Life Insurance Policies Are Running Out of Steam
This low interest rate environment has been a mixed bag for individuals. For clients looking to borrow money it has been a great time to buy or refinance real estate. For those relying on cds for income it has been a different story. The one asset many clients take for granted are life insurance policies. The vast majority of clients we meet for the first time typically haven’t looked at their policy since the day they signed their delivery requirements.
With interest rates at all-time lows, many permanent policies sold in the 1980s and ’90s – are at risk of lapsing. Clients will have to make the choice between letting the policy go, taking a cut in death benefits or shelling out even more money to fund premiums and keep the policy in force. They didn’t think of the life insurance as an investment, but rather as something they could set and forget. Many of these policies are now set to fail with a tremendous price tag to keep them going.
The problem is that these policies were based on optimistic interest rate assumptions, back when those rates were as high as 15%. Universal Life features included not only a death benefit, but also a cash value account that receives interest and that can be funded by a portion of premium dollars. Upbeat interest rate projections at the time meant that clients being sold these policies did not expect to pay much to fund the policy’s costs. Those high credited interest rates supposedly would help foot the bill. Even the most conservative agents and brokers were projecting 7% to 10% interest rates. But in today’s interest rate environment, it’s become significantly harder for insurers to credit the rates clients were expecting 20 years ago.
I worked with a client a few years back who had purchased a universal life policy back in the early 1980’s. It was a 250,000 policy and he was paying $120 per month. Fast forward 20 years as I reviewed his policy I had his carrier run multiple illustrations to determine his best course of action.
Option 1: Keep everything the way it is and the policy defaults in 3 years
Option 2: Start paying $270 per month to keep it in force.
Option 3: Reduce the death benefit to 100,000 and continue paying $125 per month to keep it inforce.
After getting an earful for a solid 15 minutes the client came to the realization that as an individual in his mid 60’s on a fixed income none of the options seemed ideal. The good news for him is that he was still in good health. We were able to write a new policy on him for 200,000 for $140 per month. The new policy had a built in guarantee to last until his death that his previous universal life policy did not contain.
Attorneys, accountants and financial advisers are struggling with universal life insurance policies that were written during periods of higher interest rates for use within an irrevocable life insurance trust to help soften the blow of estate taxes. Many of these were bought when the estate tax exemption was far below what we have today(5.25 million for individuals). Still, there may be cases where clients need the liquidity, say for state-level estate taxes or if it’s part of a buy-sell agreement or for succession planning
Trustees overseeing the affected trusts are many times relatives of the person who set up the vehicle in the first place. They accepted the position without any knowledge of their responsibilities. Many times they do not have the skills necessary to successfully keep the trust’s primary holding — its life insurance — from expiring prematurely. Evaluating Trust Owned Life Insurance
With life expectancy continuing to trend up the cost of insurance has trended lower. Along changes in life expectancy the number of insurance carriers and options available to clients has made for a more competitive marketplace. There’s a lesson here for advisers and fiduciaries: Just as you review other aspects of your client’s financial situation on a regular basis life insurance is no exception.