The curse of large numbers

Not too long ago, I wrote you this short email:


When my dog was just a wee pup, we took him to the dog park and a pack of dogs chased him down and I had to save him.

Diving into a pack of barking, snapping, dogs isn’t my favorite thing to do but I did it anyway and I didn’t walk away unscathed.

One of the dogs bit my leg and the owner left faster than an intern’s dignity at a cigar club meeting.

So… I was stuck with an interesting proposition: assume the dog had its rabies shots and never got into a fight with a rabid animal afterwards or… go to the ER and get checked out.

By the way, do you know the odds of contracting rabies from a domesticated animal in the U.S.?

Neither do I, but I was told by the doctors in the ER it’s less than 1%.

Thems are good odds.

But… if I did have rabies, I wouldn’t know until I showed symptoms and by then, the illness has a 100% fatality rate.

100% fatal.


No cure.

Goodnight Irene.

Listen to me now and hear me later. If you ever get bit by a bat, skunk, squirrel or any other wild animal, and you happen to get rabies, you dead my friend.

This is why every doctor in every ER will always recommend the rabies postexposure prophylaxis.

It’s the only way to guarantee you’ll live.

The risk of loss, in many cases, and in many areas of your life, is small.

But… given enough time and enough risks, the risk of loss explodes. Eventually, SOMETHING will happen. Something you didn’t expect. Something you didn’t plan for. Something that goes horribly wrong.

This is precisely why insurance exists.

All this got me thinking more and more about how the life insurance business relies on its customers trusting them to do what’s right over the long-term. And how they spread out those risks, price them, and work to protect their policyholders.

And, in many cases, I started to realize they’ve failed to make good on some of their implicit promises.

That’s not to say insurers have folded and policyholders lost money. On the contrary. Almost no policyholder has lost any money in any life insurance policy issued in the last 100 years… provided they kept it in force and paid their premiums.

The life insurance business is (mostly) solid.

But, policyholders HAVE been promised specific rates of return in their life insurance policy, which haven’t always panned out as expected. Mostly, policyholders have received LESS than what was originally quoted and illustrated.

A lot of the reason for this is that policies issued in the last 30 years were illustrated at higher than normal interest rates. So, instead of assuming the policyholder would earn 5% over the long-term (which was reasonable)… the insurance agent made an IMPLICIT promise that people would earn 7% or 8% or more.

I bring this up because the new crop of life insurance products out there makes promises that are… how shall I say… sketchy in some of their assumptions… similar to promises made 30 years ago. In one case, a life insurer is showing 20%+ returns PER YEAR on cash values.

That… uhhhh… yeah I’m not even going to address that one. It is so far outside the bounds of reality that it need not be mentioned ever again.

If the illustrated double-digit rate of return on cash values is so unrealistic, then why do some life insurers do this?

One reason is sales. Double-digit returns are secksy.

Another reason is insurers have benefited from falling interest rates for the last 30 years. This has allowed them to play some clever accounting gimmicks with their crediting rates. Essentially, life insurers were able to hide behind a concept (fundamental to life insurance) called The Law of Large Numbers. By spreading risk around to many policyholders, and constantly bringing in new money, they were able to show really great illustrated performance.

Now? All those new policyholders will end up hurting illustrated performance since new money is invested at lower rates than old money from 20 or 30 years ago. Now is the time to prove that these insurance companies are fundamentally sound businesses as interest rates start to rise. What helps insurers in the falling interest rate environment can cut them (and their policyholders) when rates rise.

Just as investors feel the pinch in their investment portfolios as rates rise, so do insurance companies.

How you deal with that will determine how successful you are in your future plans.

And one small crop of life insurers has an edge over all others… and for reasons which aren’t immediately obvious. Anywho, if you want the “inside” info, you gotta join the email list where I discuss this and much, much more.

David Lewis, AKA The Rogue Agent, has been a life insurance agent since 2004, and has worked with some of the oldest and most respected mutual life insurance companies in the U.S. during that time. To learn more about him and his business, go here.