Is Your Life Insurance Policy on Life Support?

Contact: Carlile Patchen & Murphy LLP (Columbus, Ohio, USA)

If you have a home mortgage, or other retail debt, you have no doubt been quite happy with the Federal Reserve's monetary policies over the last few years that have kept interest rates at near record lows. On the other hand, you probably don't feel so pleased looking at the return your interest-sensitive (can you say, "CD"?) investments are producing. If you haven't checked up on your life insurance policy(ies) lately, you might find they aren't enjoying the low-interest rate environment much at all. In fact, they could be in critical condition.

If you own an "interest-sensitive" type of life insurance policy, a type extensively marketed since the 1980s as "universal life," "variable life," or "adjustable life," among other similar names, hopefully you have reviewed the policy with your agent at least every other year to check up on its financial health. In these types of policies, little is guaranteed -not the premium, death benefit, or duration. You started off paying annual premiums that were higher than a similar amount of pure term insurance at that age. This excess amount was credited to the policy's cash value, which is invested tax-deferred inside the life insurance policy for your benefit and used to pay future premiums as the cost to insure you increases as you get older. By paying a little more each year in the early years, and earning a "nice" return (often projected by the insurance company back in the 1980s and 1990s as 8%-12%) on the invested excess premiums for many years, you will pay much less in later years, making these polices much cheaper than a traditional "whole life" policy wherein the same amount of death benefit and premiums are guaranteed forever.

The problem is that the 8-12% investment return on the excess premium amount that was used to project the amount of premiums and death benefit over your life was not guaranteed; the guaranteed amount was typically only 3%-4%. If you just kept paying the premiums based on the initial 8-12% illustrated return, then, as the actual investment returns on your cash value plummeted over the last 10 years, the policy has eaten up all the accumulated cash value, and now your policy looks just like a new term policy taken out at your current age, with a whopper of a premium required to keep the policy in force.

For a real-life example, a husband and wife (now 80) took out a $2 million second-to-die universal life insurance policy in 1996 and put it in a trust for their children when the couple dies. At sale, the policy was illustrated with annual premiums of $30,000. At the initial illustrated 10% return on accumulated excess premium cash value, the policy would have been able to pay the $2M death benefit even if one of the insureds lived beyond age 100. However, because the actual return on the excess premium cash value since 1996 has averaged only 5%, the policy now has no cash value, and to keep the policy going will now require annual premiums of $225,000, which the couple can either pay or terminate the policy and receive nothing. This is a very common situation for people who have not paid attention to the actual performance of their policy over the years, and there are many.

What to do? Start now by requesting an "in-force" review of your policy from your insurance agent. It shows how the policy's cash value and premiums are expected to change using current interest rates, death benefit costs and other fees. Depending on your age and how bad the numbers look, you might decide to: sit tight; reduce the death benefit to make the cash reserves last longer; put in more money (if you're sitting on cash and a 4% return is guaranteed); swap the policy for a different one; or sell the policy on the secondary market (a very treacherous landscape). We have helped many clients navigate this thicket. Please call your CPM lawyer if you would like our help.