We've all seen articles chronicling the woes faced by policyholders who own universal life insurance. The names change, but the theme tends to remain the same. Joe insurance purchaser bought a universal life insurance policy years ago and recently learned that the premium he paid for all these years wasn't enough to keep the policy in force. Now Joe must make significant increases to his premium or else forfeit the policy leaving him with zero death benefit despite years of premium payments.
This unfortunate circumstance has hit all too many past purchasers of universal life insurance, and I suspect many more are awaiting a reality similar as they sit on policies purchased years ago with low-balled premiums used mostly to compete on price against some other product such as whole life insurance.
But recently we saw a shift on this discussion. For years it was the niche financial media and us squawking about this problem and trying to offer up insight on how it happened and how you–if you own universal life insurance–can shield yourself from this cruel reality. Now, we've gained an ally in the way of a regulatory body, the New York Department of Financial Services (i.e. the Department of Insurance).
The current acting superintendent of the New York Department of Financial Services (NYDFS), Linda Lacewell issued an alert to New York residents concerning universal life insurance. It is one of her very first acts in this new role.
The warning came as a cautionary note to New Yorkers who own or are considering a purchase of universal life insurance. Apparently, the NYDFS received nearly 1,400 complaints from New York residents concerning universal life insurance policies over the course of the past five years. This is, presumably, more complaints than received for any other life insurance product within the state.
Ms. Lacewell's alert wants New Yorkers to know that the expenses charged on a universal life insurance policy can and do increase as the insured ages and this fact can leave many policyholders with an increasing required premium if they wish to keep their death benefit protection in force. An excerpt from the alert reads as follows:
“The Department has seen many cases of consumers who purchased universal life insurance and who made payments for years, thinking their premium payment would not change or that their coverage would remain in effect. But many found that their policies had lapsed (were no longer in effect) with little to no [cash] value due to declined in interest rates, market volatility and other factors, or they were required to pay large additional premium payments to keep their coverage in effect.”
This story remains unchanged from the ones reported in major news outlets such as the Wall Street Journal or the New York Times. It's also the same narrative we've highlighted numerous times throughout the years here at The Insurance Pro Blog.
The New York Department of Financial Services went on to mention five key points it wished all New Yorkers to understand as a part of the alert. These five key elements of the alert are:
I understand that insurance law and jargon can be a tad obtuse, so I'm going to take the majority of the rest of this blog post to breakdown these five elements for our readers and anyone else who might stumble upon this page in the future as they try to understand what is going on with their current or future universal life insurance policy.
Universal life insurance comes in many different flavors. There's current assumption universal life insurance, variable universal life insurance, indexed universal life insurance, and guaranteed universal life insurance. On all of these forms of universal life insurance EXCEPT the last one mentioned, the premium amount paid by the policyholders DOES NOT generally guarantee the death benefit for the entirety of the insured's lifetime.
Many of these forms of universal life insurance provide a guaranteed death benefit period provided the policyholder does pay a minimum amount of premium for the entire guaranteed period. This timeline, however, is generally something in the range of 20 years and almost never the entire lifetime of the insured.
This means that no matter how much premium you pay to these types of universal life insurance, the contract will never guarantee that the death benefit will remain in force because you paid those prior premiums.
Now, it's important to understand that there is most definitely an amount of premium you as the policyholder can pay to ensure that the death benefit remains in effect for the entire lifetime of the insured, there's even a way to safety check this (see the section below about asking your agent about guaranteed and/or adverse scenarios). But the premium you must pay to ensure the death benefit remains in effect for the insured lifetime is often much higher than most agents depict. This probably seems like a strange phenomenon and I'm sure you're wondering why this is, so let's dive into that.
I want to very explicitly drive a distinction between the first three types of universal life insurance I mentioned above and the last one (guaranteed universal life insurance) all I have discussed so far concerns the first three and ignores guaranteed universal life insurance. I plan to elaborate a lot more on the guaranteed version of universal life insurance near the end of this blog post, but for now understand that I'm only talking about the first three mentioned in the last section (current assumption, variable, and indexed universal life insurance).
These types of universal life insurance can calculate a premium amount that the policyholder should pay according to the assumptions plugged into the software that spits out a proposal for life insurance. Factors that affect this calculation are:
Let's understand each of these in a bit more detail.
The age of the insured obviously influences the premium with a positive correlation. This is to say that younger ages will tend to produce lower amounts of premium and higher ages will tend to require higher amounts of premium. There's little anyone can do to influence how the effect of age the insured has on the reported premium, but there is a nuanced way someone might cause the output to reflect a somewhat lower premium for older insured's.
