Death Takes a Policy: How a Lawyer Exploited the Fine Print and Found Himself Facing Federal Charges
Caramadre had landed in an industry on the cusp of a historic transformation.
Life insurance used to be safe and profitable. Many insurance companies had begun in the 1800s as mutual aid societies. They were ostensibly owned by their customers who sometimes even received dividends. The idea behind the business was simple: Collect premiums from lots of people at a price high enough to account for mortality, which can be quite accurately predicted. The companies invested their pools of money. When they wandered into trouble, it almost always involved poor investment choices rather than unforeseen behavior by policyholders. By 1985, annual compensation for a top company CEO could be in the high six figures. While this was not a Wall Street salary, the business had the benefit of comfortably predictable profits.
Insurance agents worked for specific companies and offered products only from that firm. The agent was a man of the community, hawking a service that few young and healthy people want to contemplate. The old adage in life insurance is that "it's sold, not bought." Agents sold a relationship and a vision for the future, encouraging clients to protect their family from a tragic event and, possibly, give their heirs a leg up.
By the 1990s, the business was changing.
Under pressure from banks offering new retirement products including annuities, insurance companies decided to shed the cost of keeping large numbers of agents on their payroll. Rather than train, staff and equip insurance agents, the industry moved increasingly to a freelance model. "Independent" insurance agents paid for their own offices and expenses solely through commissions earned on the policies they sold. Insurance companies like Prudential, which once had as many as 18,000 agents, whittled their in-house force down to about 2,500.
The rise of independent agents was accompanied by the widespread transformation of mutual companies. Between 1985 and 2003, more than 20 mutual life insurance firms converted themselves into stock companies, most of which were traded on Wall Street. This process heightened the focus on quarterly earnings and eventually helped lead to an increase in executives' pay. Rising stock prices meant bigger bonuses.
The change in culture and incentives in the life insurance business created the perfect conditions for the arms race. It also made the business a prime target for Caramadre.
It wasn't until the 1990s that the growth of variable annuities took off. Between 1990 and 1999, the amount of variable annuities individuals purchased in the U.S. leapt from $3.5 billion to nearly $63 billion in 1999, according to the American Council of Life Insurers.
For the companies, it was easier to sell a product customers could use while still alive. Unlike life insurance, annuities did not require an expensive health examination. Life insurance was based on premium payments that remained steady. But the yearly fees charged on annuities, which sometimes topped 4 percent of the value of the account, would rise in line with those values. More money under management meant more fees, which buoyed the companies' stock prices and their executives' compensation.
Annuities were not a terrible idea. They fit a growing gap in the nation's pension system. The defined benefit plan, a retirement approach where the employer guaranteed a pension based on salary and years of service, was disappearing. From 1980 through 2008, the proportion of private sector American workers covered by company pensions fell from 38 percent to 20 percent, according to the Bureau of Labor Statistics. Meanwhile, a demographic bubble of baby boomers needed other retirement options. Annuities seemed to be tailor-made.
At Penn Mutual, Caramadre broke sales records, becoming at age 24 one of the youngest Golden Eagles — a recognition the company bestowed on top sales performers. Caramadre left Penn Mutual two years before the company ended its captive agent system. As an independent agent he could find better deals for his customers on the open market. He became a student of insurance products, deconstructing the product software provided by the companies, delving deep into the contracts. It became almost like scouting a ball player, he says.
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