No term life insurance. The Truth Behind Whole Life Premiums, Wealth Management

Last September, I wrote a response piece to a New York Times article titled “ Skyrocketing Premiums.” I was taking issue with some aspects of the article, which was interesting and made some valid points, but wasn’t entirely accurate. As expected, I got some interesting responses. Whole life insurance rates.

Though I was somewhat blaming carriers for some of the problems with underperforming and collapsing life insurance policies, I was also deflecting blame directed at carriers, which was unwarranted. In response, I received fervent notes about how wrong I was. This response further proved much of the ignorance in the market regarding how life insurance actually works.

The other response came from some agents who specialize in whole life (WL) policies, as opposed to universal life, variable life and indexed products. I often hear from this constituency that their products don’t have the problem of rising premiums because WL premiums are guaranteed. I feel sad for these agents for they’re either appallingly ignorant regarding the polices they sell or they very well know better but purposely keep up the façade for sales and marketing purposes.

Here’s my disclaimer … WL isn’t bad. Not all WL works the same way. I don’t have anything against it. It can be a good tool when understood, properly implemented and well managed. I even own some. There! I’m not trying to dis WL. What I am going to do is tell the truth.

WL crashes and burns too! I see it all the time. The remnants of misunderstood and unmanaged policies litter my desk. In fact, though less frequent, the WL problems that find their way to me are clearly the most disastrous trainwrecks I see. But how can that be when WL incorporates guarantees many other modern life insurance policies don’t? Because not all WL works like most consumers, or even advisors, understand.

Let’s step back. Old-fashioned WL, a product sold many decades ago, was a truly guaranteed, “no moving parts” product. If an individual wanted $100,000 of WL, the agent pulled out a rate book and a slide rule and could calculate the guaranteed premium cash value and death benefit every year to policy maturity. This isn’t how all modern WL works. Modern WL, built since the prevalence of technology and marketed in the high-interest-rate markets of yesteryear, is a product that’s modeled on computers and incorporates dynamic and variable assumptions, just like other life insurance. Sure, it’s theoretically possible to build and sell an old-fashioned, guaranteed WL policy, but I don't see it in real life in my market. In real life, these policies are illustrated and sold with term blends to keep the premiums down, on short-pay scenarios and projecting significantly increasing cash values and death benefits. None of that is guaranteed. Show me an all-base, full-pay, level death benefit WL contract, and we can have an honest discussion about WL guarantees.

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In the mid 1980s, as a result of the sky-high fixed-interest-rate markets, WL policies were crediting 11 percent, 12 percent and 13 percent. Today they’re a fraction of that. One major player is down from 5.45 percent in 2016 to 5 percent in 2017. That’s an 8.25 percent reduction in one year and a 625 basis point or 55 percent reduction from its peak in 1986. In other words, the high was 225 percent greater than where it stands today. Now … how do you think that’s affected policies over the years?

It’s important to remember that the premiums, cash values, death benefits and how many years one has to pay out of pocket were all based on those higher rates in effect at the point of policy issue, and they aren’t fixed. Even the responsible agents who ran projections at lower rates never dreamed they’d get this low. Who did? A dozen or so years ago when dividend rates were about 8 percent, many agents swore they were at their bottom. I just shook my head. Anyone who understands the basics of financial markets and how life insurance actually works, especially WL policies built on portfolio rates, knew what was coming. I promised anyone who would listen that rates would keep coming down even after the fixed interest market rates bottomed out. I was eviscerated for doing so. However, I told the truth. It could only sound arrogant but I said, “I promise you they will fall and they will keep falling and I will keep being right until the year I am not. The year I am not right you will know we’re finally at the end.” I haven’t been wrong yet.

One of my biggest pet peeves is when a WL agent tells the world his premiums are guaranteed. While narrowly and technically it can be true, it’s absolutely not really true across the board. Recently, I wrote about “premiums” in universal life, variable life and indexed life policies. I put premiums in quotes because they aren’t really premiums by definition. The “premiums” represent the calculated cash flow for the policy to pan out given a set of assumptions that are subject to change and almost certainly will change. The problem is that the consumer market is still largely under the old-fashioned notion that these “premiums” are guaranteed and are shocked to find out they aren’t, and their policies are suffering or collapsing. The bottom line is they’re realizing something they weren’t expecting.

