Updated: May 3, 2013 12:14PM
Originally published: November 19, 2002
The two-year-long decline in stock prices and interest rates may have had a hidden impact on your life insurance policy. And if you don’t know what questions to ask, your life insurance could disappear long before you’re planning to die.
Here’s the problem: In the 1990s many people purchased cash- value insurance policies--universal life or variable life. These policies were designed to build up cash over the years to help pay the premiums in later years. But lower interest rates and lower stock prices mean the policies aren’t growing as predicted. You’ll either have to start making higher annual payments or watch your policy expire early.
Illustrations are not guarantees
Universal life policies were designed so that your annual premium payment was augmented by an annual “crediting” of interest from the insurance company. Back in the 1990s, the interest rate in that model was set at 7 percent or higher. So the insurance agent counted on that extra cash credit every year when he figured your annual premium to keep the policy in force.
But those premiums were based on “illustrations,” not guarantees. You had to read the small print to find that the “minimum guaranteed rate” was more like 4 percent. These days, with the insurance company’s own portfolio yielding less, there’s less money to credit toward the cash in your policy.
To keep your policy going, you’ll need to pay more in premiums. The sooner you do that, the better. Here’s an example:
In 1999, Susan, then a 52-year-old non-smoker, purchased a $500,000 universal life policy. Her agent explained that she would have to pay a premium of only $4,450 per year to keep this policy in force for the rest of her life (estimated by actuaries to be age 86).
Susan’s $4,450 premium was calculated based on then-current crediting rates of 6.85 percent. But this year, as a result of the decline in the stock market and interest rates, the insurance company is crediting only 5.75 percent to Susan’s policy. If Susan keeps paying the same annual premium, her life insurance coverage will end when she reaches age 83. Further interest rate declines could shrink her period of coverage even more.
There are some alternatives. Susan has the option with a universal life policy of either reducing the face amount of the insurance, or paying a higher premium every year to extend her death benefits for her foreseeable lifetime. Since she doesn’t want to reduce her coverage from $500,000, the agent tells Susan that to keep her policy in force until the originally intended age 86, she will have to increase her annual premium payments by $1,000.
Obviously, the sooner you take a look at the issues, the less expensive it will be to rebuild your life insurance structure. If Susan waited to find out about this problem for another decade, when she becomes 65, she’d find that her coverage was going to expire just after her 80th birthday, and Susan was planning to live a lot longer than that.
Variable life problems are worse
As bad as the problems are with universal life policies, variable life policies are in worse shape. These policies allow holders to invest their extra cash in a series of mutual fund sub-accounts in order to make their policy’s excess cash grow. Many agents predicted growth rates of 10 percent or higher, but now the investments inside the policy have actually lost money.
Variable rate policy holders could face huge premium increases to keep their coverage in force. And if they cancel the policies to buy new, more conservative ones, they could be hit with a surrender charge. Plus, they may no longer be insurable at premium rates now that they’re older.
If you own this type of cash-value life insurance, you should immediately contact your agent and ask for an “in force ledger.” This will tell you how your policy is doing. Then ask two questions: (1) When will my policy run out of cash given the minimum guaranteed rate? (2) How much extra premium must I pay starting immediately to keep my policy in force?
The answers may be painful. But it could be a lot more painful in the future if you don’t check up on your insurance policy now. And that’s The Savage Truth.
Terry Savage is a registered investment adviser and is on the board of directors of McDonald’s Corp. Send questions via e-mail to firstname.lastname@example.org. She appears weekly on WMAQ-Channel 5’s 4:30 p.m. newscast.