How could this happen? Because life insurance quotes for cash value policies can be based on not only guaranteed projections in policy illustrations but also very optimistic non-guaranteed projections.
As it turns out, many quotes for all forms of universal life and whole life insurance are based on the non-guaranteed portions of policy illustrations (this does not apply to term life insurance, which has no cash value.)
Essentially, it’s a bait and switch: You think your life insurance quotes reflect what you’ll pay as long as you own the policy, but years later you could be hit with a need for unexpected, extra premiums. It does not make any sense to buy a policy with a low premium initially and have to pay more later?
What Is Cash Value Life Insurance - Life insurance typically is meant to provide protection for those who count on you financially. However cash value life insurance is also marketed by some agents as a retirement planning tool.
Permanent life insurance policies such as whole life, endowment and investment-linked policy have a cash value feature. When you pay premiums for permanent policy, your premium first goes toward the actual cost of insuring you, the insurer’s fees and operating expenses. Anything left over goes toward the cash value component of your policy.
The cash value typically earns interest and it grows tax-deferred. What makes cash value policies appealing for retirement planning purposes is that they can be a source of income in retirement if you take a withdrawal or loan from the cash value.
How Cash Value Life Insurance Quotes Are Calculated - The premium you’ll pay for a cash value life insurance is a function of these three factors:
a: The cost of insurance
b: Expenses (policy fees, underwriting, administrative costs and agent's remunerations)
c: Interest, or rate of return on the cash value
Typically, 85% of the premium you pay goes toward the cost of insurance, with 15% going toward expenses. Interest earned on the cash value can offset those costs and reduce the premium you would have to pay. So the premium formula would look like this: Premium = cost of insurance plus expenses minus interest. The higher the interest rate, the lower the premium will be.
How the Quotes Can be Misleading - Most insurance laws allow agents to provide life insurance policy illustrations that show non-guaranteed elements as long as the corresponding guaranteed values of those elements are shown first.
A policy illustration uses text and graphics to provide consumers with an example, based on certain assumptions, of how a policy’s costs and benefits may develop over time. These illustrated values must meet certain tests to ensure they are reasonable and supportable.
It’s common for agents to show projected returns on the cash value as high as allowable. That will make the premium supposedly needed to cover the cost of insurance and expenses look lower. This practice is most egregious with investment-linked life policies. Consumers are pitched a product that will supposedly earn a high interest rate and have a low premium. But when the high interest rate on the cash value fails to materialize, policyholders may have to shovel more premium into the policy in order to keep it in force—especially if they’ve already taken a loan or withdrawal that depleted the cash value.
To be clear, insurers must disclose any potential for increased premiums in the illustration. By showing the values based on guaranteed maximum charges and minimum credited interest rates for universal iife or based on $0 dividends for whole life, the risk of additional premiums down the road are disclosed since these values are the worst-case scenarios for the policyholder.
But if consumers don’t pay attention to guaranteed elements of the policy, meaning the worst-case scenario—and the policy doesn’t perform as well as they hoped—they’ll be in for a surprise when they get a notice from the insurance company that the interest rate that was calculated at the time of sale is now lower. “If it doesn’t work out, the client has to pay more. Often, it’s dramatically more, he says.
When indexed universal life purchases involve bank loans to buy big policies, the policy illustrations can look even brighter because of the leverage between the projected high rate of the policy accumulation and the lower bank loan rate. The fallout for consumers if those projections don’t pan out can be worse for consumers who took out loans to purchase their policies. They not only might lose the policy but also other collateral they pledged as part of the bank loan.
The return on the cash value might not be enough to cover the payments on the bank loan that’s being used to make premium payments. Without the necessary premium, the policy could lapse, and policy owners who borrowed against the cash value of their policy to make payments on their bank loans will end up with a potentially big tax bill—and a big bank loan to pay off.
How To Protect Yourself When Buying Life Insurance - To be clear, life insurance is a good product for protecting your family. Consumers just need to understand what it is they actually are buying with a cash value life insurance policy versus what they are being sold through potentially misleading illustrations.
