Much has been written about elderly individuals who, decades after retiring, have found themselves handcuffed to universal life insurance policies with exorbitant ongoing costs. Angry customers felt cheated — though the problem may actually boil down to insufficient understanding.
Traditional, nonguaranteed universal life insurance is often described in the industry as current assumption UL, according to Jordan Smith, the vice president of advanced design at US-based boutique financial services firm Schechter. “Current assumption UL is a flexible premium permanent life insurance product that contains both an insurance component and an investment component,” he wrote in a column for Insurance News Net Magazine.
Current assumption UL policies differ from other types of nonguaranteed permanent life insurance in that their cash value is based on a flat crediting rate — not a dividend rate — established by the carrier and adjusted from time to time. Projections of the policies’ performance are based on annual policy charges and the insurance company’s crediting rate; many policies allow the carrier to raise policy charges under specific conditions, though that discretion is rarely changed from the schedule set forth when a policy is issued.
“In contrast, the crediting rate, which is tied to the interest rate that the insurance carrier is able to earn on its portfolio of fixed income investments, changes regularly,” Smith said. He explained that current assumption UL policies underperform primarily when crediting rate changes are overlooked and annual premiums aren’t adjusted accordingly. The illustrations that are run when a policy is issued project the policy’s performance assuming the scheduled policy charges and the crediting rate don’t change.
“The amount of death benefit paid to the beneficiary under most permanent life insurance products … doesn’t vary based on the cash value of the policy,” he added. Since the death benefit is level regardless of the policy cash value, Smith said, most policy projections assume the minimum funding necessary.
“[E]very additional dollar that doesn’t have to be used to pay premiums is a dollar (plus any future earnings on that dollar) that the insured’s beneficiaries will receive in addition to the insurance policy’s death benefit,” he said.
But when reality sets in — that is, when the crediting rate rises or falls because of interest-rate changes — they will not perform as cost-efficiently as expected given the premium payments set out in initial projections. Over time, if the problem isn’t detected right away, the policies could become so underfunded that getting them back on track would be unaffordable for the policy owners.
“To the extent that some policy owners believed that they were promised [high-single-digit] returns, it should reflect poorly not on the underlying insurance product,” Smith said. The lesson, he said, is that advisors must conduct suitability tests to ensure their clients can afford to maintain their policies in adverse crediting-rate scenarios. They should also properly explain the policies to their clients, and help ensure the policies are maintained adequately.
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