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Is your Life Insurance Policy about to Implode?





This is a guest column by insurance specialist Glenn Cooke.

Your life insurance policy may be about to implode. You may be on the verge of having to pay exhorbitant premiums just to keep your existing life insurance policy in force – and with those premiums continuing to increase year over year.

Life insurance companies are already becoming aware of the issue but for the most part have not taken any action. Consumers currently are mostly oblivious to the looming problem, so take this as your wake up call!

I’m going to show you how to check your life insurance policy for danger signs, but first a bit of life insurance history is an order.

Vanishing Premium Lawsuits, 1980′s and 1990′s

Back in the 1980′s life insurance (specifically whole life insurance) was often marketed to consumers on the premise that their policies would become paid up – generally at retirement. Buy a policy when you’re 40, pay premiums for 25 years and when you hit 65 your insurance premiums are paid up for the rest of your life.

Those policies depended on non-guaranteed dividends to make the policy paid up. In the 80′s and 90′s, the non-guaranteed part came through – dividend scales were lowered. People who’d had policies for many years and were now expecting their insurance premiums to stop for the rest of their lives started to receive notices like ‘just another 10 years to go’. How would you feel about getting that letter?

Well, that’s how a lot of consumers felt. And the end result was successful class action lawsuits against the life insurance companies. The lawsuits were called ‘vanishing premium lawsuits’ because consumers had been led to understand their premiums would vanish.

Illustration Guidelines Introduced, 1990′s

So the life insurance industry collaborated and created a set of guidelines surrounding how illustrations and quotes should be displayed to consumers. Since that time consumers who purchase some types of life insurance have had to sign a piece of paper that basically says ‘stuff about this policy isn’t guaranteed’. Remember that part for later – the insurance companies now have a piece of paper that you signed that says ‘I told you so’.

Universal Life Insurance

Enter Universal Life Insurance. This insurance product become popular at about the same time as all the vanishing premium lawsuits were happening. Universal life insurance has two components – an insurance costs, and an investment. The insurance costs come in two flavours – level costs for life, and annually increasing.

Many people purchased universal life insurance (and still do today) with the annually increasing costs of insurance. The lower initial insurance costs lets them put more money into the investments early on. The investment earnings can then be used to pay part or all of the insurance costs later.

Example 1:

Insurance costs: $250/year when you’re young. Becoming $2000/year later when you’re older

Premiums you pay: $1000/year

Investments – you’re paying the company $1000 per year. Since they only need $250 for insurance

costs, the extra $750 goes into the investments.

Fast forward to 2008. Let’s say you’re investments have grown to $10,000 and your insurance costs have grown to $2000. You’re still paying your $1000 in premium – so half the insurance cost is paid out of your pocket each year. Let’s assume your investments are earning 10% – so your investments kick out the other $1000 and those investment earnings are then used to cover the other half of the $2000 insurance costs. That went well didn’t it? You’re still paying $1000 per year and are happy enough – it’s level just like you thought it was.

But….Anyone remember any recent market crashes?

Let’s take an alternate scenario. It’s 2008. And your $10,000, instead of earning 10%, drops 40%. Your investments are now $6000. You pay $1000 out of pocket towards the insurance costs. The remaining $1000 in unpaid insurance costs now come from the $6000, leaving you with $5000 in the investments. Even if things bounce back to 10% earnings, every year when the insurance costs are deducted, your investments are going to get smaller and smaller and eventually hit zero.

Heads up!

You’ll notice that the problem doesn’t become apparent immediately. The market crashes, and it may take 2,5, or even 10 years for the investments to dry up. But that’s making the problem worse – remember in this situation the underlying insurance costs go up every year. The longer it’s delayed before the problem becomes apparent, the worse your options are going to be.

In the initial vanishing premium scenario consumers were faced with premiums that were likely level but continuing for a longer period. The reaction was successful lawsuits. In today’s looming universal life insurance scenario consumers may be facing premiums that start out already very high and skyrocket every year after that. And the companies this time have your signature saying you were aware that these things were not guaranteed.

Do you have one of these policies?

If you have any kind of life insurance that has cash values, investments, or premiums payable over your entire lifetime, you should go dust off the policy and see if you in fact have a universal life insurance policy.

If you do have a universal life insurance policy, find the description of the insurance costs. Different companies have different names, but you’re looking for something like ‘annually increasing’, or ‘yearly renewable’. If you’ve got universal life insurance with annually increasing insurance costs, you’re in danger of your policy imploding.