The problem of life insurance quotes that are tied to non-guaranteed portions of policy illustrations does not apply to term life insurance, which does not have any cash value. And be especially cautious if your agent suggests you buy a larger policy by getting a bank loan to pay for it.
If you’re shopping for investment-linked life insurance, insist on getting the detailed expense pages. These pages, also called policy accounting pages, will show year by year what the insurance company will charge for the policy. Don’t compare hypothetical premiums. Focus on compare what company says it will charge. Rarely do companies charge less than what they say they will charge.
If you’re shopping for whole life insurance, ask for the “dividend interest crediting rate” used to calculate non-guaranteed values. Premiums are calculated based on the cost of insurance, expenses and the dividend interest rate credited to the policy.
There are companies that are calculating premiums based on 5% to 7% or so rate of return. This makes premiums appear lower than what they will actually be because a return that high is questionable. Whole life policies are required by regulation to invest cash values predominantly in high-grade bonds and government-backed mortgages that have historically earned only 5%, and that was before the current and persistent low-interest-rate environment, Flagg says. So question any projected interest rates that are higher than that.
Ask the life insurance agent for the worst-case scenario policy illustration—what would the premium be and what would happen if only the guaranteed rate of return is achieved rather than non-guaranteed rate. Understand what the downside is. It’s very easy to focus on the possible upside when you’re buying a policy.
Most importantly, keep in mind that, unless otherwise stated, a policy illustration is not a guarantee of future performance. It is meant to be a guide for consumers to help them find a policy that fits their unique needs. Consumers should read and thoroughly understand all material they receive about a policy before signing the policy contract.
So if you don’t understand what you’re being sold, ask questions. If you still don’t understand, you probably shouldn’t buy the policy. If you already own a cash value life insurance policy, you can ask your insurer for an in-force policy illustration. This will show you how your policy is actually performing.
Permanent life insurance policies such as whole life, endowment and investment-linked policy have a cash value feature. When you pay premiums for permanent policy, your premium first goes toward the actual cost of insuring you, the insurer’s fees and operating expenses. Anything left over goes toward the cash value component of your policy.
The cash value typically earns interest and it grows tax-deferred. What makes cash value policies appealing for retirement planning purposes is that they can be a source of income in retirement if you take a withdrawal or loan from the cash value.
Agent Sales Pitch - In the hands of a savvy insurance agent, a cash value life insurance policy—particularly an investment-linked policy—can be made to look quite appealing. In a typical sales pitch, the agent might say it’s a great financial product to accumulate money for retirement and that it can participate in the upside of equities and never go down. The agent will point out the investment return on the cash value is guaranteed to never drop below 0%.
The advanced pitch, will involve arranging for a bank to lend you money to buy an even bigger policy (known as premium financing). The agent promises that the big policy will essentially pay for itself. The proposal relies on very optimistic assumptions that show the policy accumulating enough value to pay back the loan to the bank and still have hundreds of thousands of dollars available in your policy to take out tax-free in retirement. Using this sales strategy, policyowner supposedly won’t have to pay anything out of pocket for the policy.
The advanced pitch, will involve arranging for a bank to lend you money to buy an even bigger policy (known as premium financing). The agent promises that the big policy will essentially pay for itself. The proposal relies on very optimistic assumptions that show the policy accumulating enough value to pay back the loan to the bank and still have hundreds of thousands of dollars available in your policy to take out tax-free in retirement. Using this sales strategy, policyowner supposedly won’t have to pay anything out of pocket for the policy.
How Cash Value Life Insurance Quotes Are Calculated - The premium you’ll pay for a cash value life insurance is a function of these three factors:
a: The cost of insurance
b: Expenses (policy fees, underwriting, administrative costs and agent's remunerations)
c: Interest, or rate of return on the cash value
Typically, 85% of the premium you pay goes toward the cost of insurance, with 15% going toward expenses. Interest earned on the cash value can offset those costs and reduce the premium you would have to pay. So the premium formula would look like this: Premium = cost of insurance plus expenses minus interest. The higher the interest rate, the lower the premium will be.
