“What to Do with My Cash Value Life Insurance?”

Ok, I know life insurance is one of the more boring topics in financial planning but let me begin this topic with a true story.

Not long ago a gentleman in his early seventies called asking to meet to get our advice regarding a life insurance policy he had purchased decades earlier.  During the meeting, he unveiled the problem.  His insurance company had raised his premiums 60%!  If you read last week’s column, you know we ask three questions when deciding whether to keep or drop a life insurance policy:

  1. Does the reason you purchased the insurance still exist?  In this case, his children were all grown and financially on their own…so no need for insurance here.
  2. Is there a current or expected future liquidity need?  His estate was significantly under the $5,490,000 death tax exemption, so again no need to keep the policy for liquidity purposes.
  3. How’s your health?  Unfortunately, his health was not good and he was no longer insurable so this would typically cause us to think of ways to keep the policy.  But, while his health was not good, we believed he could easily live for a decade or longer, so paying 60% higher premiums was unsustainable for him.

I’m guessing you’re wondering, “Is it legal for the insurance company to do that?”  Herein lies the point of this article.  Yes, the insurance company does have the right to raise premiums in most cases.  In this case the policy was a Universal Life policy.  This means that in addition to a death benefit (called the mortality charge), there is a side fund that is invested at something resembling current interest rates.  This Universal Life type policy was a hot product during the eighties and early nineties when interest rates were very high.  The insurance companies ran projections at ‘conservative’ interest rates of 6% or more.  To make a long story short, the insurance companies made three critical errors:

  • They did not anticipate the extremely low interest rate environment we have experienced since 2007.
  • They underestimated how long people would live (improving medical technology).
  • They overestimated the number of policies that would lapse due to policyholders dropping their coverage.  The vast majority of life insurance policies lapse due to non-payment of premiums.  People just decide, at some point, that they no longer need or want to pay for the coverage.  What changed is the blooming of a boutique industry where investors pooled money to buy policies of sick people who were about to cancel their policy.  As a result, policies on people who were in the worst of health remained in force until they died so the insurance companies ended up paying out more death claims than expected.

The result has been a pretty ugly picture for many policyholders.  To protect profits, insurance companies are requesting state insurance commissioners allow them to raise rates…in some cases, to unaffordable premiums.

What should you do if you have a cash value life insurance policy?  Get with your agent and request an in-force illustration showing how the policy is projected to play out over your full life expectancy (I would suggest at least age 95).  You may find that what is affordable now will become unaffordable in your later years.  As a result, you may need to develop an alternative financial game plan that does not depend on life insurance.

Oh, and by the way, if you are in your sixties or older and less than perfect health, you may be able to sell your policy rather than allow it to lapse.  We were just involved in a case where the insured sold his policy for $135,000 net after cash value and policy loans (before income taxes).