Estate planning clients have purchased life insurance over the years for a variety of reasons: paying estate taxes, making charitable gifts, buying out business partners, and providing income for surviving spouses, among many others. For clients who need to maintain these policies for the long term, there may be a ticking time bomb. The unprecedented decline in bond and other fixed income rates that affects what insurance companies and insurance policies can earn to support the promised death benefit has put at least some of these policies at risk. The concern is not so much the solvency of the insurance company, but rather that the premiums that are being paid which were sufficient to maintain the policy when the interest rates were higher, cannot do so now that interest rates are at a historic low and seem likely to stay there for awhile longer.
Not all policies have this issue. To understand the problem, which is as multifaceted as there are types of insurance policies, it may be helpful to divide the universe of life insurance policies into two groups: term and permanent. Term insurance offers a death benefit for a number of years and typically has no cash value. Permanent insurance is designed to stay in force for the insured’s entire life and typically relies on the policy’s cash value to support the death benefit. Existing term insurance has generally not been affected by the decrease in interest rates. Permanent insurance policies generally have been affected.
Also not a problem are permanent policies which guarantee coverage at a fixed premium. Of these there are two types: traditional whole life insurance with no term element, and a policy known as a no-lapse guarantee policy with a cash value that tends to disappear over time.
More at risk are so called “universal life” policies where premiums are flexible. Also at risk are fixed premium policies where permanent insurance is mixed with term insurance. What all of these policies have in common is a dependence on crediting rates or dividends to support the death benefit over time. If the actual crediting rates or dividends are less than the level that prevailed when the policy was purchased, there may be a problem.
What to Do
Policy performance is a result of a number of factors, including the type of policy, the level at which the premium was originally set, and other policy design features. Nonetheless, the low interest rate environment should set off an alarm bell. What should be done?
- Ask your agent to prepare an “in force illustration” which will show the performance of your policy over time with current or even lower crediting rates and dividends.
- Consider whether the financial need or risk that caused you to purchase the insurance in the first place still exists.
- If the coverage needs to be continued, consider whether the premium needs to be increased and if so, by how much.
- If the coverage is no longer affordable, consider reducing the death benefit so that the coverage fits the available premium.
- If you decide to surrender the policy, consider options to mitigate the possible income gain upon the surrender of the policy, such as a tax-free exchange to a non-qualified no-load annuity.
- If a policy is to be surrendered, consider whether it has a value in the “secondary market” where investors buy insurance policies from older insureds and those in poor health.