The length of time specified to keep the death benefit in force does allow the agent or policy designer to practice liberty over just how long he/she believes the insured will live. If this individual assumes that the policy need not remain in force (for example) longer than the insured's age 80, this would produce a lower suggested premium than a scenario that stipulates that the death benefit should remain in effect through the insured's age 120.
An example will help paint the picture and highlight the danger of this.
Agent A provides Harold with a universal life insurance policy that has a $5,000 per year premium, while agent B provides Harold with a similar universal life insurance policy that says Harold will have to pay $9,000 per year.
Harold is surprised by the price difference but decides that Agent A's offer is better and begins the application process. While waiting to hear back from the life insurance company on his application, Harold begins to more thoroughly look through the proposals offered by both agents and he discovers that Agent A's proposal assumes the death benefit will only remain in effect until his 80th birthday. Agent B's proposal, on the other hand, assumes that Harold's death benefit remains in effect until he reaches his 120th birthday.
Realizing that coverage that only lasts through his 80th birthday might be inadequate for his needs, Harold decides to cancel his application with Agent A and instead purchases Agent B's policy.
Assumed interest rate accumulation affects the premium amount with a negative correlation relationship. This means the higher the assumed interest rate, the lower the suggested premium amount and vice versa. This element for universal life insurance can become very tricky to compare across different universal life insurance contracts and is often glossed over by a lot of people.
For indexed and variable universal life insurance proposals, agents can practice a lot of liberty over just what assumed interest rate they use to produce the output premium the policyholder should pay.
For example, take the example with Harold from above, but let's now assume that both agents assumed the same period for the death benefit to remain in effect (his age 120). Let's assume though that the recommended premium amounts came out similarly (Agent A at $5,000 per year and agent B at $9,000). Upon investigating, Harold discovers that agent A assumed the policy interest rate at 6% per year, while agent B assumed 4% per year.
The exact amount of death benefit affects the recommended premium with a positive correlation relationship. This means the higher the specified death benefit that higher the recommended premium and vice versa.
It's probably obvious that the agent has little control over the outputted recommended premium with the age of the insured and exact death benefit amount inputs but can manipulate the output by adjusting the length of time the death benefit remains in effect and/or the interest rate assumption. These inputs are no fixed nor universal among life insurers so prospective buyers need to be hyper-vigilant in ensuring that similar assumptions are made across life insurance products to ensure that they are comparing apples to apples.
This is precisely what the NYDFS means when it warns New Yorkers to understand how the agent determined the premium the current or prospective universal life insurance owner should pay. If the assumptions are bad, then the likelihood of falling into the trap of needed higher premiums in the future to keep the policy in effect rises exponentially.
All universal life insurance proposals must include a guaranteed ledger in order to comply with insurance regulation in most states (New York definitely included). This ledger intends to show the prospective buyer what the contract guarantees.
For example, you might receive a proposal that shows you pay $5,000 per year for a $250,000 death benefit keeps the policy in force for your entire life on one (the non-guaranteed) ledger, but when you look at the guaranteed ledger paying that same $5,000 premium keeps the death benefit in force only until your age 75. That means paying that $5,000 premium DOES NOT guarantee the death benefit forever, it guarantees it to your age 75.
If you notice something like this, you can ask your agent to provide you with a proposal that shows what amount of premium you'll need to pay to keep the policy in effect forever. In other words, what level of premium shows the death benefit remaining in effect for all years shown on the ledger (generally your age 120).
From here, you'll have to decide what you think will happen moving forward and if you should pay a premium in the amount suggested under the guaranteed ledger. You might not need to pay the amount recommended under the guaranteed assumption, but you might want to hedge somewhat and pay something higher than originally depicted. A good comparison for any given level of the death benefit under a universal life insurance policy is to see what premium requirement you'd have under a whole life policy with the same death benefit.
Whole life insurance guarantees the death benefit will remain in force and, as such, mean the life insurer will make extra special sure that it is collecting enough premium to fund the guarantee is committing itself to. Life insurance companies have no difference in the chances of a policyholder dying based on the type of permanent life insurance someone buys (whole life or universal life insurance) so you can take the math the actuary did for whole life insurance and assume that it is close to correct for universal life insurance. Let's use an example to understand this point a little better.
Due to her concerns about the premium being too little, Jane requests a whole life insurance proposal from another agent and discovers the premium she would need to pay for the same $500,000 death benefit is $10,000 per year.
For various reasons, Jane would prefer to purchase universal life insurance instead of whole life insurance, so she opts to buy the universal life insurance policy but pay $10,000 per year in premium instead of the proposed $6,000.
