Insurance Doesn't Costs - It Pays

Recently, class action lawsuits were filed against several life insurance companies, including Transamerica, for raising the “cost of insurance” (COI) inside of their policies.

What does that mean to you if you own a life insurance policy? It may mean that your policy will lapse or be unaffordable and not be in force when you die, depriving beneficiaries of the funds you planned to bequeath. Often we find that policies are in danger when the insured is diagnosed with a serious health challenge or a terminal condition.

Life insurance contracts are complex legal documents and they often end up in drawers and filing cabinets and rarely are reviewed. The insurance agent asked the woman if she knew the value of her husband’s life insurance policy?

When she asked what the agent meant, he said, “Well, if your husband died, what would you get?”
The lady thought for a minute, then brightened up and said, “Probably a poodle.” That may be funny but you don’t want your estate plan to be a dog.

Term insurance is pure death benefit and it is relatively cheap because most insured’s outlive it. The purpose of term insurance, say, 20- or 30-year term, often is placed with the idea that if you don’t make it to retirement and accumulate a nest egg, money will be there for your spouse or other loved ones. The goal is to outlive your term insurance and live to a ripe old age with a happy retirement and a bucket list fulfilled!

Life insurance with cash value in some form serves a different purpose, designed to pay off even if you die late in life. Higher premiums are charged in the earlier years of the contract to help offset the higher mortality costs as one ages. If 1,000 healthy men or women, age 40 or 50 take out policies, the insurance company knows about how many will die each year. They just don’t know who that will be in any given year, and you don’t either.

Beyond yearly administrative and other costs, the bulk of the premium is invested in conservative investments to grow and provide funds in future years to handle death claims. In the Transamerica case, with universal life insurance policies sold in the late 1980s and early 1990s, many guaranteed an interest rate of no less than5.5 percent annually. There’s the rub.

With the average yield on a five-year CD at 1.29 percent, cash values growing at 5.5 percent are a very good deal...for the policy owner. For the insurance company, guaranteed rates in the 3 to 4 percent range or more are a financial drain. The lawsuit claims that Transamerica hiked the premiums on the policies when contractually they were not permitted to do so. The suit alleges the COI was increased to force insured’s to surrender policies they no longer could afford so the company could recoup past losses and get unprofitable policies off of the books.

Low interest rates are expected to continue for some time. If you have a cash value policy and cash values are dropping, it may be that insufficient premium is being paid. The policy may “implode” at some point with no remaining cash value and no death benefit. We have dealt with situations where a person had a cash value insurance policy and they either thought it was “paid up” or they were not paying enough premium. Often the shock that a policy will terminate comes about when the insured is diagnosed with a serious medical condition.

The solution is to ask the insurance company to run an “in force illustration.” A knowledgeable advisor can look at the report and see if the policy is in danger of blowing up. Often, by the time an insurance company tells you that a policy is in danger, the cost to remedy the situation is unaffordable. That’s what is alleged in the Transamerica case.

Life insurance salespeople like to say that “insurance doesn’t cost, it pays!” You want to make sure that your contracts will pay off as you assume they will. Talk to your adviser about a life insurance audit. A surprise at a time of stress would not be welcome.