A life insurance policy is a valuable asset. Too often the document ends up in a drawer or file and rarely is looked at. That’s a mistake, especially if the cash value policy you’re counting on to pay loved ones or other beneficiaries is likely to lapse!
There are two basic forms of life insurance: term insurance with no cash value, and policies such as whole life or Universal Life that combine a death benefit with a cash value savings element.
Term insurance provides a death benefit if you pay the premium and die within the specified coverage term, say, 10, 20, or 30 years. Term insurance has its uses but only about 1 percent of term life benefits are delivered to beneficiaries as the insured generally outlives the coverage period. The policy will not lapse if you pay premiums on time as specified.
Traditional whole life was designed as “permanent life insurance” as the combination of a death benefit plus cash value savings was to last “the whole of your life.” The “risk element” is the difference between the cash value and the face amount to be paid at your death. When the policy matures, the cash value savings element is to equal the insurance amount.
Since odds of death increase each year as you grow older, the price of the risk element, expressed as the “cost of insurance,” rises over time. The idea behind whole life versus pure term insurance is to “overpay” in earlier years, creating a cash reserve to offset the higher risk premium at older ages. To create the cash reserves, insurance companies invest the premiums you pay in bond, stock, and real estate markets, and that involves variability. To put that in perspective, a brief history lesson.
In the 1970s, inflation ran rampant in America with rising interest rates. The CPI reached 13.5 percent annually in 1980. In March 1980, banks issued six-month CDs with annualized rates as high as 17.74 percent. In October 1981, a one-year Treasury bill offered 14.73 percent. While the Economic Recovery Tax Act of 1981 cut the highest personal marginal tax bracket from 70 percent to 50 percent, with relatively high inflation and tax rates, investors clamored for both significant returns and tax shelter.
In 1979, a new type of permanent cash value life insurance was introduced offering high interest rates and premium payment flexibility. Called Universal Life (UL), demand for the product soared, as interest rates credited were significantly greater than with traditional whole life. Most UL sales in the early 1980s involved replacement of traditional whole life policies.
But here’s the rub concerning all cash value policies. Since the early 1980s peak, interest rates and the yields on bonds, a mainstay of insurance company investments, have been declining. Without getting deep into technical weeds, bond yields that support the building of your cash values have been under pressure. If bond yields are declining, and interest rates currently are at new historical lows, low yields and rising costs can impact cash value balances, whether whole life or the various forms of UL.
Many policies were sold years ago with long-term projections (non-guaranteed illustrations) illustrating yields far higher than today. The compounding results looked like pure magic! Note the term “non-guaranteed.” If you’re not monitoring your policy, you might not notice that cash values may be declining, putting the policy in danger of lapsing. That’s a surprise you do not want!
Another trap. Some policy owners were left with the false impression that if they paid premiums for 10 years, the policy would be “paid up” and no more premium needed to be paid. Not true. The illustration merely showed that if you paid the scheduled premiums and if the interest or dividend rate projected, and the cost of insurance remained constant over time, most likely the policy would support itself beyond year 10. In a declining interest rate world, that’s a very dangerous assumption.
You monitor and track your investment portfolio. Why not your insurance portfolio? How are your cash value policies performing? Are they doing what you planned for them to do? Is the policy meeting expectations? Is it likely to lapse?
To answer critical questions, contact your financial advisor and order an “in-force” illustration. The illustration shows the current cash value and projects how the policy will perform if you continue paying premiums as you are currently given current interest or dividend rates, which may differ substantially from the crediting rate on the original illustration provided when you bought your policy. If the policy is in danger of lapsing, wouldn’t you want to know? Many policy owners have been shocked to learn how much premium must be paid to salvage their contract.
An in-force illustration and a consultation with an experienced financial advisor can tell you what the data means. That discussion may be critical to your financial health and that of your heirs. Order yours today!
Lewis Walker, CFP®, is a financial life planning strategist at Capital Insight Group; 770-441-3553; firstname.lastname@example.org. Securities & advisory services offered through The Strategic Financial Alliance, Inc. (SFA). Lewis is a registered representative and investment adviser representative of SFA, otherwise unaffiliated with Capital Insight Group. He’s a Gallup Certified Clifton Strengths Coach and Certified Exit Planning Advisor.