The ‘Dirty Little Secret’ of Universal Life Insurance



Henry Montag

HAVE YOU EVER DISCOVERED AN ERROR IN YOUR CHECKING ACCOUNT REGISTER and realized that you had $1,000 less than you thought? Well, imagine how much worse it would be if you found out that your life Insurance policy—which you thought was worth half a million dollars—was not there when your family needed it.

That could happen, if you’ve never taken the time to evaluate the performance of your existing life insurance portfolio to make sure the contract doesn’t expire before you do. The reason: Millions of life insurance contracts purchased over the last 25 years were “universal life insurance” contracts, which, unlike the more expensive “whole life insurance” contracts, were not guaranteed to last a lifetime.

Let me explain. Back in the mid-1980s, when average interest rates were 14% to 15%, there were only two types of life insurance contracts. The first type, term insurance, provided a certain amount of insurance, guaranteed over a specific period of time for a specific premium. The second was known as “whole life insurance,” which, as the name implies, was guaranteed to be there for a person’s lifetime. These whole life contracts contained an accumulation account known as “cash value,” which earned a fixed 3% interest annually and could be withdrawn by the policyholder and used for any purpose, as long as the person paid a 5% interest charge on the withdrawn money.

So people started to borrow, put their lower interest insurance money in then high-earning interest rate accounts (again, paying as much as 14 to 15%).

Not surprisingly, the insurance companies were not happy about this. To stop this outflow, the life insurance industry created “universal life insurance,” which paid an interest rate based on current interest rates, rather than the fixed rate in whole life contracts. If interest rates went up, premiums went down and insurance coverage would last for a longer period.

But if interest rates decreased, the length of coverage would be reduced. I’ve referred to this as the insurance industry’s “dirty little secret,” because at the time the universal insurance contracts were first introduced, no one questioned whether the length of time the contract was guaranteed—and this was something clearly not understood by many consumers.

With universal life insurance policies paying interest rates similar to CDs, the industry did manage to stem the tremendous outflow of monies from insurance companies to banks.

But as interest rates declined dramatically in recent years, many policyholders now faced a potential “time bomb” in universal life insurance policies. That is, if the insurance company’s projected investment returns of 20-30 years ago failed to materialize, the company could make up the difference by reducing the cash value of your policy (taking money out of your cash value savings account) and essentially reducing the length of your contract coverage.

As a result, if you originally assumed your life Insurance contract would last to age 92, you might now find that contract would only last to age 82. In order to maintain your death benefit, you would have to pay a higher premium to make up the unrealized investment return of the insurance company—or your policy would expire prematurely and become worthless.

So what should you do?

Sit down with an insurance agent or financial professional and conduct an audit review of your policy. First, request a “historical projection”—that is, the actual interest rate return earned each year (rather than the original assumed rate), to determine how long the contract will remain “in force” if you continue paying the current premium. Second, find out how much you would need to increase your premium to keep your current policy in force until the age you desire, whether it is 85, 90 or older.

It’s better to know the truth about your universal life insurance policy sooner rather than later. The more advance notice you have about a potential shortfall, the less additional money is needed to adjust the contract back to a desired and realistic age.

Furthermore, in the process of doing this audit you might discover other important questions you need to consider about insurance coverage: Do you have the right type of insurance, based on your current objectives today rather than when you first purchased the contract? Are the people you’ve previously named as beneficiaries still those you want as beneficiaries today? And should you consider new insurance benefits available today, such as a chronic-care rider that can pay for some long-term care costs?

In the end, the biggest problem is that too many people file their life insurance policies away and don’t look at them again. But as more people enter their mid-70s and 80s, and with many people living longer than they did just 25 years ago, their families may be facing the rude realization that their insurance contracts are expiring prematurely. So it’s important to check your policy today to make sure your beneficiaries will indeed have something to collect when you’re gone.

Henry Montag is an Independent Certified Financial Planner as well as a Certifed Long Term Care Specialist, based on Long Island. He is a contributing writer for The Moneypaper, and has been cited as an expert in many publications, including Investors Business Daily, the Wall Street Journal, and Investment Age. Contact:

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