Morello v. Nesbit Burns: Selling the impossible and the unknowable…

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Universal Life was supposed to have been simple where the insurance would be unbundled from its investment component. However this has never truly happened and instead there are many links between these two elements. They are inseparable and indivisible and this gives an open door to the insurer to use the investment to pay for the Cost of Insurance. The result is clear. You have more chances to get kidnap by aliens in the middle of the day while strolling in the middle of New York than being able to achieve the cash values shown on Universal Life illustrations. In fact even the so called experts that offer testimony in court case don’t even understand Universal Life…

From the judge Lalande in Morello versus Nesbit Burns

[2] Lorenzo is a seasoned businessman who works in the field of construction and real estate. During his active professional life, he managed to set aside large amounts of money by investing in various financial vehicles. To do this, he consulted with professionals in the field.
[3] From 1997 until his death in 2003, he did business with BMO Nesbitt Burns Financial Services Inc. (BMO financial services or the Cabinet) to advise him in respect of financial products that it distributes.
[4] In 1998, Morello purchased a pair of universal life insurance policy issued by National Life, a life insurance company, called Comptaflex (Police). Lorenzo and Micheline are the two lives insured by this product. The policy death benefit is payable on the death of the last survivor. Their only daughter, Elizabeth Morello (Elisabeth) is the beneficiary.

In suing Nesbit Burns, the Morello retained the services of an expert to explain the sale of this product to the judge. Nesbit Burns also retained the services of an expert. What we found is that the experts like the advisor who sold the policy did not understand Universal Life and as a result the judge was unaware of many important details pertaining to Universal Life

1) Illustration rate of 6%: This is the illustration rate that was used to create the illustration presented to the client. It is important to understand that the illustration rate is equaled to the credited rate and not equaled to total earned rate of return. This does not appear on the illustration and Morello did not know this.

When Morello was shown this illustration he did not know the investment he wanted to select for his Universal Life. In fact, when the policy was issued, the client still did not know the investment he wanted and the money went into the Daily Interest Account. Finally he selected the Bond fund as the investment

If you don’t see a problem with this chain of events, you should not be selling Universal Life as an investment. The client wanted to earn a better rate of return than the guaranteed rate of return available under the policy of 3%.

Judge Lalande stated:

Michel Bertrand established the amount of the sum insured based on the amount of the deposit, the type of sum insured, insurance factors and an assumed interest rate of 6% ;

[114] He also noted that the insights generated by Bertrand using interest rates of between 6% and 8% were fully justified, given the age of the data.

The MER of the bond fund is 3%. This meant that the client to achieve a credited return of 6% needed to earn 9%. Contrary to the statement of Byren Innes, the expert for Nestbit Burns, a long term rate of 9% was absolutely not justified for a bond fund. It’s even worst for the illustrated rate of 8%. The advisor would have to believe he could achieve a long term rate of return of more than 11% for a bond fund. It is clear that the advisor Michel Bertrand forgot to take into account the MER when he presented the illustrations to the client. This is a grave mistake.

Based on past historical performance of any bond funds, the expected total return would have been around 6%. When we apply the MER, we get a 3% credited return. As a result, there is no upside in selecting a bond fund as an investment in a Universal Life. You can achieve the same rate of return just by selecting the 3% minimum guaranteed rate of return without taking any risks.

2) Morello changed his investment from bonds to equity: This is not surprising since the client could not achieve the illustrated/credited rate of 6% using a bond fund and had to change his investment allocations. Two years later, Morello changed his investments to equity. This is what he received from National Life:

You average annual total return objective is 9.00% over a full market cycle. This is in line with long-term historical experience. However, past performance is not necessarily indicative of future performance.

The problem with this statement is that it is only true if National Life referred to total return of 9%. With MER of 3.5%, this meant a credited return of 5.5%. This is lower than the 6% but there is no evidence a new illustration was done to reflect this rate. However if Morello viewed this 9% as the illustrated rate/credited rate, he would have had to earn 12.5%. This would not be in line with historical performance. What was the 9% for Morello? Was it the illustrated rate or the total rate? Since illustrations don’t disclose this vital information, it is impossible to determine…

3) The minimizer does not work with equity investments that are subject to volatility: Morello selected a YRT COI with the minimizer option to minimize the Cost of insurance and therefore maximize the cash values. Here is the greatest deception. The minimizer does not work for volatile investments. When I was at Maritime Life, we conducted a study on the minimizer. The conclusion was that the minimizer, if investments were volatile, would in fact do the opposite of what it was supposed to do. This is why we created a Stabilizer option to smooth the volatility.