How the Quotes Can be Misleading - Most insurance laws allow agents to provide life insurance policy illustrations that show non-guaranteed elements as long as the corresponding guaranteed values of those elements are shown first.
A policy illustration uses text and graphics to provide consumers with an example, based on certain assumptions, of how a policy’s costs and benefits may develop over time. These illustrated values must meet certain tests to ensure they are reasonable and supportable.
It’s common for agents to show projected returns on the cash value as high as allowable. That will make the premium supposedly needed to cover the cost of insurance and expenses look lower. This practice is most egregious with investment-linked life policies. Consumers are pitched a product that will supposedly earn a high interest rate and have a low premium. But when the high interest rate on the cash value fails to materialize, policyholders may have to shovel more premium into the policy in order to keep it in force—especially if they’ve already taken a loan or withdrawal that depleted the cash value.
To be clear, insurers must disclose any potential for increased premiums in the illustration. By showing the values based on guaranteed maximum charges and minimum credited interest rates for universal iife or based on $0 dividends for whole life, the risk of additional premiums down the road are disclosed since these values are the worst-case scenarios for the policyholder.
But if consumers don’t pay attention to guaranteed elements of the policy, meaning the worst-case scenario—and the policy doesn’t perform as well as they hoped—they’ll be in for a surprise when they get a notice from the insurance company that the interest rate that was calculated at the time of sale is now lower. “If it doesn’t work out, the client has to pay more. Often, it’s dramatically more, he says.
When indexed universal life purchases involve bank loans to buy big policies, the policy illustrations can look even brighter because of the leverage between the projected high rate of the policy accumulation and the lower bank loan rate. The fallout for consumers if those projections don’t pan out can be worse for consumers who took out loans to purchase their policies. They not only might lose the policy but also other collateral they pledged as part of the bank loan.
The return on the cash value might not be enough to cover the payments on the bank loan that’s being used to make premium payments. Without the necessary premium, the policy could lapse, and policy owners who borrowed against the cash value of their policy to make payments on their bank loans will end up with a potentially big tax bill—and a big bank loan to pay off.
How To Protect Yourself When Buying Life Insurance - To be clear, life insurance is a good product for protecting your family. Consumers just need to understand what it is they actually are buying with a cash value life insurance policy versus what they are being sold through potentially misleading illustrations.
The problem of life insurance quotes that are tied to non-guaranteed portions of policy illustrations does not apply to term life insurance, which does not have any cash value. And be especially cautious if your agent suggests you buy a larger policy by getting a bank loan to pay for it.
If you’re shopping for investment-linked life insurance, insist on getting the detailed expense pages. These pages, also called policy accounting pages, will show year by year what the insurance company will charge for the policy. Don’t compare hypothetical premiums. Focus on compare what company says it will charge. Rarely do companies charge less than what they say they will charge.
If you’re shopping for whole life insurance, ask for the “dividend interest crediting rate” used to calculate non-guaranteed values. Premiums are calculated based on the cost of insurance, expenses and the dividend interest rate credited to the policy.
There are companies that are calculating premiums based on 5% to 7% or so rate of return. This makes premiums appear lower than what they will actually be because a return that high is questionable. Whole life policies are required by regulation to invest cash values predominantly in high-grade bonds and government-backed mortgages that have historically earned only 5%, and that was before the current and persistent low-interest-rate environment, Flagg says. So question any projected interest rates that are higher than that.
Ask the life insurance agent for the worst-case scenario policy illustration—what would the premium be and what would happen if only the guaranteed rate of return is achieved rather than non-guaranteed rate. Understand what the downside is. It’s very easy to focus on the possible upside when you’re buying a policy.
Most importantly, keep in mind that, unless otherwise stated, a policy illustration is not a guarantee of future performance. It is meant to be a guide for consumers to help them find a policy that fits their unique needs. Consumers should read and thoroughly understand all material they receive about a policy before signing the policy contract.
So if you don’t understand what you’re being sold, ask questions. If you still don’t understand, you probably shouldn’t buy the policy. If you already own a cash value life insurance policy, you can ask your insurer for an in-force policy illustration. This will show you how your policy is actually performing.
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