AN UPDATE ON DEBIT LIFE INSURANCE IN THE U.S.

AN UPDATE ON DEBIT LIFE INSURANCE IN THE U.S. Barbara Poole, Roger Williams University, (401) 254-3182, bpoole@rwu.edu Denise Williams-Shannon, DWS Financial Services, (610) 649-8185, dws@itfp.com ABSTRACT Debit life insurance, which includes industrial life, monthly debit ordinary, and monthly debit industrial, is permanent life insurance sold to low and middle-income consumers for burial costs. These insurance products have been in the news for the past few years due to a series of class action suits and state investigations regarding debit insurance, particularly the industrial product. This paper presents the first complete compilation of the lawsuits and state investigations regarding these products. Additionally, the paper provides a history of the debit life insurance industry. Keywords: debit insurance, industrial insurance, life insurance, underserved populations I. INTRODUCTION Debit life insurance products, which include industrial life, monthly debit ordinary, and monthly debit industrial, are forms of permanent life insurance. Debit life insurance historically has been sold to low and moderate/middle-income consumers to cover burial costs. These insurance products have been in the news for the past few years due to a series of class action suits and state investigations regarding debit insurance, particularly the industrial product. The debit system is primarily associated with industrial life insurance. Several other debit life products evolved from industrial life. These products are less well known, and will be discussed in later sections. Insurance products other than life products marketed through the debit system include health and property and casualty insurance (Alrich & Buckman, 1963). Although billions of dollars in industrial life insurance coverage are currently in force, little is commonly known about this product. Academic literature has tended to be descriptive rather than quantitative in nature, and few academic studies have been done since the 1960s. Students of insurance typically learn little about the product, as insurance textbooks ether allocate less than one page to industrial insurance (e.g., Vaughan & Vaughan, 2002), or fail to mention it at all (e.g., Beam, Bickelhaupt, Crowe, & Poole, 2002). Executives in the financial services industry should be aware of debit product related issues so that they can more accurately assess their company s potential risk exposure. This exposure is higher now than prior to the class action suits, which raised the standard of conduct for insurers. Although to date class action settlements have been small relative to company assets, adverse publicity could taint other company products and affect shareholder value. Management should be aware of the character of the insurance products on their books and to determine whether correction action is necessary. Further, managers considering mergers with or acquisition of

other insurance companies should be aware of the debit products and their associated liability exposure. The purpose of this paper is to describe the current issues related to debit life insurance. This paper presents the first complete compilation of the current lawsuits and state investigations regarding these products. A secondary purpose is to provide a history of the industrial life insurance industry. Prior to this work, a history has not been related since the condensed history related in LaPorte s critique of the industry in 1979. This paper will begin in Part I by describing the development of industrial life insurance, and characteristics associated with these policies. In Part II, the academic literature is discussed in the context of product features. Court cases and state investigations are discussed in Part III. The paper concludes in Part IV with suggestions for educators, advisors, and financial practitioners working with members of the industrial life insurance target market, and with suggestions for future research. I. HISTORY AND BACKGROUND Debit life insurance has been marketed as burial insurance for low- to moderate-income families since the late 1800s. The product has evolved somewhat over the years, but the purpose and target market have remained constant. A recounting of the long history of industrial insurance is helpful for understanding recent lawsuits and investigations related to the product. The English Roots Debit insurance products developed in England, where the industrial insurance form was created in the late 1600s. At that time, Friendly Societies and Burial Clubs provided aid to families of deceased workers (Bernstein, 1996). Throughout the 1700s, these Friendly Societies flourished in English communities. The demand for this insurance was driven by the desire to provide a customary burial for the insured rather than a pauper s funeral, which was considered humiliating to the decedent and the family (Marshall & Zubay, 1975). The funding of the Friendly Society s coverage was unlike that of a traditional insurance product. Each policy owner paid the same premium, regardless of the insured s age or health. Standard actuarial practices such as reserving and underwriting were not observed, even though by 1800, English insurance companies used these methods for their life products (Davis, 1944). Insurance similar to that of the Friendly Society was introduced in 1848 by the Prudential Assurance Company, Ltd. This insurance was designed using actuarial practices for premium construction and reserving, but the usual extensive medical underwriting was not required. The product was called industrial insurance because it was target marketed to low-income industrial workers. The name industrial life became synonymous with insurance in small amounts for families with limited means ( Industrial Life Insurance, 1905). The industrial insurer, like the Friendly Society before it, used a debit system for premium payment. With the debit system, also known as home service, a field representative went to the

