Saturday, 25 May 2019

When is Whole Life Not Really Whole Life? –

Over the years, there have been innumerable pieces written on the failings of universal life insurance (UL).  However, if consumers paid attention when these products were explained to them, they’d be no more surprised by this than discovering their retirement plans weren’t going to pan out when they experienced only half the expected market return.  None of this should be a surprise; if projections aren’t realized, results will differ. 

That being said, there’s little discussion about the failings of whole life insurance (WL). Now, when I say WL, I mean actual WL and not just permanent cash value life insurance.  Somehow, WL has been held up as somewhat holy and unaffected by the travails of UL.  This has got to stop because many policy owners and their policies are suffering for it. 

Name Brand Companies Aren’t Immune

I rarely name insurance companies when I write but I’m going to make exceptions because it is pertinent to the conversation.  Northwestern Mutual (NML) is a top rated insurance company.  It’s conservative, traditional and has a good reputation in the consumer market.  What I’m writing about today isn’t a criticism of NML or any other insurance carrier I mention, but a warning to the market that things aren’t always as they seem.  I don’t want to risk a reader blowing this off because of an assumption these issues only affect marginal insurance carriers.  Nothing could be further from the truth.

Guaranteed WL

Most consumers I talk to believe life insurance is guaranteed while it seldom is.  Even more believe their WL is guaranteed, and only sometimes it is.  Before I go further, I’m going to make some differentiation so no one tries to come after me on technicalities.  True WL is guaranteed.  However, policy owners who believe they have WL don’t always really have WL. 

Let’s start with what guaranteed WL is.  A WL policy is guaranteed for the initial death benefit when a premium is paid out of pocket every year that it’s due, and the policy has no term blend incorporated.  But many don’t understand this.  Most clients believe that if they sign off on a policy designed to have 10 premiums, for example, when they pay the 10 premiums, they’re done, and the contract is guaranteed.  More often than not, this isn’t true.  A true 10-pay contractual policy will work this way.  However, most short pays are projections and not guarantees. 

Real Life Stories

Just ask the 40-year-old NML policy owner who came to me with a policy he purchased at age 30 on a 10-pay basis and was trying to figure out why he now had to pay more than the 10 years.  He understood it to be a 10-pay contract, period.  Try to track with me because this is kind of funny.  When he came to me, I told him he couldn’t stop after 10 years, and he now had to pay to age 76.  He was understandably floored.  We then scheduled a meeting with him, his financial advisor and myself so I could explain.  By the time we got to the meeting, the NML dividend rate had been reduced again. I ordered a new ledger, and he now had to pay to age 84.  After the dividend was reduced again, he had to pay to 100.  After the dividend went down yet again, he had to not only pay to age 100, but also, he had to pay significantly more premium.  OK, not really funny.

An attorney friend of mine has an NML policy on his wife, and they have dutifully paid every single year on time for a couple of decades.  He had me review his policy, and I had to tell him the death benefit was decreasing every year and would be much lower than they thought it would be; half of the original death benefit by life expectancy. 

A trust officer friend of mine was on the phone with me yesterday after I was analyzing his mother’s NML policy.  It’s a 33-year-old policy, issued in 1986, and the death benefit is dropping every year and is now lower than when the policy was issued and will go much lower. 

Lately I’ve been brought in to evaluate some in-force and proposed premium financed transactions funded with Mass Mutual WL.  These were highly front-end funded, non-blended WL policies.  Some of them were projections so they haven’t even had a chance to disappoint.  But I couldn’t advise to move forward with them because not only did the policy owner and advisor team not understand how the transactions really worked, but also, they actively misunderstood them in ways to come to the exact wrong conclusions when making decisions.  The numbers didn’t really work how they were led to believe, and the plan prospects were unsustainable. 

How about my client who owns and runs a global enterprise?  He and his wife owned a $40 million New England/MetLife WL policy as part of a larger insurance portfolio in their irrevocable trust.  It was only 15 years old and already falling apart.  I ordered in-force ledgers that showed their $150,000 annual premium increasing to seven figure annual premiums.  So much for guaranteed WL, huh?

Whole Life With Term Blends

These policies were all sold projecting increasing death benefits and some as short pays but they need much more premium, and the death benefits are still sinking.  Why?  Term blends.  Term isn’t WL.  Term was layered in to reduce the premiums and make the policies more affordable and competitive in the face of UL.  The term insurance was never intended to be in the picture after a number of years because the base WL was supposed to grow and replace it.  However, when the dividend rates plummeted with the interest rate market, the WL portion didn’t grow as fast, and the term stayed in the picture.  Why is that a problem? Because the cost of term insurance increases as you get older.  Fundamentally your client is  paying annual renewable term rates as a 60-, 70-, 80- or 90-year-old individual.  How’s that going to work out for him? 

The term starts getting so expensive that not only do the paid premium and the dividends not cover it, but also, the policy starts surrendering parts of itself to pay for the increasing term costs.  I know the definition of cannibalism but what’s it called when you eat yourself? 

But if WL is guaranteed, then why’s this happening?  Because WL, as it’s often purchased, isn’t guaranteed.  The increasing death benefits aren’t guaranteed.  The dividends aren’t guaranteed.  Most of the short pays aren’t guaranteed.  The term blends aren’t guaranteed.  So many of what are referred to a paid-up policies aren’t really paid-up, it’s just the vernacular people use.   

Effects of the Interest Rate Markets

Ok, so those features aren’t guaranteed, but why is everything going downhill?  Because interest rates have gone downhill, and everything follows.  A policy I referred to earlier was issued in 1986.  That was possibly the worst time in the history of the world to buy a traditional WL policy on a budget basis.  It sure looked attractive but the NML dividend rate peaked at 11.25 percent that year, and NML’s 2018 dividend rate was 4.9 percent.  When’s the last time that something projected to credit at 11.25 percent and dropped to 4.9 percent worked out?

The other WL companies were in the same boat.  All dividend rates have sunk by many hundreds of basis points since the mid-1980s.  You think that’s bad?  Wait, it gets worse! 

Short Pay Policies and Loans

In many of these short pay scenarios, where policy owners thought that after paying their 10 premiums, their policies were paid up, the owners had another kick in the gut in store.  Because the premium was often unknowingly payable, and the policy owners didn’t pay it, it had to come from somewhere.  Here’s where loans come in.  Many, if not most, WL policy owners have no idea that a loan can accrue on a policy even when they don’t take money out of the policy.  Yes, that premium that wasn’t paid out of pocket may have been, and often was, paid by an automatic internal loan.  Many times, this was a default action chosen for the policy owner and not by the policy owner when the policy was being designed.

That may be how the policy was designed, and when the dividend rate is much higher than the loan rate, this is supportable.  However, when the dividend rate drops to well below the loan rate and it’s not serviced, bad things can happen.  Unfortunately most policy owners aren’t informed of this, and because they were never taught to actively manage their policies and relatively few are being actively managed by agents and trustees, these loans grew out of control.  Ultimately the policy owner may get the insurance equivalent of a margin call.  Imagine getting a margin call when you don’t believe you have anything out on margin.  I regularly inform people of loans they had no idea existed.

Increasing Premiums</