Have you ever discovered a bank entry error in your checking account register, resulting in $100 or $1,000 less than what it should be? Imagine how much worse it would be if your client’s $1,000,000 life insurance policy’s death benefit was suddenly unavailable to a spouse or child due to a technicality. Unfortunately, as a result of sustained low interest rates over the last twenty years, as well as policy owner and trustee inattention to performance monitoring, approximately 35 percent of existing non-guaranteed life insurance contracts are expected to expire prior to an insured’s normal life expectancy.
Very few lay people and professionals are aware that their life insurance contracts can expire prior to their lifetime. Clients and trustees often incorrectly assume that either the agent or the insurance company is monitoring their contracts to make sure they will always remain in force, but that’s not true. As a matter of fact, it would be in the insurance company’s best financial interest if, after all those years of paying the premium, it became exorbitantly expensive to maintain the contract and the death benefit had to be reduced or the policy surrendered. According to Donald Walters, General Counsel for the Insurance Marketplace Standards Association, (IMSA), “While insurers have not publicized the issue, there is a growing concern in the industry about lapsing universal life policies.” Carriers and agents have no obligation to monitor policy performance relative to original performance expectations. Carriers are merely required to send a scheduled premium billing and an annual policy value statement. It is solely the responsibility of the policy owner to review the policy value statement and determine the needed premium adjustment to achieve originally illustrated policy values.
In August, 2012, the Office of the Comptroller of the Currency (OCC) issued revised guidelines which directs financial institutions serving as trustee of an insurance trust to treat life insurance as they would any other asset. This means life insurance, just like stocks, bonds and real estate, needs to be actively managed. Providing a policy performance evaluation and then monitoring it every 1-3 years, depending upon product type, is the only way to determine whether a life insurance contract issued in the 1980s is in danger of expiring prematurely. These universal life or variable universal life insurance contracts, unlike their more expensive whole life counterparts that have lifetime guarantees, are not guaranteed for a lifetime. This is because their performance was tied to an anticipated annual interest crediting rate, or an anticipated stock index performance, neither of which was guaranteed, and neither of which were achieved.
In the mid-1980s, when prevailing interest rates were as high as 18 percent and life insurance companies were crediting guaranteed policies much lower rates, thousands of astute policyholders switched the accumulated cash value in their whole life contracts into higher yielding bank deposit instruments.
In order to stop these outflows, the life insurance industry created a new product called universal life insurance.” These policies paid an interest rate based on prevailing market interest rates instead of a fixed rate, as had been the case in their traditional whole life contracts. If interest rates increased, then the scheduled premium could be decreased or remain unchanged for policy coverage to remain in force. What was not clearly understood, however, was that, if interest rates decreased, then the length of time the coverage would remain in force would consequently be reduced, or a greater annual premium deposit would be required in order to prevent an early expiration of coverage.
When universal life was first offered, agents and brokers would ask their clients how long they wished the coverage to remain in force. Clients would typically respond that they wanted the coverage to last until age 90–95. Next an interest rate assumption was made for the time period between the insured’s current age and this age 90–95 target in order to generate a computer illustration calculating the anticipated annual premium needed to keep the policy in force. However, this scheduled premium amount was not guaranteed.
While the introduction of this interest-sensitive product solved the outflow problem for the insurance industry, it has created other problems for policy owners in the last ten years due to policy owner misunderstandings and inattention. Few policy owners or “amateur” trustees understood that they carried performance risk. Moreover, they did not know which risks to monitor or have the tools to do so. As interest rates declined, they simply paid the scheduled premium, unaware that the policy would lapse much earlier than insured age 90-95 unless the scheduled premium amount was increased. This fact has created a crisis of lapsing policies that requires corrective action.
To avoid lapse risk, a policy performance evaluation of a universal life, variable universal life or indexed universal life contract should be independently conducted to determine, at a minimum, (1) the probability the current premium will sustain the policy to the insured’s life expectancy, (2) the insured’s age at policy lapse, (3) the competitiveness of the policy charge, and (4) the needed correcting premium to sustain the policy to the insured’s life expectancy. Inforce carrier illustrations disclaim predictive value. Hence, an actuarially certified evaluation should be obtained. Also, for older insureds, a life expectancy report should be considered so that the premium payment period is based upon the insured’s medical history and current medical condition.
The more advance notice an insured or trustee has about a potential premium shortfall, the less additional monies are needed to adjust the coverage back to its originally projected level. Since cost of insurance charges increase annually, annual performance monitoring and periodic premium adjustment avoids a lapse notice ‘surprise’ that requires a significantly higher premium to maintain the policy inforce.