Life Insurance – Regular Review is a Smart Practice
Dust off those insurance policies and take a look to ensure your needs are being met.
by FirstWave Financial
Life insurance products are many and varied, as are the needs and goals of the individuals, families and businesses that use these tools. It’s clear that careful planning and consideration is crucial when making life insurance decisions. What may not be as obvious is that routine reviews of policies and monitoring of goals is critical as well.
This need for review is highlighted by a current situation – a class action lawsuit is pending against Transamerica Life Insurance Company because Transamerica is drastically raising cost of insurance rates for many of its universal life insurance policies (not variable universal policies). Transamerica is not alone among life insurers in raising costs on this type of policy. As a result of these developments, people who own universal life policies may no longer be able to afford to maintain them. Needless to say, this will be a bitter disappointment to those who have been paying premiums for years and are counting on the policies to fulfill particular financial goals. Nevertheless, the contracts representing these policies do have provisions that provide for the increased costs, so it isn’t clear that the lawsuit will be successful. The question is, what happened that made the costs of these policies rise so dramatically and what can be done with these policies if you own one?
Universal life insurance is complex. To simplify, when a premium is paid on a universal life policy, part of the premium goes to pay for the risk that the insurance company will have to pay a death benefit. Additionally, part of the premium pays for administrative expenses and profit of the insurer. The rest of the premium goes into a savings account (the policy’s cash value). The idea is that, as the insured ages and the cost of insuring the risk of death increases, the savings account grows to offset the “amount at risk,” which is literally the difference between the policy’s stated death benefit and the policy’s cash value, thus keeping premiums affordable.
Unfortunately, the savings portion of universal life insurance policies haven’t performed as was probably illustrated when they were issued – mostly in the 80’s and 90’s when interest rates were more attractive. Furthermore, as a result of declining interest rates, insurance company portfolios, which are invested to pay eventual claims and are heavily weighted in favor of fixed income investments, haven’t performed as well as was anticipated.
Cash values in universal life insurance policies are the fuel that keeps these policies going. If cash values can’t keep up because of lower interest credits and higher costs of insurance, policies may lapse unless the policy owner pumps more and more premium dollars into it. In other words, the policy may run out of gas.
If you are confronted with this situation, you should immediately request an in force illustration of your policy and discuss the implications with your agent. Requesting regular in force illustrations is a smart practice regardless, but is particularly important now to understand what will be necessary to keep your policy going.
Based on the illustration, you may decide that you can afford to maintain the policy and that it still fulfills the financial goals for which you bought it. But if you can’t afford the policy anymore or conclude that it no longer fits your goals, there are several options to explore:
- Surrender the policy for its cash value. It is important to note that, to the extent that the cash value you receive is greater than the premiums you paid, you will have to report income that will be taxed at ordinary income tax rates.
- Tax-free exchange of the cash value into an annuity.
- Under certain limited circumstances you may be able to execute what’s known as a “life settlement,” in which a third party institution pays you a lump-sum to take over ownership of the policy. The third party pays the premiums necessary to maintain the policy and collects the death benefit upon your death. To the extent that the lump-sum you receive is greater than the premiums you paid, this strategy will also result in ordinary income.
Life insurance is extraordinarily complicated. Surely owners of these older universal life policies never imagined this outcome when they bought their policies. An independent comprehensive wealth manager such as our wealth services firm in Satellite Beach, FL – Melbourne/Brevard can help you negotiate difficult financial potholes like this and also alert you to opportunities so that you can live the life you dream about. If you are interested to learn how we can help you, please feel free to contact a WealthCoach™ at (321) 773-7773.