So far in this series of articles we’ve discussed Universal Life – how it works, how interest rates might affect its performance, and what cost of insurance is. In this final installment, we’ll look at what you can do today if you find yourself in the position of owning a failing UL policy.
In the big picture, there really are only three actions you can take to remedy a failing Universal Life policy; you can pay more, you can reduce your coverage, or you can die before it runs out. Before you can decide what actions to take, you need to look at a few basic financial questions.
First and foremost, the most important question to ask is whether or not you still need the death benefit. It’s easy to get caught up in the years of premiums you may have paid into the policy in the past and become determined to get some value out of the policy “no matter what.” However, it rarely makes sense to pay for insurance you don’t need. If the policy has served its purpose, and there’s no need to continue to carry the death benefit, it’s perfectly acceptable to surrender it for its remaining value and cut your future expenses.
If you do still need benefit, you’ll want to consider how much benefit is needed, and how long you’ll need it. If the policy will remain in force until you complete your retirement plan, and then will lapse, it’s probably still a good bet for you. On the other hand, maybe you feel you need permanent coverage still, but you don’t need the full face amount of this policy. You may be able to reduce your coverage under your existing policy, thereby reducing the premium you’ll need to pay to keep it in force.
A third consideration is how healthy you are. If you’re in ill health, it may be that your life expectancy is shorter than the remaining life of the policy, and you may be able to get away with doing nothing. Or, if you’re healthy and still need coverage, it may make sense to replace the policy with a different carrier. Sometimes this makes sense, especially since the older policies are mostly using life expectancies from 1980 to calculate their cost of insurance figures. Today’s policies use the longer life expectancies from the 2017 Commissioners Standard Ordinary table. Of course, if you do choose to replace a policy, always make sure you’ve compared all features, costs and benefits of both policies, and never cancel one policy before the other is in force.
In the end, choosing how to react to a failing UL policy can be simple decision, or a complex one. It may make sense to discuss your options with a qualified life insurance agent. As always, feel free to leave questions in the comments section, or contact us for personalized help in finding a qualified agent in your area.
Welcome back to my ongoing series about Universal Life. We’re exploring how Universal Life policies work, and why yours might be failing, especially if you bought it between the late 70s and late 90s. Previously, we talked about how UL works in broad terms, and discussed that it was designed for flexibility, and to take advantage of the high interest rates at the end of the last millennium. Following that, we discussed how the ongoing trend of declining interest rates has impacted the performance of these types of policies, resulting in many of them failing. Today, we’ll look at the other major moving part of Universal Life, cost of insurance.
In my vlog post – What is Insurance – I covered the insurance term “Premium.” The premium is simply the dollar amount you pay the insurance company in exchange for your coverage. Whether you’re buying auto insurance, a warranty on your phone, or insuring Beyonce’s legs, the premium is calculated by the carrier using some assumptions. The folks doing these calculations are called actuaries, and their job is to analyze (among other things) the likelihood of having to pay a claim on a policy, and how much interest they can earn on your premiums until they have to pay. From these assumptions, they calculate a premium. All else being equal, the lower the likelihood of a claim, or the longer it will be until a claim is likely to be paid, the lower the premium. In addition, the higher the interest rate they can expect to earn, the lower the premium.
With life insurance, besides the interest rate, the biggest factor determining your premium is your life expectancy. Most life insurance companies have been in business for over a century, and during that time they’ve been gathering and analyzing data on who lives and who dies. If you’re expected to live a long time before they have to pay your death claim, they can collect a low premium on you, because they have lots of time to earn interest on those premiums before they ultimately have to pay your claim. This life expectancy component of life insurance pricing is known as the cost of insurance.
With the other two main forms of life insurance, namely whole life and term life, the cost of insurance is simply baked into the premium. You never see “how the sausage is made.” You simply pay your premium and you’re covered. With Universal Life, however, they make this component of your premium visible to you from day one. Each Universal Life policy (like, the actual paper contract that binds the carrier to pay) includes a cost of insurance schedule. If you look at it you’ll see a table of figures that show how much you can expect to pay for your cost of insurance at each age. As you get older, the likelihood of you dying in any given year increase, and therefore, so does your cost of insurance.
The intent of a Universal Life policy is to take advantage of interest rates by paying in more than the cost of insurance when you are young, and then using that cash value build up to cover your higher cost of insurance when you are older. This is why you can find a situation on older policies where the premium being paid is much lower than the actual cost of insurance. The interest you earn on your cash value is intended to make up the difference.
As we saw last week, though, if interest rates fall, that cash value might not be there to help you pay. In a prolonged period of declining interest rates, such as what we’ve experienced since about 1981, a Universal Life policy can find itself in a situation where the premiums paid, plus the interest earned, is still lower than the cost of insurance. In that situation, the difference is simply deducted from the cash value.
