Over the years, there have been innumerable pieces written on the failings of universal life insurance (UL).Â However, if consumers paid attention when these products were explained to them, theyâd be no more surprised by this than discovering their retirement plans werenât going to pan out when they experienced only half the expected market return.Â None of this should be a surprise; if projections arenât realized, results will differ.Â
That being said, thereâs 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.Â Somehow, WL has been held up as somewhat holy and unaffected by the travails of UL.Â This has got to stop because many policy owners and their policies are suffering for it.Â
Name Brand Companies Arenât Immune
I rarely name insurance companies when I write but Iâm going to make exceptions because it is pertinent to the conversation.Â Northwestern Mutual (NML) is a top rated insurance company.Â Itâs conservative, traditional and has a good reputation in the consumer market.Â What Iâm writing about today isnât a criticism of NML or any other insurance carrier I mention, but a warning to the market that things arenât always as they seem.Â I donât want to risk a reader blowing this off because of an assumption these issues only affect marginal insurance carriers.Â Nothing could be further from the truth.
Most consumers I talk to believe life insurance is guaranteed while it seldom is.Â Even more believe their WL is guaranteed, and only sometimes it is.Â Before I go further, Iâm going to make some differentiation so no one tries to come after me on technicalities.Â True WL is guaranteed.Â However, policy owners who believe they have WL donât always really have WL.Â
Letâs start with what guaranteed WL is.Â A WL policy is guaranteed for the initial death benefit when a premium is paid out of pocket every year that itâs due, and the policy has no term blend incorporated.Â But many donât understand this. Â Most clients believe that if they sign off on a policy designed to have 10 premiums, for example, when they pay the 10 premiums, theyâre done, and the contract is guaranteed.Â More often than not, this isnât true.Â A true 10-pay contractual policy will work this way.Â However, most short pays are projections and not guarantees.Â
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.Â He understood it to be a 10-pay contract, period.Â Try to track with me because this is kind of funny.Â When he came to me, I told him he couldnât stop after 10 years, and he now had to pay to age 76.Â He was understandably floored.Â We then scheduled a meeting with him, his financial advisor and myself so I could explain.Â 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.Â After the dividend was reduced again, he had to pay to 100.Â 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.Â 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.Â 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.Â
A trust officer friend of mine was on the phone with me yesterday after I was analyzing his motherâs NML policy.Â Itâs 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.Â
Lately Iâve been brought in to evaluate some in-force and proposed premium financed transactions funded with Mass Mutual WL.Â These were highly front-end funded, non-blended WL policies.Â Some of them were projections so they havenât even had a chance to disappoint.Â But I couldnât 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.Â The numbers didnât really work how they were led to believe, and the plan prospects were unsustainable.Â
How about my client who owns and runs a global enterprise?Â He and his wife owned a $40 million New England/MetLife WL policy as part of a larger insurance portfolio in their irrevocable trust.Â It was only 15 years old and already falling apart. Â I ordered in-force ledgers that showed their $150,000 annual premium increasing to seven figure annual premiums.Â 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.Â Why?Â Term blends.Â Term isnât WL.Â Term was layered in to reduce the premiums and make the policies more affordable and competitive in the face of UL.Â 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.Â However, when the dividend rates plummeted with the interest rate market, the WL portion didnât grow as fast, and the term stayed in the picture.Â Why is that a problem? Because the cost of term insurance increases as you get older.Â Fundamentally your client is Â paying annual renewable term rates as a 60-, 70-, 80- or 90-year-old individual.Â Howâs that going to work out for him?Â
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.Â I know the definition of cannibalism but whatâs it called when you eat yourself?Â
But if WL is guaranteed, then whyâs this happening?Â Because WL, as itâs often purchased, isnât guaranteed.Â The increasing death benefits arenât guaranteed.Â The dividends arenât guaranteed.Â Most of the short pays arenât guaranteed.Â The term blends arenât guaranteed.Â So many of what are referred to a paid-up policies arenât really paid-up, itâs just the vernacular people use.Â Â