Keep in mind that the guaranteed ledger is not the only area you can evaluate on a universal life insurance policy that might require a higher level of premium. I discussed in the above section that agents can make assumptions about various elements of the policy that require some careful consideration because they influence the recommended premium.
It's wise to ask what level of interest rate the agents is assuming in the proposal as well as how long he/she assumes the death benefit will remain in force under the planned premium amount. Looking at adverse scenarios as the NYDFS suggests include things like a lower assumed interest rate or a longer assumed period for the death benefit to remain in effect. This will allow you to understand what level of premium you'd need to pay to keep your death benefit under those scenarios.
While most reputable life insurers will provide policyholders with as many free, in-force ledgers as they wish (though these things don't often change much more than once per year) New York has established a law that requires life insurers to provide these upon request for free once per year. In other words, the life insurer cannot charge you for doing this.
The in-force ledger (also known as an in force illustration) shows the current values of the policy, both cash value, and death benefit, as well as what the policy will do in the future if you pay the currently planned premium. The in force can also show you what happens if you:
These four things I mentioned are all things you'd need to specifically request. They are not the default outputs for an in-force ledger.
I would highly discourage an attempt to interpret an in force ledger on your own, especially if you have no background in insurance. These documents can often include numerous tables of values and are not the friendliest depictions of values to the layperson. There's a lot of disclosure that the insurance industry feels it must include avoiding accusations of concealing or misleading, and this can often lead to an overwhelming amount of information being presented all at once.
The insurance company itself is limited in its ability to help policyholder interpret these documents. Life insurers are unwilling to take on an advisory role and this stems from fears of liability if they take on the task of advising policyholders on these products. But this is why insurers have agent staff or you can always seek the advice of an insurance professional to help discern the information contained in an in force ledger. Fees for doing this are generally nominal.
All states in the United States have a free look period for insurance purchases. This is a timeline under which you have the right to back out of an insurance purchase and receive a full refund on the premiums paid to the life insurer. In New York, this is a 10 day period beginning on the day you receive the policy and sign the paperwork stating you accept the insurance policy (this period extends to 30 days for policies delivered to you by mail, i.e. where you did not personally meet with the agent/broker who sold you the policy).
The NYDFS mentioned this in its alert to let New Yorkers know that if they recently bought a universal life insurance policy and are now having second thoughts, there might be time to back out if they feel they've made a mistake.
Once the Free Look period ends, the policyholder can still cancel the policy, but will not receive a full refund for premiums paid. Instead, the policyholder will receive a refund of unearned premiums and/or any cash surrender value the policy has.
I mentioned above that I wanted to explicitly differentiate between the universal life insurance contracts that could end up causing the problems associated with the NYDFS alert and a special form of universal life insurance that most likely would not. Guaranteed universal life insurance is a special form of universal life insurance that DOES guarantee the death benefit provided the policyholder pays a minimum amount of required premium to guarantee the death benefit. This premium amount can guarantee the death benefit effectively forever and if you own one of these forms of universal life insurance you have fewer reasons to worry.
But…you shouldn't walk away assuming that you are completely immune. This special form of universal life insurance does–I assure you–guarantee the death benefit remain in effect provided you do nothing more than pay the required premium–and paying the required premium is an absolute must.
Failing to pay the required premium can and will forfeit the guaranteed death benefit feature, so it is important to understand the one area of susceptible failure this product does have. This one element, however, is arguably no different than any other type of insurance. If you don't pay the premium, you risk losing the coverage.
It seems with all the media and now New York State highlighting the weaknesses of universal life insurance, we might want to declare it a failure and walk away. Doing this, however, would be short-sighted and likely cause a lot of people to lose out on a product that can provide a significant amount of benefit to the right person.
As with any industry, it's not so much a bad product story as a bad matching of product to the person. Universal life insurance does have a lot of great features to offer the right type of insurance buyer. Universal life insurance comes with incredible flexibility, but that flexibility also comes with certain consequences that can cause problems for those who don't treat it correctly.
Unlike whole life insurance that comes with a myriad of features that in some respects protect people from themselves, universal life insurance lacks these features in the name of greater consumer choices. For some people, this is a great benefit. But for other people, this is a dangerous choice. Matching the right person (or personality) to the right product is where the good or bad will ultimately manifest.
Brandon launched the Insurance Pro Blog in July of 2011 as a project to de-mystify the life insurance industry. Brandon was born in Northern New England, and he currently calls VT home. He attended Syracuse University and graduated with a triple major in Economics, Public Administration, and Political Science.