risky."

Demand more information about where your premium goes and how the policy works. Ask the salesman how much commission he stands to pocket on the policy in the first year and subsequent years. Then inquire whether there is a lower-commission version of the policy you're considering. Also, ask the agent whether the policy contains any accounting assumptions that might inflate its cash value. If the agent balks at answering such questions, look for one who will be candid. Life insurance is too important to buy with your eyes closed and your wallet open.