On August 9, the Wall Street Journal ran an article entitled “Retirees Stung by ‘Universal Life’ Cost.” The article discusses a problem with universal life insurance policies that, I believe, provides one of the underlying rationales for engaging in life settlement transactions.
As the article points out, universal life policies accounted for 25 percent of life insurance sales in the 1980s, a period when the 10-year Treasury yield peaked at 15 percent. These policies use some of the premium to pay the cost of insurance, and the remainder of the premium remains in the policy earning interest or returns from investments embedded in the policy. While insurance company illustrations often show the policy performing at an assumed rate of return for the life of the policy, the guaranteed minimum rate is normally much lower.
As interest rates and investment returns decrease, the anticipated and illustrated returns on the account values of such policies would likely fall, thus leaving a reduced account value to fund future premium obligations as the insured ages. This happens to many insureds at precisely the same time that the insured, due to getting older, faces rising costs of insurance. The result is that the policies often do not perform as expected, and the insureds would be facing large premium payments to keep them in force. The issue is compounded as insureds live longer than expected, further increasing the gap between cost of insurance and policy account value.
One option for someone in such a situation is a life settlement. This is a transaction where the insured can sell the policy to an investor. The insured, who often has outlived the need for the insurance, receives an up-front cash payment for the policy. This payment can be many times more than the surrender value offered by the insurance company, and the insured is no longer responsible for premium payments.
The issue with universal life insurance outlined by the Wall Street Journal is one of the reasons that people desire a fair market value to monetize an insurance asset. This is precisely what is provided by the life settlement market.