Once you’ve reached this “tipping over” point, it can be a pretty dramatic downward spiral from there, since your policy is going to be hit by a “triple whammy” of compounding problems. Since you have less cash value the following year after your policy tips over, you will earn even less interest, meaning the policy will have to consume even more cash value to stay in force. On top of that, in most policies, you only pay cost of insurance charges for what’s known as the “Net Amount at Risk”. For example, in a policy that has a $100k death benefit, and a $20k cash value, you’re only paying cost of insurance charges on $80k of risk. Next year, if your cash value has gone down to $19k, you’re not only earning less interest, but you’re also paying for $81k of risk. On top of that, you’re paying the cost of insurance associated with being one year older. So you’re paying more money per dollar of coverage, for more coverage, and you have less interest to help you pay it – a triple whammy.
Typically, once we see a policy tip over, there’s at most a decade of coverage left in the policy before it lapses entirely, leaving you with no cash value, no death benefit, and no policy. If the policy has served its purpose, maybe that’s not a problem, and you can just surrender it or let it go. Most people I meet, however, want to try to fix it somehow. Next week we’ll talk about some options that have worked for our clients.
Go back to UL Part 2 Go to UL Part 4
In my last blog post, we talked about Universal Life, how it works, and why yours might be failing. There are really two moving parts to a Universal Life policy, the interest rate, and the cost of insurance. I’ll talk about cost of insurance in the next post, but today we’ll talk about interest rates. Why does it matter what interest rate your UL policy is earning?
OK, first let’s review. Universal Life insurance is a flexible premium product. This means that, within certain ranges, you can pay what you want into the policy. If you pay in more than it costs, the extra premiums will be deposited into your cash value and will earn interest. As you get older, the internal cost of the policy rises, due to the cost of insurance, which I’ll explain next week. The idea behind UL is that you pay extra early, so that down the road, you have enough cash value accumulated that the interest it earns will help pay your higher cost of insurance. If you purchased a policy back in the 80s or 90s, your agent would have calculated an assumed premium that would keep your coverage in force based on how the policies were performing back then. One of the assumptions would have been interest rate.
How much impact can the interest rate really have on a policy? Frankly, a huge one. I know that one of the carriers I work with was paying as high as 12% back in the 80s, but they are only paying 5% today. That’s roughly half the interest rate. Intuitively, you might feel like earning half the interest results in half the cash value, but that’s not how compounded interest works. Let’s work through a quick example.
Say you bought a policy when the company was paying 10% interest, and let’s assume you paid a premium of $50 a month from the outset. Let’s ignore any other costs of the policy, and just look at the result of changes in interest rate. Paying $50 a month for 35 years (remember, we are talking about policies purchased in the 80s and 90s) at 10% interest would have given us a projected cash value of $193,427.52 today. That would mean your policy would be earning $19,343 of interest each year to help pay your insurance costs.
Now let’s drop that interest rate to 5% and see what happens. The same $50 a month premium at 5% for 35 years results in a cash value of only $57,169.80. That’s less than two thirds of the above example. What’s more, this policy is now only earning $2,858 of interest to help pay your costs. That's less than one sixth of the interest you would have been earning at 10%! This would leave you with almost $17,000 of policy costs to make up out of your pocket.
As you can see, the interest rate you’ve earned over the years has a major impact on the ultimate performance of the policy. It’s not even a proportionate impact; in other words, earning half the interest actually reduces your performance by almost 85%, not 50%. Any plan to “rescue” your coverage is going to need to take this impact into account.
Next time, I’ll cover the other major moving part of a Universal Life policy, the cost of insurance. I’ll explain what it is, why it goes up every year, and how it impacts your policy. Finally, the post after that will discuss some of the more common options for dealing with this situation, hopefully giving you the tools you need to come up with your own plan if you happen to be in the same boat. As always, contact us, or leave a comment below with any questions.
Go back to UL Part 1 Go to UL Part 3
The most valuable feature of a life insurance policy is the carrier's promise to pay upon death. But if you purchased a Universal Life (also known as Adjustable Life or Flexible Life) policy in the 80s or 90s, there's a good chance you might lose that coverage before you can collect the death benefit. In this series of articles, I'll explain how Universal Life works, why it might be failing, and what you can do about it.
All life insurance is built in the same way at its base. First, the insurance carrier assesses the risk of you dying while covered, based on your age, gender, health, and other factors. Next, they make an assumption of how much interest they can earn on the premiums they collect from you while you're living. Finally, they calculate how much premium they need to collect from you over the life of the policy so that your premiums, plus interest, cover the cost of the risk, plus a profit for the company.
