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Q%amp;A: Life Insurance Policy Guarantees

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Guarantees are taking on new life in the insurance products of the 2000s. Here are some common questions they are raising, plus some answers.

Q: What is meant by a secondary guarantee on a universal life insurance policy?

A: The secondary guarantee usually means that if the customer pays a certain amount of money into the policy, over a certain period of time, the insurer guarantees the policy won’t lapse. Even if the cash value has fallen to zero, if the provisions for the secondary guarantee have been satisfied, the policy will not lapse. So, while the customer may not have any cash value that could be borrowed, the policy death benefit remains in force.

Secondary guarantees take many shapes and forms. Some of the most creative thinking in the industry has gone into their development. These policy provisions have provided the opportunity for planning where none may have existed before. By informing the customer of what is available, an agent can offer an important value-added service to the sales process.

Q: Have secondary guarantees caused any controversy in the life insurance industry?

A: Yes. Most of the controversy has been about how to reserve properly for these benefits. There are ongoing attempts within the industry to reach agreement on what is appropriate for these policies.

Q: Are policies with guarantees always better for the customer than policies without guarantees?

A: Sometimes yes and sometimes no. The answer really depends upon what the customer wants and needs. For long term planning, where the customer needs to be sure that the death benefit will be available at death, the secondary guarantee may be desirable. But, the customer must be able to afford the increased cost usually associated with this benefit, as well as believe that the guarantee is worth the extra money. Depending on the situation, a policy may be designed to provide what the customer needs without a secondary guarantee.

Q: How would a new policy with a secondary guarantee compare to an old one without a secondary guarantee?

A: This is like comparing apples and oranges, because the two types of policies provide different benefits. It is not an easy comparison to make. Again, the customer’s particular needs and circumstances must be considered. There is no one answer to fit all situations.

Q: If a new policy with guarantees appears to fit the customer’s needs better than the old one, is a replacement justified?

A: The decision to replace the old policy should not be made lightly, and should be considered carefully. You should be sure that the customer considers not only what may be required by law, and by the new insurer, but also, what makes sense to you as a life insurance professional.

Customers trust and rely upon their agents for guidance more than the agents may sometimes realize. If the old policy is performing well, and if it still meets the customer’s needs, then the customer may not need to change. After all, the customer bought the policy in the first place because the customer thought it would do what the customer wanted. If that is still true, a change may be inappropriate and improper.

Q: Will a premium on a new policy with guarantees be higher than the premium on an existing policy?

A: Again, this depends on the situation. One would expect the new policy to be more expensive, if for no other reason than an increase in the customer’s age. But, sometimes old policies have cash values that can be utilized in a Section 1035 exchange, and in doing so, the new policy premium, with guarantees, can be decreased. Also, sometimes the new policy may have lower cost assumptions. For this reason, each case should be examined separately, as there are no hard and fast rules to cover all possibilities.

Q: Do customers understand how the guarantees work?

A: Well, if they did, they would not need an agent. The agent should carefully review the policy features, including the guarantee provisions. Even after an explanation is made, the customer may forget how it works–and, in particular, what to do and not to do so that the guarantee is not lost.

For example, taking a loan can upset the guarantees. Also, paying a premium too late may upset the guarantees.

One cannot remind the customer too often of how the guarantees work. Customers may forget what the agent tells them no matter how good the explanation, or how often it is made. This happens in all professions; I have seen in my law practice that clients may forget what is told to them, even with the best of explanations.

Sometimes, the customer may have trouble understanding what is being said. Or, the customer may simply be thinking about something else when the explanation is given, so the message just does not get through. But, whether the information is coming from their life insurance professional, or their attorney or CPA, the result may be that in a month, a year or several years, they forget what they can and cannot do without affecting the guarantee.

Q: Is the guarantee on an insurance contract the same as the guarantee on a bank account?

A: No. The bank account may be protected by the Federal Deposit Insurance Corporation, which is backed by the United States government. The promises in a life policy are backed up only by the insurer.

While there may also be a state guaranty fund, those funds vary widely. For example, one state gets an annual allocation from the state legislature. This allocation is then used to pay benefits from the guaranty fund. If there are more claims than money to pay them, some claims go unpaid until the next year. At that time, hopefully there will be another allocation, so that the outstanding unpaid claims may be paid. But, if there are a lot of claims, and not a lot of money to pay them, a claim could go unpaid for years.

To help shoulder the burden, if an insurer fails, most likely the state insurance department will seek a buyer to cover the insurer’s obligations. To attract a buyer, sometimes the state gives the buyer some allowances to ease the financial burden. These allowances, for example, may reduce or extend the time to make good on promises under the policy. So, the bottom line is, if an insurer becomes insolvent, the guarantees sold with the policy may not continue–but, hopefully they will.