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April 4, 2016

A Risk-Free Life Insurance Policy? (No)

Summary:

"Guaranteed" life policies are falling victim to low interest rates. Holders may see death benefits drop or premiums increase.

Photo Courtesy of Douglas Scortegagna

Is your life insurance policy risk-free?

At its core, a cash-value life insurance policy consists of three components: interest rates/dividend rates, mortality costs (cost of insurance) and expense charges. And, over the last 10 years, interest rates have been at historic lows. They are often lower than the guaranteed interest rates on universal life insurance policies.

Something has to give.

Insurance companies traditionally have invested their funds in debt-related investments (mostly bonds). As insurance companies are not earning enough interest to meet the projected interest rates on universal life and other cash value life insurance policies, they have had to lower the interest rates they credit to their policy owners. On some of these older policies, the guaranteed interest rate is higher than what the companies are earning, so the insurance companies are losing money on interest rates.

See Also: How to Reach Millions With life Insurance

What happens when insurance companies lose money? Well, they’re not charities, so they look for the money in other places. Some companies have been able to make up some of the difference by changing their investment portfolio; however, by regulation, they are restricted in what they can invest in to some degree. 

Why Am I Reading About Universal Life Policies Terminating? 

Keeping in mind that almost every universal life insurance policy is crediting the guaranteed minimum interest rate, the insurance companies really only have one other component they can change to continue to maintain profitability. And that’s the mortality costs, also known as the cost of insurance.

A number of companies have recently announced increases in their mortality costs, though they do not typically disclose what the actual change is (dollar amount or  percentages). These companies include AXA Equitable, Banner Life, Security Life of Denver, Transamerica Life, Voya Life and William Penn Life. It is important to note that the companies are only raising mortality costs on some universal life policies, not all of them. 

It is highly likely that other life insurance companies will follow, especially if there are no repercussions (regulatory, media, consumer, etc.).  

Universal life insurance policies were originally promoted and designed to be transparent life insurance policies where the components were unbundled and, therefore, could be monitored. Transparency has not been the case — changes to mortality rates are not usually disclosed, — and changes in mortality rates can have a more significant impact on the performance of a universal life policy than a reduction in interest rates. 

If you have a whole life policy, you may be thinking, “Well, I’m safe, I’m getting my dividends.” Dividends are tricky. Companies with whole life policies have reduced dividend scales, but this is usually not disclosed anywhere—you just receive lower dividends. On a whole life policy where your original projection was to pay premiums for X number of years, you’ll find yourself paying premiums for much longer periods without ever being told. Most people don’t realize their premium payment periods have been significantly extended. 

Also, you won’t be building up the cash value that was on the original projection, so if you bought a policy using the “Missing Money concept,” “Be Your Own Banker concept” or a similar concept, you are almost certainly not going to end up where you expected. (This is setting aside the issue of whether these concepts really make sense, but that’s a topic for another newsletter/article.)

What’s This Mean for You? 

If you have a cash value life insurance policy, especially one purchased more than 10 years ago, your policy has a very high chance of terminating without value. To avoid this unwanted outcome, higher premiums are needed on almost every older universal life policy (traditional universal life, variable universal life or indexed life), basically on any life insurance policy where the premiums are not fixed. And if your premium is guaranteed, such as on a whole life policy, you may be paying premiums for significantly longer than expected or will be receiving a lower cash value.

“So,” you ask, “why hasn’t my insurance company or insurance agent told me about this?” Good question. The answer could be any or all of the following: The insurance companies are not facing facts; the insurance companies would prefer to not face the issue; the insurance company does not realize the issue exists; the agent doesn’t understand the problem; or the regulatory system is not addressing it yet. 

This is definitely a matter of concern because life insurance companies are not detailing the impact on premiums and the life of the policy. And companies are not required to do so; nor are they even required to notify policyholders of increases in their costs of insurance (mortality costs). 

How Do I Find Out About My Policy? 

Recently, Bottom Line Personal interviewed me for a story on this topic: “Your Life Insurance Policy May Be Terminated.”

As mentioned in the interview, the only way to determine the impact of this increase in mortality costs is through an in-force illustration. An in-force illustration is a projection of future values based on current assumptions. The Insurance Literacy Institute has free “Insurance Annual Review” guides that include a form letter to request in-force illustrations in the Resources Section. 

Your in-force illustration request should include a projection based on current premiums and assumptions, along with a request for the required premium to continue your policy to maturity (maximum length). The difference in premium may be significant.

What Should I do? 

A couple of things to consider are your health and life expectancy as well as your current need for life insurance. Most people find they don’t have a need for permanent life insurance because they have other assets they accumulate and that replace the need for life insurance. Remember, life insurance is for protecting those who are financially dependent upon you.

If you do need your life insurance policy, consider if you can pay the higher premium that would be required to keep your policy in force to maturity, or consider if a reduced death benefit would meet your needs.

You should also take a look at the ratio of premiums to death benefit. If you’re paying in 10% of the death benefit each year in premiums, then the policy doesn’t provide you good leverage.

Surrendering the policy is an option to consider, especially if there is a sizable surrender value.

See Also: Bringing Clarity to Life Insurance

Another option is selling a policy in the secondary marketplace (life settlement), though this needs to be approached carefully.

Big Question: 

How many other companies have increased their mortality costs, and how many other policies are affected?

The Future: 
 
Whether interest rates increase and when they do so and whether insurance companies are able to start to increase their investment earnings will determine whether insurance companies will maintain or increase their cost of insurance.   
 
The most concerning news came from Transamerica, which issued an announcement that illustrations requested by policyholders will no longer include information about the current cost of insurance rates or interest rates. Yes, that’s right. Policyholders with Transamerica will, possibly, not be able to have any idea of the premium required to fund their universal life policies. However, according to a recent report, Transamerica may have changed its mind.
 
The future is up to us. If we start to treat cash value life insurance as the complex investment vehicle it is and start to carefully manage it, there will be positive outcomes. If we continue with the current approach, lack of education and disclosure, more policies will terminate, and there will be significant negative consequences for policy owners and their beneficiaries.
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About the Author

Tony Steuer connects consumers and insurance agents by providing “Insurance Literacy Answers You Can Trust.” Steuer is a recognized authority on life, disability and long-term care insurance literacy and is the founder of the Insurance Literacy Institute and the Insurance Quality Mark and has recently created a best practices standard for insurance agents: the Insurance Consumer Bill of Rights.

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