“You got to know when to hold up, know when to fold up, know when to walk away, and know when to run.”—Kenny Rogers, “The Gambler”
Recently, we gave you the good, the bad, and the ugly about universal life insurance policies. As it turns out, there isn’t a lot of “good” for aging policy owners who are seeing their premiums skyrocket. Lawsuits continue to mount from policy owners who feel they have been misled. Some realize their “permanent” policies will expire before they do! Others realize their policies will lapse if they cannot make ever-increasing premium payments. This was not what they thought they signed up for!
Last year, state regulators in New York issued a cautionary alert to consumers about universal life insurance with this all caps, bolded warning: “YOUR PREMIUM PAYMENT AMOUNT IS PROBABLY NOT GUARANTEED AND MAY INCREASE.” In 2018, the Texas Department of Insurance put out a similar warning. A short informational video illustrated how universal life policies can lose value and even lapse due to the ongoing costs, especially in timse of low interest rates and underperforming investments.
Now, warnings are great if you are shopping for life insurance. But what should you do if you already have a universal life policy that lacks guaranteed level premiums and a guaranteed death benefit? In this article, we’ll outline options and actions that can help protect you from an imploding policy.
We’ve helped concerned policy owners who are wondering what to do with their universal life policies for years. Some common questions are, “Should I keep my universal life policy?” and “Should I surrender my universal life policy?” And there are other options worth considering, such as reducing the death benefit or exchanging your universal life policy. You may have several choices that can make sense. The only thing you should definitely NOT do is bury your head in the sand, cross your fingers and just “hope” it all turns out!
Evaluating your universal life policy.
Before you make any decisions, understand exactly what you’ve got. Start with the policy’s coverage. Some universal life policies only pay to age 90, 95, or 99. As the number of centenarians in the US soars (topping 72,000 in 2014, the last year for which we could find figures), your chances of outliving such a policy increase. With some policies, the death benefit will be cut in half at a certain age. (We’re not sure why these policies continue to be described as “permanent policies,” but they are.)
Next, you need an “InForce illustration” of your policy. An InForce illustration provides a picture of your insurance policy as it currently stands. It shows the exact results of what has happened from the policy’s inception to today, including premiums paid and growth of cash value. Most importantly, an InForce illustration also gives you future projections based on current assumptions.
To obtain an InForce illustration, you can contact your insurance company directly or the agent who helped you purchase it. (If you have a 1-800 customer service number on your policy, that’s a perfect starting point.) If you and your spouse both own policies, you will only be able to request illustrations for policies that you personally own.
Typically, you can obtain one free InForce illustration per year. With a universal life policy, it is a good idea to do an InForce illustration at least every couple of years. Ask for an InForce illustration based on current assumptions – meaning with the current scheduled premium. You may also decide to request further InForce illustrations to see how projections may change if you alter the policy. For instance, you may want to see how lowering the death benefit will affect policy projections.
What you’re looking for with the InForce illustration is what we call the “crossover point.” That’s the point at which the policy is no longer growing cash value, but rather, consuming it. There is no real rule of thumb of when that might happen—it all depends on the company, the level of premiums paid, the mortality costs inside of the policy, etc.—but we often see that point reached when the insured is in their 80’s. The crossover point is critical, because once the policy costs start to outpace the growth of the policy, you are at risk of either having your policy implode or facing higher premiums to keep it in force.
Since universal life policies do not typically have guaranteed premiums or guaranteed death benefits, it is especially important to look at the “worst case scenario” projections. If interest rates (or the stock market, in an indexed policy) perform poorly, how will the policy perform? Will rising policy costs begin to consume the cash value? The sooner you are aware of a problem, the more you can do about it.
A “cost-basis report” can also be helpful. This will help you understand any potential tax implications of surrendering a policy. The cost basis of a life insurance policy is the sum of all your insurance premium payments. If you surrender a cash value life insurance policy, any gain on the policy over and above your cost basis (premiums paid) will be subject to federal (and possibly state) income tax. (Note that outstanding loans are also counted as part of the gain.) In general, the amount the policy owner has paid for the policy, up to the cost basis, is tax free.
Weighing the risk of keeping a universal life policy.
As we explained in our previous article, the problem is how universal life policies are constructed. Universal life and indexed universal life (IUL) policies have changeable costs—especially, mortality costs that rise as the insured ages. As the New York Department of Financial Services warned, “The internal charges of universal life policies can increase every year… as the insured gets older and can be very high in later years.” Eventually, these costs can eat away at cash value, require higher premiums, or cause a policy to implode. If that happens, you end up with a lapsed policy—no death benefit, no cash value, nothing.
