Many investment insurance policies aren’t having the results that were expected. Their buyers didn’t realize that insurance policies also could be hurt by a bear market just like stocks and mutual funds.
Here is what you need to know to avoid this situation, and to make a good decision regarding the future of any policy you already own.
Life insurance policies are sold using projections or illustrations of possible future results. Often investment policies such as variable life, whole life, and universal life are sold with projections that the premiums would vanish after a certain number of years, though the policies would remain in force. The premiums would vanish because the cash value accounts were forecast to be high enough that income and gains would pay future premiums.
Other policies had projections showing that the investment returns would significantly increase both the cash values and the death benefits over the years. Some policies were projected to have both vanishing premiums and increasing benefits.
These days, most projections are not being met. Premiums continue or increase instead of vanishing. Owners are being told to add more money to keep the policies in force. Other owners aren’t seeing the cash value or benefit increases they expected.
Insurance buyers get into this bind largely because they don’t fully understand the nature of insurance policy projections. Agents and insurance companies often don’t fully explain or downplay the nuances of the projections.
Insurance policy projections, known as illustrations, are not part of the contract and are not guaranteed. An illustration is simply a hypothetical forecast about what would happen to a policy under certain conditions. Knowing that is the basis for reading an illustration and knowing the questions to ask before buying a policy.
- What are the assumptions behind the illustration? Ask for the projected interest rate or investment rate of return. Then, ask yourself if that is a reasonable projection. Also, ask about the assumptions for premiums and expenses. Verify that these assumptions are reasonable by determining that comparable figures are either listed in the contract or currently charged by the insurer on the same type of policy.When comparing different policies, whether or not from the same insurer, be sure that the investment assumptions are the same.
- Are the results net of fees? Here’s where many illustrations lead consumers astray. An 8% annual return projected in the illustration might be reasonable given how the cash value will be invested. In reality, various fees and expenses might be deducted from the actual investment return before the account is credited with the net amount. The 8% return in the projections might be gross of fees, while 6% to 7% is likely to be credited to your account.
- What is the surrender fee and how long does it last? This is key. Most permanent life insurance buyers believe they have liquidity. They believe that if cash is needed they ca take loans or distributions from a policy’s cash value at any time. Unfortunately, that often isn’t the case. The illustration of steadily increasing cash value might not reveal that a surrender fee prevents access to the cash value for years. A surrender fee that doesn’t disappear for seven years or longer is not unusual.You want an illustration that shows the cash value net of surrender and other fees. Ask how much of the cash value can be borrowed, distributed, or used to pay premiums each year.
- What happens if the investment return changes? Many buyers wish they had asked this question a few years ago. Falling interest rates or stock market returns can dramatically change the results of an illustration. Most of the computer programs can’t show varying returns over the years. They can show only one steady annual return. So, ask for a second illustration showing a lower annual return. The effect a drop of one or two percentage points in the annual return can be surprising.
- Can the insured amount be changed? Ideally, you want to be able to increase the death benefit without an additional medical exam or review. Some policies also will allow a death benefit to be increased without a significant premium increase.
- How long is the premium absolutely guaranteed? Illustrations generally show premiums remaining fixed, at least until they vanish. Be sure you know what events could change the premium. If the cash value account’s return drops for one year, will the premium increase? Two years? Many people who thought they had vanishing premiums find that a couple years of low returns reduce the cash value and trigger significant premium increases. Find out if that premium really is fixed. Another way to ask the question is: What is the minimum annual premium needed to guarantee the full death benefit to age 100?
- What is the cost of the life insurance? Many insurance policies are sold more for their tax deferred investment features than for the life insurance. By promoting the investment and tax features, insurers often are able to charge a lot for the life insurance. You should be able to get a breakdown of how much of the premium is for insurance and how much for investments, fees, and other items.
- Variable life policies can be tough to compare and evaluate. There are technical features that change the results of two seemingly similar policies. You probably should prefer what is sometimes called a defined contribution policy instead of a defined benefit one. Or you want a hybrid of the two. The defined benefit policy requires increasing premiums as investment returns fall, because the benefit is supposed to be fixed. Defined contribution variable life policies will have less volatile premiums but benefits might fluctuate. If you already have a defined benefit policy, you might be able to convert it to defined contribution.
- Ask for policy in force illustration every year or two. These projections update the original illustration based on the actual experience so far. They also give you a chance to ask all of the above questions again to determine the likely future of the policy.
Life insurance can be a valuable investment tool for some people. Permanent life insurance, instead of term insurance also can be useful in the right circumstances. Unfortunately, too many people who sell life insurance view it as the solution in every situation or oversell the investment benefits. To make sure a particular policy is right for you, study carefully and understand what is behind the illustrations. Ask the questions listed here and you’ll be well on the way to making a good decision.