Today’s low interest rates mean that many people who think they have fully paid-up whole and universal life insurance policies will one day receive some distressing news in the mail—there are insufficient funds in their accounts to keep their policies in effect.
When consumers purchase whole or universal life insurance, they typically are told that if they make payments of a certain size for a certain number of years, their policies will be fully paid up, with no additional payments required for a lifetime of coverage and death benefits for their heirs.
Trouble is, those payment schedules are not guarantees—they’re just estimates based on the returns that insurance companies expect to earn by investing policyholders’ payments in low-risk investments. The ultra-low interest rates paid by those low-risk investments in recent years have left many whole and universal policies that were written more than 10 years ago well short of their projected investment returns and therefore underfunded. (Less-than-stellar stock market returns mean many variable life policies written in the mid-to-late 1990s have fallen well short, too.) When that happens, any cash value that the policy has built up begins to erode—eaten away by the need to fund new premium payments.
Policyholders who receive notices of insufficient funds typically are given two options—make sizable additional payments or allow the policy to lapse, requiring no more payments but voiding the coverage. If a policy is allowed to lapse, the policyholder and beneficiaries will receive nothing despite all the money previously poured into the policy. Many of these policyholders now are retired and living on fixed incomes. The additional payments required to keep original coverage amounts can take a massive bite out of their nest eggs.
Example: A 72-year-old man who thought his $3 million universal life policy was completely paid up decades earlier, ensuring that his heirs would receive $3 million when he died, instead received a notice warning that he would have to pay an additional $50,000 per year for 10 years.
Helpful: There might be a third option—some policies allow policyholders facing this situation to keep their policies in effect with a lower coverage amount. But insurance companies often do not mention this option unless policyholders know to ask.
What policyholders need to know now to protect their policies…
Insurers typically send policyholders notices of insufficient funds only when their policies are on the verge of default. The companies have no incentive to send them out sooner—they would prefer that the policies lapse so that they never have to pay out the death benefits. The earlier that you identify such a problem, the smaller the annual payments required to keep your policy in effect.
What to do: Don’t wait. Call or send a letter to your life insurance company’s policyholder service department requesting your policy’s “In Force Policy Pages.” (A form or written request signed by the policy owner may be required.) You will receive paperwork projecting what the future looks like for your policy, including whether additional annual payments are likely to be required. Contact the agent who sold you your policy or the insurance company’s policyholder service department for help interpreting this complex document.
If your paid-up status is in danger, you may feel angry about it, but resist the urge to allow the policy to lapse because of this anger. Instead, assuming that you can afford to make the additional payments, think of them as the cost of a new investment and the amount that the policy eventually will pay out as the investment’s return. Compare that return to what you could earn from other safe investments. A financial planner can help with this analysis if necessary.
Example: If you must pay $40,000 a year for 10 years to keep a $1 million policy in effect, your $400,000 essentially is earning a 150% return ($600,000) over the remaining years of your life, which might be far better than you and your heirs could do with any other low-risk investment.
If you cannot afford to make the annual payments required, give your heirs the option of making them for you. As the beneficiaries of the policy, it might be in their financial interests to do so.
You are at risk if you are a trustee for a trust that contains an insufficiently funded life insurance policy. You could be sued if this policy lapses—even if you agreed to be a trustee only as a favor for a friend. Do not assume litigation is unthinkable because the trust belongs to a friend who would never sue you. You still could be sued by your friend’s adult children, the future beneficiaries of the trust.
Bring the policy to a well-credentialed insurance expert, such as a Certified Life Underwriter (CLU), Chartered Financial Consultant (ChFC) or Certified Financial Planner (CFP), for review. Doing this should fulfill your fiduciary duty as trustee. This expert might charge $500 to $1,000 for his/her time—a fee that typically is paid by the trust—or he might audit the policy for free to build a relationship with a potential new client.
Source: Thomas J. Henske, CFP, CFS, a chartered life insurance underwriter, certified in long-term care, and a partner in the wealth-advisory firm Lenox Advisors, Inc., which has offices in New York, Chicago, San Francisco and Stamford, Connecticut. www.LenoxAdvisors.com