What can you do?

If you find yourself in this situation, the first thing to do is get informed. Call you insurance company and ask for an ‘inforce illustration’. They should use your current investment balances, along with a reasonable and conservative investment rate of return. That will give you an estimate of what things may look like going forward. I would point out that even ‘reasonable and conservative’ may not match reality. Try throwing a -40% rate of return in there once in a while and see what happens.

Any specific actions you take after you’ve become informed is still likely to be painful, but the best time to fix it is now. If you’re healthy, you may consider purchasing a new insurance policy with guaranteed level insurance costs. Of course if you surrender your existing policy, any cash that comes out of it will probably be taxed and may also have surrender fees attached to it.

If taking a new medical exam isn’t an option, you may ask your insurance company if you can convert your insurance costs from annually increasing to level. Different companies will have different rules surrounding this. And if you’re still confused, don’t hesitate to call a couple of insurance brokers. These are complicated policies with complicated choices so review your options carefully and ask questions. In the end, the best thing you can do is ensure as much about your insurance policy is guaranteed as possible, and don’t let your future insurance premiums be dependent on anything not guaranteed – no matter how sweet the illustrations look.

Glenn Cooke is an independent life insurance broker and president of Life Insurance Canada Inc. He can be reached at (866) 662-5433.





32 Comments, Comment or Ping

  1. 1. Rachelle

    I had a friend who purchased one of these investment/insurance policies for both of her daughters’ education. This was actually marketed to her as an alternative to the RESP. Needless to say it didn’t work out nearly as well as the salesman said.

    I forget the exact details but she would have been much better off just to put her premiums under her mattress earning no interest at all because of the changes that were made to her policy midway through the process. Not to mention that although she did get bland letters about the changes, the impact of the changes was not explained and it took her a few years to realize what was going on. She’s a single mom and very frugal and conservative so the impact of it was devastating, instead of her daughters having a paid for education after her paying for years, her daughters had to get student loans.

  2. I guess not a lot of readers have universal or whole life insurance. :)

  3. 3. Brandon

    Wrong or not, I operate under the philosophy that whenever possible, it is always better for me to underwrite my own risk if I can afford the damage. Otherwise I am paying for all the overhead and profit margin of an insurance company as a part of the premium, instead of just paying for the cost of damages.

    As such, I dont have a whole lot of insurance.

  4. Hi Glenn,

    The investment part of the UL (which is exposed to the market) works until it doesn’t. Just like advisors talking about a long term 8% or 10% rate of return (which clients have not seen).

    What I am not sure, is your claim on whole life insurance problems. Can you give me any examples? The UL problems (see markets) I have heard of, but not whole life policies, since the dividends have been positive for over 100 years in many cases.

    cheers,

    Brian

  5. Brian,

    Here’s one link: http://www.classaction.ca/content/actions/vanishing_premium.asp

    There are other links in Google. Not as much info online because this happened pre-internet but there was still lawsuits going on into the 90′s. I recall the era well as I was involved in illustrations at an insurer during that period.

    I would suggest caution with your premise that dividends have been positive for over 100 years.

  6. Glenn,

    I still think you maybe thinking about UL policies. The dividends over the last 30 years ranged from about 12% (at the peak mid 80′s) to around 7.3% for 2010. (Participating whole life.)
    If I look at Canada Life’s dividend history 1975- 2010 as a guide.

    If you have some example cases on cases like whole life (lawsuits) that would be interesting to see the illustrations/cases. Since the dividends were much lower than the GIC rates at that time (high teens) unless the agent did his/her own illustrations I believe you maybe mixing the two up.

    The dividends example(100 years) would be companies like London Life as an example.
    http://www.londonlife.com/web5/groups/iiiplifeinsurance/@public/documents/web_content/s5_008227.pdf page 8 of 16 ….since 1874.

  7. Brian,

    Vanishing premium lawsuits were the result of whole life insurance dividends, NOT universal life insurance. There’s no confusion on this point – none whatsoever. I’m surprised that you’re not familiar with the issue.

    You mention London Life. Here’s a long document that discusses London Life’s class action settlement over dividends (not universal life):
    http://www.londonlife.com/web5/groups/corporate/@public/documents/web_content/s5_008160.pdf

    Yes, London Life got sued successfully over matters relating to vanishing premiums on whole life policies (not universal life) due to dividends.