Effects of the Interest Rate Markets
Ok, so those features arenât guaranteed, but why is everything going downhill?Â Because interest rates have gone downhill, and everything follows.Â A policy I referred to earlier was issued in 1986.Â That was possibly the worst time in the history of the world to buy a traditional WL policy on a budget basis.Â It sure looked attractive but the NML dividend rate peaked at 11.25 percent that year, and NMLâs 2018 dividend rate was 4.9 percent.Â Whenâs 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.Â All dividend rates have sunk by many hundreds of basis points since the mid-1980s.Â You think thatâs bad?Â Wait, it gets worse!Â
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.Â Because the premium was often unknowingly payable, and the policy owners didnât pay it, it had to come from somewhere.Â Hereâs where loans come in.Â Many, if not most, WL policy owners have no idea that a loan can accrue on a policy even when they donât take money out of the policy.Â Yes, that premium that wasnât paid out of pocket may have been, and often was, paid by an automatic internal loan.Â 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.Â However, when the dividend rate drops to well below the loan rate and itâs not serviced, bad things can happen.Â Unfortunately most policy owners arenât 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.Â Ultimately the policy owner may get the insurance equivalent of a margin call.Â Imagine getting a margin call when you donât believe you have anything out on margin.Â I regularly inform people of loans they had no idea existed.
Iâve seen a policy ownerâs premium increase from $40,000 to $400,000, from $150,000 to $7 million and from nothing to thousands a year.Â Time out.Â I hear howling, so let me explain.Â No, the base WL premium doesnât increase but the payments increase.Â Does it sound more palatable when I say you only owe $40,000 in premium and $360,000 in loan interest?Â Much better, isnât it?Â Good heavens, of course not!Â So all day long Iâm going to refer to premium as base WL premium, term premium and loan interest collectively because thatâs what honest people do, forget the technicalities.Â How many understand what happens when out of control loans tank a WL policy?Â The loans are forgiven.Â That sounds so sweet, doesnât it?Â But the dastardly Internal Revenue Service considers that forgiven debt and taxes it as ordinary income to the extent it exceeds basis in the contract.Â
Iâve witnessed the most devastating circumstances you can image.Â How bad?Â How about a policy owner being driven into bankruptcy by a lapsing, loaned out WL policy?Â A tax bill due on a failing contract that exceeds the entire net worth of a family?Â Iâve seen it happen.Â Dramatically negative consequences come home to roost more often than you might think.
Cash Value and Death Benefit Shortfalls
Even when devastating results donât occur, it doesnât mean that allâs good.Â Many policy owners who were funding a WL policy for supplemental retirement funding or deferred compensation plans will be surprised to discover the policy wonât provide the expected funds.Â Death benefits that were projected to be significant will be substantively tempered.Â
Does any of this mean WL is bad?Â No!Â If your car runs out of gas does that make it a failure? Â Really, itâs more your fault, isnât it?Â Â What it does mean is that youâd better understand WL insurance and not envision a quaint 1960s era guaranteed product.Â
Whole Life Isnât Bad but Itâs Not Infallible
Itâs not all bad news.Â The insurance carriers I reference above are fine.Â Some policies are doing fine.Â They are almost all underperforming expectations but they have to be in a decreasing interest rate environment.Â Dividends arenât magical.Â They are predominantly driven by the interest rate markets.Â Oh, and donât expect them to recover quickly as interest rates start to edge up.Â First of all, they may never get to where they were before, and time value of money is a bitch when itâs working against you.Â
I read a lot of articles regarding life insurance, and sometimes the most illuminating aspects are found in the comments section.Â Invariably there will be an agent or two who simply recommend sticking with mutual WL to avoid problems and may even admonish those who have strayed elsewhere, often with a bit of a condescending attitude.Â I donât know that they understand that many of the people who end up working with me to fix whatâs gone wrong thought they were doing exactly that.Â Thereâs nothing magic about WL, and thereâs nothing simple about life insurance.
Bill Boersma is a CLU, AEP and LIC.Â More information can be found at www.oc-lic.com, www.BillBoersmaOnLifeInsurance.info and www.XpertLifeInsAdvice.com or email at [emailÂ protected]