So a universal life policy can be a bit of a gamble—literally. You have to determine what your chances are of having the policy last until you die. If you have (for example) cash value of $50k, a death benefit of $100k, and you are nearing that crossover point, you have to estimate the odds of the policy staying in force to pay a death benefit. You can always choose to quit and walk away with what you have—your cash value (subtract any surrender charges).
In addition to information gathered from an InForce illustration, there are many factors to consider, such as:
How new is your policy? If a policy is fairly new and you are still in good health, you might consider surrendering it before you put more dollars into it. You could start from scratch with a whole life policy—or even a combination of whole life and term—and be able to have confidence in how your life insurance will perform.
What is your estimated life expectancy? The not-so-funny joke about how to avoid universal life policy problems is, “Don’t live too long!” And unfortunately, there’s truth to this.
If the crossover point for your policy will be reached before age 90 and you are 80, active and healthy with a good family history of longevity, your universal life policy may be a bad bet. Life expectancy calculators found on Livingto100.com and the Blue Zones Vitality Test can be helpful.
If your premiums increase, can you still pay them? Unfortunately, some seniors are forced to lose or surrender their policies when nearing life expectancy because they simply can’t afford higher premiums.
What should you do with your universal life policy?
If you believe there is a reasonable chance that you will outlive your policy or have to pump increasingly large premiums into it to keep it afloat, you have a number of options.
Surrender your universal life policy?
If the prognosis isn’t good, sometimes it’s best to just walk away. Like the saying, “A bird in the hand is worth two in the bush,” sometimes keeping your cash value and surrendering the death benefit is a wise move. You can at least put that money to work somewhere else.
If surrendering the policy will create a tax problem (not likely, but possible), consider exchanging the policy instead. (See below.)
If you will pay surrender charges now that will soon drop off, evaluate if it makes more sense to keep the policy for now and surrender it later (perhaps reducing your death benefit in the meantime).
Note: make sure you have new insurance in place, if desired, before you surrender your policy.
Reduce your death benefit?
Shrinking the size of the policy’s face value can be an effective strategy. By reducing the death benefit, you reduce the mortality costs of the policy. This can actually stretch the life expectancy of your universal life insurance policy!
If you have held the policy for a time and funded it well, sometimes it is even possible to reduce the death benefit to a level where you can stop making premium payments. There’s little downside to this strategy if it works as intended! Be aware, though, the death benefit and premium level will not be guaranteed as it would be with a whole life policy—it is only projected. Keep tracking the policy with InForce illustrations so you know if things change.
Exchange your universal life policy?
You can roll the cash value into a different type of life insurance product, such as a whole life policy or a single premium immediate annuity. If leaving an inheritance is your priority, a whole life or single premium whole life policy can be a good option. If increasing your cash flow is your priority, an annuity can serve your needs well.
Unfortunately, it’s likely your policy has not built up a lot of cash value, which won’t make you feel like you’re getting a lot of bang for your buck. Still, this is a viable strategy and it will also help you avoid any taxable gains.
Keep your universal life insurance policy?
This can be a reasonable option if you believe your policy will outlive you rather than vice versa. Just do so with your eyes open, checking InForce illustrations regularly. If you live significantly longer than you think, you’ll want to be aware if the policy starts cannibalizing the cash value.
A combination of strategies?
It doesn’t have to be all or nothing. For instance, you might reduce the size of a universal life policy, keep it, and purchase a small whole life policy to ensure you have additional coverage. Now, if you hit that “crossover point” and decide to surrender your policy later, you’ll still have a permanent policy in place. Even if you don’t have a UL policy, multiple smaller policies can make more sense than one larger policy.
Do you need a life insurance pro?
An Investopedia 100 advisor, Kim D. H. Butler, is an industry veteran and recognized authority on whole life insurance. She has been on the forefront of alerting consumers to the inherent problems with universal life insurance—before it was headline news in the Wall Street Journal and New York Times! Kim has also written two recognized books on the topic: Live Your Life Insurance and Busting the Life Insurance Lies.
To schedule an appointment with Kim to discuss your situation, contact Prosperity Thinkers today. Partners for Prosperity has specialized in life insurance and alternative investments for over twenty years and is licensed to help people in all 50 states.
For more about universal life insurance (the prelude to this article), see “The Disadvantages of Universal Life: Regulators Issue a Warning.”