  8. 8. Evelyn

    Rachelle, Once a policy is inforce what kind of changes can the insurance company make partway through? They can only change anything that is not guaranteed. Did your friend agree to any changes?

  9. Glenn,

    I think what you are talking about is a mix of wholelife and term. The dividends from the wholelife was used to buy term. In general, if one was to do this having the term separate, makes sense instead of mixing the two together.

    Reading the text, that some agents may have promoted the returns (where they got them I don’t know) to be something they were not.

    The bigger problem I see is the over funded UL policies shown with high rates of returns (exposed to the market).

  10. 10. Mark

    @Rachelle

    Your friend wouldn’t have been better off putting it under her mattress because she would not have had life insurance then.

  11. 11. Elbyron

    But Mark, she didn’t die! So having life insurance did her no good. We’re talking about the past here, so it doesn’t matter what could have happened, only what did happen. If she had known for sure she wouldn’t die, she obviously wouldn’t buy any insurance. Of course she didn’t know that, so she benefited from the life insurance by having some piece of mind, but financially she and her daughters would have been better off putting it under the mattress and avoiding student loans.

  12. 12. Melanie Samson

    Interesting thoughts. We both have our policies through work at the moment. I’d like to look at our insurance more closely when we get around to making a will (sometime next year).

  13. 13. The Reverend

    Melanie, note that if you lose your job, you likely lose your insurance.

    I’m on Glenn’s side with respect to the discussion about Whole Life. I’ll agree that advisors probably over illustrated the dividend returns such that when policyholders expected premiums to vanish, they didn’t. But the dividends were still positive. I don’t know of an insurer that ever has (or likely ever will) allow dividends to go negative on whole life.

  14. 14. Ray

    I have the 20-pay life with London Life and I guess it’s Universal Life because I don’t see any of these problems with it. The policy generates a cash value, that cash value is invested and generates a non-zero (and non-negative!) dividend every single year… over the last 10 years of my policy it has been around 5 to 8% per year, including 2008 and 2009, bad investing years. The interesting thing is that the dividend gets added to my cash value and the dividend next year is compoundingly larger. If the market were to tank -40% then I imagine my dividend next year would be -40% smaller, but it’s still non-zero and non-negative. The insurance I have has a guaranteed component and then the dividends are on top and can never be taken away so it seems that my growing death benefit at worst case could stall but never decrease. My premiums vanish in 10 years. Cool policy.

  15. 15. JFG

    @Brandon

    Insurance, in all senses, is not for you. It’s for the people close to you.

    Not having insurance is moronic. Imagine leaving a mortgage, car loan and two young kids for your spouse to take care of on his/her own.

  16. Ray, if you think that your London Life policy has premiums that go to 0 in 10 years then you should read the link to the London Life lawsuit in my previous reply above.

  17. 17. Ray

    I did read it. It’s some old class action suit that ended with policies up to 1995. Mine started 10 years ago like I said and the fact that my premiums END in 10 more years isn’t even up for debate. It’s not even a remote possibility that they *wouldn’t* end in 10 more years. The plan is a 20-pay plan, that’s the whole point of it. The topic of this blog/thread is about your life insurance tanking because of a bad performing market. My point was that *maybe* any *future* dividends may be less than I’m getting now but it certainly isn’t going to subtract from my policy. Everything that I have to date is vested.

  18. London life, and many others got sued successfully because consumers were led to believe that their policies would become paidup. You have a London Life policy that you believe will become paid up – and you’re so firm in that believe (not sure why you’re so firm in that belief, unless you’re a shill for the company) that you ignore everyone else’s experience.

    Either your 20 pay is guaranteed paid up, or it’s not guaranteed. I have no konwledge of your policy either way, and you seem to be hedging suggesting that it is guaranteed. If it is guaranteed, then you’re right, it’s not up for debatie. But if it’s not guaranteed, i.e. subject to dividends, then suggesting it’s ‘not up for debate’ is a bit simplistic. You may not want to believe that nonguaranteed elements (like dividends) can fail to perform, but there’s plenty of evidence just in this thread to refute that belief.

  19. 19. Ray

    Glenn, I’m just a guy with a policy. I think I’ve stated in about 6 places that the dividends are not guaranteed and that they can fail to perform each and every year (but as demonstrated by other users in this thread, they haven’t failed to perform in 100 years). Anyways, the policy itself is actually titled 20-pay Life, you pay for 20 years, then you have no more premiums. There’s nothing in the policy that says dividends play into the insurance whatsoever. In fact, if there are dividends I can take them in a cheque format the instant they are issued. If the dividends are 0 for a particular bad year, so be it.

