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| Old Money New Insurance Tricks
Heavily advertised high interest rates on annuities often quietly convert to low interest rates. |
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| Did you know your retirement savings may be losing their virility as they age,
earning less money for your retirement? No, we are not talking about those of you who invested in the
internet/telecom/pork bellies mutual fund, and there is no little blue pill that can cure the problem.
The concept is called "old money/new money" interest crediting and many life insurance companies are using
it in fixed annuities and certain life insurance policies. In a fixed annuity, universal life insurance policy, or other interest or dividend paying life insurance product, the insurance company has two goals. First, they want to make the product look as attractive as possible to get you to invest. This means advertising an interest rate as high as possible. Second, the insurance company wants to find a way to pay their agent commissions, overhead expenses, and make a nice profit. These goals are not compatible. Sometime in the early 1990's, some insurance executive reasoned that if they advertised a high interest rate to attract the money, and kept advertising an attractive rate to keep you investing, it was okay for the insurance company to quietly start paying less interest on "old money", i.e. money you deposited in your annuity or life insurance policy more than twelve months ago. Typical wording on the bottom of your annual annuity statement would say: |
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| The Current Interest Rate on New Money is 6.00%. Current interest rates declared for new premiums include some bonus interest during the first twelve months. A different rate may be credited after the first twelve months. |
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| However, there was no "may" about it, and some companies put no disclaimer at all.
The interest rate on deposits more than twelve months old was substantially less than 6%. Throughout the 1990's,
and particularly in the last few years, the gap between the new and old money rate has gotten bigger. In some cases
the old money rate was 4%, making the gap 2%. This means your old money is earning one third less. Yet, unless you
pulled out a calculator, knew how to do compound interest calculations, and could calculate what interest rate you
were actually being paid, you probably just focused on the new money rate. Old money/new money interest crediting, which started in the field of annuities, has spread to universal life insurance policies. There is even old money/new money interest crediting on some whole life policies, which pay dividends. Perhaps burdened by their conscious, some companies actually started putting better disclaimers on the annual statements as to what they were truly paying. A more recent statement says on a fixed annuity: |
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| The following interest rate includes a 2.00% bonus which is only payable the first 12 months
after receipt. For new premiums received 09/30/1999 interest will be earned at the rate of 7.45% For premiums received prior to
07/01/1999 interest is being earned at rates between 4.60 and 6.00% depending on when those premiums were received.
The company may change the interest rate upon the expiration of the guarantee period. Interest is credited daily and compounded
annually. |
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| Insurance company actuaries justify old money/new money interest crediting by arguing that the interest
rate paid on an investment should be tied to the investments purchased at the time the money comes in. In other words, if you put money
into your annuity in 1993, that bucket of money should be tied to the interest paid on the investments purchased by the insurance company
in 1993. That would be fine if this is how old money/new money interest crediting was done, but it is not done that way. Interest rates have
generally been declining for over fifteen years. Therefore, your older money should be earning more than your new deposits. Yet, this would
defeat the insurance company's aim of publishing an attractive rate to sell the product and to keep you investing. The interest crediting histories of most insurance products show that old money rates are lower than the new money rates, that the old money rates tend to go lower over time, and that they often go to the minimum guaranteed rate in the contract. This means the longer you own your annuity or life insurance policy, the lower your overall return, compared to the new money rate, because more of your money is becoming "old money." Old money/new money interest crediting is really just a design tool used by actuaries to mask commissions, overhead and profit. In many of the products sold today, a decision has already been made that the old money rate you will be paid in the future will be substantially lower than the new money rate, that it will decline over time, and will probably be close to the contractual minimum. Sadly, many insurance companies are using old money/new money interest crediting, even though it appears to be a premeditated fraud. Worse, the full effect of old money/new money interest crediting is felt as one approaches retirement age, when the bulk of the investment is now earning the old money rate, and it is too late to fix the mistake. Just as with bonus annuities, equity indexed annuities, and any other number of other questionable products insurance companies have come up with, there is a simple truth with all interest paying life insurance products: 1) only so much money goes into the investment, plus earnings; 2) less will come out due to commissions, overhead and profit; and 3) the insurance company invests mostly in bonds. Any insurance company that tries to make you think you will get more is up to its old tricks. |
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