Anatomy of a Misleading Sales Pitch

A rash of policyholder complaints about misleading sales practices has fueled a growing number of class action suits against life insurance companies. The offending practices usually take one of two forms: "churning" (also known as "twisting") or promises of "vanishing premiums."

Churning and twisting

Once a policyholder has been paying into a whole life insurance policy for some time, its cash value builds up, making the policy more valuable. Some unscrupulous life insurance agents then convince their customers to use the built-up cash value of their existing policies to buy a "new, improved" policy - one with more coverage, different features, or a different payment schedule.

What these agents neglect to tell their customers is their existing policies are usually quite adequate for their needs, and when they use the built-up cash value to purchase a new policy, they start from square one in building up cash value in the new policy. This practice is called "churning" or "twisting." It's unethical - and illegal. Some agents churn because they earn a commission for each new policy they sell.

The fallout from churning isn't immediately apparent. A customer doesn't have to shell out any money up front because the built-up cash value of the existing policy pays the initial premiums of the new one. Once you use the cash value; however, it's gone.

Texas insurance commissioner Jose Montemayor says "churning" profits insurance agents at your expense. " If you bought the original policy at an earlier age, the new policy might cost more and offer less coverage. In addition, if you should die during the first two years of a new policy, the insurance company can contest claims for the death benefits," Montemayor warns. "Many companies pay larger commissions to agents for new policies than for renewals."

A policy's cash value is actual money the policyholder owns, although usually just on paper. Cash value can be used as security for a loan or converted into an annuity. If a policyholder decides to cancel a life insurance policy with built-up cash value, he's entitled to that money, minus the surrender charge.

Vanishing premiums

Life insurance companies take the money they collect in premiums and invest it - that's how they make their money. In the case of permanent life insurance policies such as whole life and universal life, companies then apply some of those investment earnings back to the value of your policy.

During the early 1980s, interest rates were high and it looked like they'd keep on climbing. So, life insurance companies projected the rate of return from investing today's policy premiums would eventually pay for any future premiums. Some agents told customers they would only have to pay premiums for a few years. The agents claimed returns on the insurance company's investments would pay for the policy after that.

As it turned out, those rosy projections weren't accurate. Interest rates fell, and customers who'd been told their policies would start paying for themselves kept getting bills in the mail. Angry policyholders protested, only to be told insurance company projections weren't guaranteed. In some cases, customers were able to prove they were not informed of that when they signed up for their policies.

The Missouri Department of Insurance claims since the mid-1990s, state regulators and class-action litigation nationally have secured hundreds of millions of dollars in policyholder awards for "vanishing premium" violations.

Texas insurance commissioner Jose Montemayor says some common sense can help protect you from "vanishing premium" or "churning" scams. "Ask yourself whether the agent has your best interest in mind or is just trying to get a higher commission," Montemayor says.