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.
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.
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.