    Over the 20 year period, 60% of the death benefit is collected in premiums, so you can see this is an expensive policy. Since I was in my 20s when I took it out, there’s a very good chance that the 60% death benefit in premiums will continue to be invested until the day I die by London Life and they’ll clearly be way ahead by the time they pay me out.

  20. Ray,

    I think what you have is a whole life policy with paid up additions. If that is the case, the cash value grows and so does the insurance. Over time, the policy gets better.

    I believe what Glenn is talking about is including a mix of term which is paid by the dividends. So what you have is different, to what Glenn is talking about…correct?

    The dividends paid by London or similar policies life Equitable or Canada Life (participating whole life) have always paid a dividend for many decades without fail. This dividend of course will vary form year to year, in the mid 1980′s is was as high as 12% to 2010 of above 7%, since part the dividend is use buy more insurance the cash value grows at maybe 4-5% (at year 20).

  21. 21. MDJ Reader

    FrugalTrader,

    You mentioned this: “Of course if you surrender your existing policy, any cash that comes out of it will probably be taxed and may also have surrender fees attached to it.”
    My father had a life insurance policy that he had to cancel due to the very same reason (skyrocketed premiums), I do not believe he got anything back (principal or otherwise). Did he miss out on something? He was under the impression that if a life insurance policy is canceled, all accumulated cash is forfeited.

    Toronto, Ontario if that makes a difference.

    Thank you.

  22. MDJ Reader,

    It is hard to say what your dad had, but it seems like a UL policy with increasing premiums to support the death benefit. This plus poor returns within the policy may be the problem.

    What could have happened is to modify his policy to keep it in force. Details of the policy are missing one can only guess. If your dad was older buying an annuity which would pay for the insurance may be the way to go. Currently working with a person who tries to save policies with some success.

    Brian

  23. 23. cannon_fodder

    I credit reading the wealthy barber a long time ago for educating me to the benefits of life insurance and which type is most appropriate for me. I chose term and I encourage anyone with dependents to get life insurance to cover off their debts and loss of income.

    I’ve seen too many examples of families crushed under the burden of selfish thinking. Because that’s what it is – selfish. No one who loves their family would want them to be left in a debilitating financial mess that could literally take a lifetime to resolve.

  24. This is a great blog entry. You have nailed the issue and those who have any sort of life insurance policy with cash values that is over ten years old needs to have a policy review done. I’ve seen plenty of universal life policies that are going to crash because of underfunding and lack of inside return.

    We like to see cash value policies that are funded at maximum levels for long-term safety. Otherwise, you’re just buying an expensive term policy.

    Again, great over view of the issues.

    Thanks.

  25. 25. Greg

    Just thought I would chip in on this article based on some recent talks I’ve had with WFG (World Financial Group).

    They heavily market the UL policy as a “forced savings program” and way to avoid probate fees (maxed at $400 in Alberta :P) among other things. One of their key points is that after 65 your policy pays for itself in bonus interest. They casually mention that the bonus interest is contingent on earning over 6-7% per annum…after age 65. I don’t know about y’all but I think retirement is when I would like some additional security. Maybe bonds will be up over 7% when I retire… If you don’t qualify for the bonus, you end up paying huge premium costs, which in my wife’s case total $75,000 (age 65 to 100).

    To me, a UL policy after age 65 (on the projections I received age 65 is when the cash value was near the original policy value) is essentially paying someone else a boatload of cash to insure you with your own money. The policy projection I received started at 100% policy value and slowly changed to 100% cash value (e.g. my money!) at age 84.

    I say after age 65 as UL seems to offer cheaper insurance / $ under age 65 than term.

    BTW, the UL policies are held in an indexed “savings” account (your money does not purchase a piece of the fund) that pays out interest matching the net performance of select funds. Yes, the net return, the insurance company takes the MERs…

    My Momma always said If it smells fishy and looks fishy, it’s probably fish.

    I think I will get some term insurance and invest the difference (grossed up)in an RRSP. It blows UL out of the water, even after taxes.