With most life insurance products, those premiums are fixed for the duration of the coverage, and the insurance company takes all the risk that their assumptions might be wrong. In other words, if more people die while covered than they anticipated, they'll make less money. If interest rates are lower than they assumed, they'll likewise make less money.
Universal Life is a different animal. Developed in 1979, when interest rates were off the charts, universal life was designed as a product that would allow consumers to take advantage of high interest rates, without the insurance company having to commit to continuing to pay those high rates over their clients' entire lifetimes. It works exactly as described above, except that with Universal Life, it's the consumer who takes on the risk that interest rates will decline, or that more people will die than the carrier assumed.
That's not necessarily a bad thing, since with risk comes potential reward. By making their interest rate and mortality assumptions transparent, the insurance carrier put the power in the consumers' hands to decide how much premium they wanted to pay into the product. So, consumers gained flexibility. In addition, consumers were able to take advantage of the high interest rate environment of the 70s, 80s, and, to a lesser extent, 90s. Properly managed, a Universal Life policy purchased in the 80s had the potential to offer more coverage, more cash value growth, and lower premiums than a whole life policy with the same death benefit.
The downside of this flexibility is that when interest rates fall, which has been the overall trend since about 1981, it's the consumer who has to deal with the consequences. Since the interest rate on a Universal Life policy helps to pay its cost, a policy that is earning less interest than projected needs to make up the difference somehow. Either the consumer must pay a higher premium to compensate for the lack of interest earned, or the policy uses its own cash value to make up the difference. With most Universal Life products that were on the market before the turn of the millennium, if the policy's cash value reaches zero, the policy lapses without value, and the consumer loses their coverage.
So that's a broad overview of how a Universal Life policy works, and why you might find yourself in a situation where it's failing. Next time we visit this topic, I'll dig into some of the inner workings of a Universal Life policy, making it easier to understand your policy statement, and then we'll discuss some potential solutions to this scenario. If you have questions, feel free to post in the comments below, or contact us. We'll be happy to review your specific situation.
Go to UL Part 2
Here we are in week... whatever.. of the pandemic, and you've got your sourdough recipe down pat. You've canceled travel plans, done virtual family game nights, attended drive-in theater concerts, maybe even starting your own Tik Tok channel. Maybe you've even taken a hard look at your family's finances.
You wouldn't be alone. Life Happens recently conducted a survey that polled more than 2,000 adult Americans about how the pandemic changed their financial views and behaviors. Their “Tough Talks During COVID-19” survey results showed that dramatic changes are taking place.
For starters, more than two-thirds (67%) of respondents said that COVID-19 has served as a wake-up call to reevaluate their finances. Americans aren't known for being savers, but the pandemic has made people sock away money by cutting out needless purchases.
What’s more, 66% of respondents believe that COVID-19 helped them better understand life insurance. Meanwhile, a quarter (25%) of respondents have bought life insurance for the first time because of it.
COVID-19 made many of us seriously consider our mortality for the first time. It’s sadly shown us that no one—not even the young and healthy—are assured a long life. And that an untimely passing all too often leaves the ones left behind on shaky financial ground.
That’s where life insurance can be a financial lifeline. It provides funds that let your family maintain their standard of living when your earnings are no longer in the picture.
Life insurance is probably a lot less expensive than you think. Many people are surprised to learn that a healthy 30-year-old can get a $250,000 20-year level term policy for just $13 a month. With this policy, your loved ones would receive $250,000 if you were to pass away between the ages of 30 and 50. (And they’d receive the full $250,000, since life insurance proceeds almost always pass on tax free.) To get an idea of how much life insurance you’d need, check out our Life Insurance Needs Calculator.
If you’re wondering if you have enough life insurance, you may also be wondering what you can do about it. With physical distancing protocols in place for much of the nation, you may think your insurance agent’s office is closed, and you may be asking yourself if you can even get life insurance during the worst pandemic the U.S. has seen in at least a century. The good news is you still can.
Most insurance agents and agencies are still operating in some capacity, whether that be doors open, phone appointments, online meetings or text and email. There are options to allow you to meet with a qualified professional and get the answers you need about your coverage, and to apply for more insurance if that's the best option for you.
The insurance carriers have also taken a huge leap forward in terms of their underwriting processes and technologies in response to the pandemic. More options exist for issuing policies without contact, and without the need for a physical exam. Some are using voice signatures, some email signatures, and your insurance agent will be able to find the option that suits you best.
So, although you may already be struggling to balance homeschooling your children, having to run back to your car in the grocery store parking lot because you forgot your mask, and trying to teach grandma how to connect to your Zoom call, getting the life insurance you need now can give you one less thing to worry about later.