If you don’t understand this, please cease and desist from selling these policies as investments. The point is that to remain tax exempt, you cannot increase the policy death benefit by more than 8%. If cash values fall one year, because the market crashed and as a result the minimizer drops the death benefit by 15%, if the following year, the market rebounds, the death benefit can only be increase back up by 8%. As a result, money will be pushed out of the policy and taxes will need to be paid. If the death benefit is only reduced by 8%, the COI will be 7% to high and therefore the cash values will be 7% too low which means higher COI the following year with the policy entering a negative downward spiral until all CSVs have disappeared. The minimizer option when investment are volatile minimizes cash values. You don’t see this on the illustration because the illustration is done at a constant rate of return.

These 3 things meant that the Universal Life bought by Morello could not function as an investment. It is interesting that in the end Morello’s wife did what should have been done at the beginning; making the purchase of insurance efficient by switching the life insurance to a level COI and choosing to invest at the 3% guaranteed rate of return. It’s too bad that the advisor cost her a lot of money for her to gain this knowledge. She would have been better off without an advisor from the start.

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5 comments

  1. Richard. I am not sure I agree with your description of UL as a scam. The Morello vs Nesbitt Burns you refer to indicates the it wasn’t the product at fault but the adviser. You are correct to differentiate between the rate of return and the credited rate of an investment inside a UL but this should be fundamental knowledge of an adviser. If in fact a 6% rate was illustrated the adviser should have documented the difference between the two rates and the risk of underchieving with the client signing off on the disclosure. Back in 1997 disclosure wasn’t as stringent thus it resulted in a more cavalier attitude by advisers.

    Even then a good knowldge of UL (and other) contracts is crucial. So it is not the product that is a scam.

    • Tks John for your comment and question. In fact I will be discussing this on a radio show in the US. Usually products do what they are supposed to do. So usually the product is not the scam. The scam is the representation. For example, if you say that a truck has better fuel mileage than a little car, does this mean the truck is not good and is a scam? No. The problem is with the representation that was made. The scam with Universal Life is the representation that it is an investment. This does not make the UL bad and in fact it is a great estate tool. (please note in the US there is a law that prohibits marketing UL as an investment…we should have the same law). UL is not an investment. It is a great asset but it will never an efficient investment.

      Please note that sadly there were and there are still Universal Life that are built as a scam for the same reasons we would call a scam a truck that is knowingly built with faulty breaks. I see in your comment that you do not touch on the minimizer, because you know like me this feature is faulty and does not work. UL with conditional bonus were also a scam; UL with double MER and MER as high as 12.5% were also a scam…

      Finally I do not agree with you that illustrations have evolved and are better at disclosing that the illustrated rate is net of MER.

  2. Randy McCord
    Risk Manager, Money Mentor and Private Equity Specialist

    What I find most disgusting about advisors or AGA’s that base their business model on selling this product to middle class Canadians is the fact that it is one of the highest commissions paid – and certainly that was factored into their business model. There is a time and a place for all products but this product is only now being made middle class friendly and in doing so, I see very few circumstances where a Whole Life policy is not a better strategy for permanent coverage. Save the UL for your corporate clients. They are ones that can really benefit from the product.

  3. Richard Proteau
    Founder Financial Services Consumer Alliance

    Tks Randy for the comment. I have yet to encounter one client who lost money on guaranteed whole life. Even participating whole life if sold correctly can become a great investment. The problem with UL as investment is that it relies on investing in Index funds. Now if these index investments in UL were truly unbundled from the insurance component, it could work. However the investment is linked with the insurance and the advisor cannot comprehend how volatility can affect the relationship between insurance and investment since the software does not illustrate volatile rate of returns. This is what is amazing. All of the advisors that have sold UL with index funds as investments have no understanding of the impact of volatility since they have never seen one illustration with a variable rate of return… Anyway who would even consider an investment with a MER of 4%, 6% and even 12.5%. Advisors selling UL as investment are able to do so because MER don’t appear on illustrations. Imagine a software illustrating an illustration at 8% showing cash values net of MER at 4% versus what is done currently showing cash value at 8% for an illustration rate of 8% (which means a client has to mentally adjust the rate by adding the MER of 4% which will give 12% return which now means that it is an impossible rate to achieve…) Smoke and mirrors this is how actuaries have described the illustrations produced by their software….

  4. Hi Richard, I was assistant marketing director at the time for National Life when Nesbitt was selling a ton of the minimizer product in Quebec. As you stated the illustrations looked awesome in a perfect world where volatility was non-existant and that you equity investments earned over 5% a year (so that the investment bonuses kick-in). Maritime Life back then was the only company I remember showing illustration with real returns varying from one year to the next. If national Life would’ve provided such a tool, the minimizer would’ve looked like a disaster as per above mentioned lawsuit. I can see how that product was a very profitable investment for the insurance company at the expense of the client’s satisfaction..since MER’s were in the 3.25%+ range and the product was primarily sold with a YRT COI. Unfortunately too many brokers are fooled by a nice illustration and to their defence considering one needs actuarial knowledge to demystify the UL product, the insurance company has to assume greater transparancy when promoting the product.

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