policy owner s home or workplace to collect weekly premiums and to service the policy (Marshall & Zubay, 1975). Insurers believed that low wage earning policy owners lived paycheck to paycheck, so premium collection should be coordinated with the weekly payday (Davis, 1944). The Migration to the United States The industrial insurer, like the Friendly Society before it, used a debit system for premium payment. 2 characteristics in common, the collection system and the small face value. With the debit system, a field representative went to the policy owner s home or workplace to collect weekly premiums and to service the policy (Marshall & Zubay, 1975). Insurers believed that because low wage earning policy owners lived paycheck to paycheck, premium collection should be coordinated with the weekly payday (Davis, 1944). In the late 1800s, insurers in the United States developed industrial insurance products similar to the British products. In 1875, the Prudential Insurance Company of America issued the first U. S. industrial insurance policy, which provided small amounts of life insurance in exchange for a weekly payment collected by an agent ( Industrial Life Insurance, 1905). A few years later, Metropolitan Life Insurance Company and the John Hancock Mutual Life Insurance Company introduced similar products and for many years, these three companies dominated the American industrial life insurance market. As with the English products, these American industrial life policies were intended to cover the burial component of the insurance need, and were targeted to low- and moderate-income wage earners. Death benefits were less than $1000 and were based on the premium that the household could afford. Industrial life policies usually included dismemberment benefits, unlike ordinary life insurance policies. Small amounts of cash value built up slowly in the policy, but loans against cash value were not allowed. Unlike ordinary insurance, pricing was based on age last birthday, rather than age nearest birthday (Belth & Leverett, 1965). Additionally, as with the English products, insurance companies accepted the risk without extensive medical underwriting. Medical underwriting was based on a medical questionnaire and special industrial life mortality tables were used for premium calculation. The industrial life tables reflected higher mortality than standard life mortality tables. Indeed, historically, the death rate experience in industrial workers did exceed that reflected in ordinary life mortality tables. Additionally, as will be discussed in the section regarding class action suits, some companies priced their products with a dual set of rate books, one for whites and one with higher premiums for blacks (Harrington & Hauserman, 2000). Simplified issue format after the 1960s Industrial life insurers were the first to provide coverage on women on a widespread basis. These insurers targeted female homemakers, as well as both single and married working women. Women who purchased debit insurance were usually low and moderate income individuals who worked in blue collar service sectors (Blicksilver, 1975). Women often purchased policies on themselves and every family member, sometimes including minor and adult children and grandchildren (Laporte, 1979). By 1973, although women represented one third of ordinary life purchasers, they owned 44% of industrial life policies (Blicksilver).

The Debit System Insurers promoted their debit systems as a service to their policy owners. The insurers regarded home service as a help to policy owners who otherwise lacked the discipline to budget for insurance premium payments (Marshall & Zubay, 1975). Additionally the ability to pay premiums in cash was helpful for those without bank accounts (Seaman, 1993). In the debit system, geographical territories were assigned to debit agents. Each agent was responsible for service to all of the insurer s in-force contracts residing in that territory. The agents were compensated for their home service through service commissions, premium collection commissions, and expense allowances (Marshall & Zubay, 1975). Development of MDO In 1926, a variation on industrial life insurance was introduced to appeal to middle-income wage earners. This variation, Monthly Debit Ordinary (MDO), was sold to the downscale market, with face amounts ranging from $1,000 to $15,000 (Seaman, 1993). The average sized MDO policy in 1992 provided approximately $10,823 of death benefit (Seaman). Laporte (1979) reported that, by the late 1970s, MDO sales were growing and had surpassed those of industrial insurance. However, as will be reported in a later section, sales and in force information for MDO is unknown because these data are included with ordinary life data. MDOs were sold and serviced under the debit system, although the volume and visibility of the product has historically been considerably lower than that of industrial life. Premiums were collected at the policy owner s home or workplace, but on a monthly, rather than weekly, basis (Marshall & Zubay, 1975). The monthly collection synchronized payment with monthly income earned from employment or obtained from government welfare and social security programs (Laporte, 1979). The MDO products were structured somewhat differently than industrial policies. For example, the cash value in a MDO policy began accruing sooner than the cash value in an industrial policy. Additionally, the insurer may have charged a slightly lower premium than the industrial life insurance plans because the agent did not collect the premium as frequently. Of course expense loading included the extra expense of debit collection. Until the 1950s, MDO insurers used industrial life mortality tables, and after that time, insurers tended to use ordinary life mortality tables. Product Decline The amount of industrial life insurance in force in the United States peaked in the middle 1950s (Marshall & Zubay, 1975). Insurance company reports indicate that in the early 1960s, industrial life insurance still occupied an important position in the life insurance market. In 1961, industrial life insurance premiums accounted for 14% of total life insurance premiums paid, while MDO accounted for less than 1% of total life insurance premiums paid (Alrich & Buckman, 1963).