    Greg

  26. 26. Orlando

    Re. Dividends:
    Dividends from a whole life participating policy are not the same as dividends from the profits of a company.
    Premiums charged in a whole life participating policy are higher than a regular non-participating policy; the dividends are a partial repayment of over charged premiums.
    Premiums are overpaid when the insurer incorrectly estimates mortality rates and policy administrative expenses. These so called dividends have nothing to do with the overall profits of the company.
    Once mandatory reserves have been funded the excess is returned to the par policy holder as what is called an insurance “dividend”. The dividends are not reportable income as they are refunds of the clients own after tax income.

  27. 27. Orlando

    @ Ray
    See my comment on dividends as pertaining to life insurance and you will see that those dividends are not as attractive anymore. Regarding your 20-pay life “cool policy”, of course you don’t pay after 20 yrs because you have already paid for it as they calculate how much premiums you would have to pay over the life of the policy and they compact it in 20 yrs time, so your monthly premiums are higher than if it had been a normal whole life policy. It’s like when you buy a $20,000 car an you have choice to pay your loan in 3, 5 or 7 years; if you chose to pay it back in 7 yrs, your payments are lower than if you pay it back in 3 years, but you still pay $20,000.

    Glenn, your article is right on the money and very educational. Hope a lot of people read it. Good job!

  28. Orlando,

    I think you are missing some details on whole life dividends and I am sure you do not get involved in personal or corporate tax returns.

    The dividends comes from different sources. One is the premiums charged to the policy holders. This is to cover the death benefit because this built to last, any extra money is is invested in other areas such as bonds, mortgages and some stocks in a pooled fund which a fee of less than .4% is charged. After all other expenses such as claims paid, dividends are paid to the policy holder. Since the investments are conservative, many of these investments did not go down in 2008 like other asset classes.

    These dividends have been paid out in some cases every year for 100 years in Canada.

    If set up correctly, the insurance coverage and cash value grow every year. (the cash value can be accessed tax free if done correctly). Is there better investments the answer is yes! Can you get more coverage for less money when you are young yes. Is this for everyone, no! Cash flow is important.

    If one has good cash flow (personal or through their corporation) the money can be used many times over.

    In retirement, when one is in the distribution phase you can pay less taxes and have more money to spend with better protection against all economic conditions .The money can be used to buy other things, provide protection. If one is sick, the policy can be paid up to 65 by the insurance company. No investment can guarantee that.

  29. 29. Orlando

    Dividends–

    The tax code considers policy dividends to be refunds of overcharges and thus not taxable, but there are two exceptions to this general rule. First, when the total of all dividends paid in cash exceeds the total premiums paid, the excess becomes taxable income (this rarely happens). Second, when dividends are accumulated at interest, the interest becomes taxable
    as if the account were passbook savings.

    But dividends used to reduce premiums do not trigger either of these tax issues and dividends used to purchase one-year term or buy paid-up additions remain tax-free benefits.

    As per LLQP manual on Life Insurance and Taxation

  30. 30. Brad

    Brian is a CFP? And drinks the koolaid on dividends. Dividends have paid out for 100 years, of course they have because they are not dividends in the ‘stock’ sense of the word, Insurance dividends are nothing more than a refund of an overcharge of premiums. I charge you more than the cost, give you a bit back and ask you to thank me for giving you back the overcharge. What a scam.

  31. 32. Brad

    One truth about Universal Life is that they are very complex financial instruments. In the right situations (not that common) they can be a great tool. But they are certainly not for everybody, just a small minority.

    And if you are going to buy Universal Life, unless you are very wealthy and max funding the plan, you should always be sure that the premium is set to Level Cost of Insurance (not Yearly or Annual Renewable Term).

    Unfortunately, the people at WFG (I started my career there and then left as soon as I figured out what they were about), for the most part do not understand much about financial instruments. They are a Mult-Level Marketing company with a very high attrition rate of personnel, and no internal financial planning methods or tools. Their leaders have actually said that ‘everyone should own Universal Life Insurance’, but they are the very people responsible for setting up many of these imploding UL plans.

    The average person, and many insurance advisors, do not generally understand the implications of Yearly Renewable Term, and by the time they realize the problem, they are either unable to afford to fix it, and may not be able to qualify for insurance as they have aged substantially.

    The insurance companies, especially Transamerica who owns World Financial Group, should have been beaten mightily by regulators long ago. But little has changed in spite of the problems.

    Having said all this, Universal Life can still be a powerful tool when set up properly by someone who truly knows what they are doing, for the right client.

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