The premium associated with the actual WL portion of a policy is, in fact, guaranteed. However, many of these policies are sold blended with term insurance to lower the premiums. The plan is that the term insurance portion of the policy will systematically be replaced by the growing WL portion of the policy, and it will all be fine while costing less. Many policies are sold on a short-pay basis (referred to as “vanishing premiums” in the old days), but that short-pay scenario usually isn’t guaranteed either. Many policies are sold focusing on the growing cash value and death benefits over time, but that growth isn’t guaranteed.

Where does the rubber meet the road? A term blended policy may not pan out if the projected dividend rates don’t pan out. The increasing cost of the term portion of the policy can cannibalize a contract. I’ve seen it happen many times. I was brought a policy in which the $150,000 annual premium, which was projected to go away after a decade, actually rose to a multiple million-dollar premium per year due to term costs. This was a dividend-paying WL policy from a major player. Not really guaranteed, was it?

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A short-pay policy that doesn’t experience the expected dividends may end up needing premiums to be paid out of pocket for many more years. A 30-year-old client bought a mutual WL contract expecting to stop paying premiums out of pocket at age 40 before my analysis showed him he could never stop paying even if he lived to 100. In fact, the premiums increased annually in addition to being paid every year until death. I wouldn’t call that guaranteed, at least as the client understood it.

The increasing death benefits that were so attractive at the high dividend rates aren’t materializing in this market. The cash values that were to be the underpinnings of a comfortable retirement or deferred comp payouts are not only a fraction of what was to be expected in most situations, but also, they’re nonexistent in some.

In the worst cases, when consumers aren’t aware of how these contracts work, and the contracts aren’t managed by the agents who sold them, consumers often stop paying premiums per the original sales ledger. They’re entirely unaware of the insidiously growing internal loans that are compounding inside the policy. The insurance carrier is loaning the policy premiums that should be paid out of pocket but aren’t because the original sales ledgers showed they didn’t have to be, and they’re growing at interest to dollar amounts that are unimaginable. Sometimes, these internal loans grow to millions of dollars. Many times, these accumulating loans encumber a policy so much they force it to collapse. What happens when a policy suffocated with loans is on the verge of collapse? The “premiums” skyrocket. Oooooohhhhhh... Did I just go there?

So, premiums on WL policies can increase? No. But “premiums” sure can. What’s with the quotes? Here’s a story. I was brought into a case in which the $40,000 annual 10-pay premium eventually returned at $400,000 a year. Did the premium actually go up $360,000? No. The increase was the required loan interest payments to keep the policy from collapsing, different from the above-referenced situation in which the multimillion-dollar increase from the projected $150,000 premium was all term costs.

Here’s the only question that matters. Does your client really give a rat’s petootie what you call something if he has to write a check for that amount? Checkmate! Just imagine trying to soothe a seething policy owner by telling him that of the $400,000 he needs to pay to keep the policy from collapsing, only $40,000 is actually the (guaranteed) premium. I’m sure that will make him feel better.

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What if he decides it isn’t worth writing that check and lets the policy implode? The massive internal loan is forgiven, and we know how forgiveness of debt is taxed, right? I’ve seen cases in which the tax payable to the Internal Revenue Service on a collapsing WL policy is actually larger than the expected tax-free death benefit of the policy. Really! I’ve seen a collapsing WL policy create an actual, payable tax bill to the IRS for an amount greater than the policy owner’s net worth. Really! Ergo, my “most disastrous trainwrecks” comment. It isn’t uncommon that these increased “premiums” are painting the policy owner into a corner. He doesn’t want to pay the premium, but it’s the only way to keep a devastating tax bill at bay. In the prior case, the $400,000 premium was required to keep a $12 million phantom tax gain from materializing.

This doesn’t have to happen. Understanding of the contract, questioning conventional wisdom, and ongoing management can prevent these problems.

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