The Civil Rights Act of 1964 legislated changes to the way that industrial life insurers priced their policies. The Act, which banned discrimination because of a person's color, race, national origin, religion, or sex, effectively outlawed the practice of race-based pricing. As a result of the Civil Rights Act, insurers began to eliminate their separate pricing schedules for new policies and to make adjustments to rate-based policies. However, some insurance companies continued to collect in-force race-based policy premiums, which may have been as much as 25 percent more than premiums for white insureds (McKinney, 2001). Improved general economic conditions contributed to the decline of industrial policies. Wages rose by 42% between 1952 and 1962, compared to a 13% increased cost of living. These economic improvements enabled American workers to purchase higher amounts of insurance coverage than those offered by industrial life policies. In this favorable market, the larger companies began to concentrate more on the sale of larger policies (Alrich & Buckman, 1963). Responding to the changes due to the Civil Rights Act and the general economic conditions, by the late 1960s, major insurance companies began phasing out the sale of weekly premium industrial policies. These companies included the pioneers of the industry, Prudential, Metropolitan Life, and John Hancock. Other large insurers, also referred to as combination companies because they offered a combination of different lines of business, tended to withdraw from the industrial life industry (Alrich & Buckman, 1963). Although the major insurers phased out active sales of industrial life insurance, smaller companies that specialized in the debit system of marketing continued industrial life sales. After the 1960s, insurers developed Monthly Debit Industrial (MDI), a variation of Monthly Debit Ordinary, has emerged. Like MDO, MDI premiums were collected monthly, but the premiums for the MDI are higher, due in part to differences in the geographical target markets. The MDIs are targeted to very poor areas, such as housing projects, while MDOs are sold to moderate and middle-income consumers. Around this same time1960s, the debit product began to be referred to as the home service (w1, p4) Debit Life Insurance Products Today Today, industrial life insurance is a small component of the life insurance industry, representing.1% of the total life insurance coverage in force, and 6.7% of the total number of life insurance policies in force. In 1998, the last year for which the American Council of Life Insurers (ACLI) reported these data, $17.365 billion in industrial life insurance death benefit was in force, representing 24.065 million policies, with an average death benefit of $721.59. The industrial life insurance industry paid $437 million in death benefit in 1998 (ACLI, 1999). Industrial life insurance in force is concentrated in a small number of companies. The seven highest volume companies in 1998 accounted for 72% of the in force business, as shown in Table 1. Within the last five years, each of these companies has been associated with a lawsuit or investigation related to the industrial life or debit life insurance business. These suits and investigations will be discussed at length in a later section.

MDO and MDI debit products continue to be offered in the home service arena today, but the annual sales and coverage in force are unknown. Industry reports, such as those from Best s and ACLI, include these products with the ordinary life insurance statistics. Consequently, the numbers cited in the prior paragraphs concerning industrial life insurance constitute only a portion of the debit life insurance in force as of 1998. II. LITERATURE REVIEW The academic literature concerning industrial life insurance is sparse, and little has been written since the 1960s. Additionally, the majority of the academic literature is descriptive rather than empirical. The most recent work, Laporte (1979) and Seaman (1993), described issues associated with the industrial life insurance product. Issues that emerged from a review of the extant literature provided the organizing structure for the literature discussion. Regulation Insurance in the U.S. has been regulated primarily on the state level since the late 1800s. The McCarran-Ferguson Act of 1945 confirmed the right of the states to regulate insurance, but allowed that the federal government can take over regulation when state regulation is inadequate. As will be seen in the discussion concerning the class-action suits and state investigations, states collaborate in their regulation and enforcement efforts. The remainder of this paper is available from either author on request. Copyright 2007. Barbara S. Poole and Denise Williams-Shannon. All Rights Reserved. A limited, non-exclusive license is granted to Northeast Decision Sciences Institute to publish this article in the 2007 NEDSI Proceedings. Available on request from either author. REFERENCES AND APPENDICES