By Bill Boersma
I was recently referred to a policy owner with a mutual whole life contract who had just discovered a significant issue with their policy. It’s crucial to recognize that not all whole life insurance policies are created equal and sometimes they can fail. Now that a thunderbolt hasn’t struck me down, I’ll continue.
The Complexity of Whole Life Policies
A significant issue is the lack of consensus regarding the definition and characteristics of whole life insurance. While it is true that 100% base whole life insurance provides guaranteed benefits if premiums are paid as stipulated in the contract, not all policies offer this assurance. I maintain that not all whole life provides guaranteed benefits while others assert this is impossible and contradicts the fundamental principles of whole life. I’ve encountered numerous whole life policies over the years that have failed in notable ways, including many from the largest and most reputable mutual insurance carriers. Clearly these companies are not immune to such failures.
Features such as increasing death benefits, non-guaranteed short pay options (unlike “Whole Life 10” or “Pay to 65”, for example) and term blends that rely on dividends beyond the base guarantees are not guaranteed. Automatic policy loans rank near the top of dramatic surprises for policy owners.
Misconceptions About Guarantees
Critics may argue that true whole life insurance is always guaranteed; however, this perspective can be misleading. Policies from companies like ABC Mutual Life Insurance may label their offerings uniformly, regardless of whether they provide only base coverage or include term blends.
Be assured that a majority of policyholders are unaware of these distinctions and this calls into question the relevance of dissecting the terminology we use in the industry, as it may not hold any real significance. After all, many consumers tend to refer to any cash value policy as whole life and struggle to differentiate between it and other products such as universal life, indexed universal life or variable universal life.
In a broader context, one should refrain from making definitive claims such as “Whole Life is Guaranteed” as such assertions can be misleading. Additionally, some whole life enthusiasts delight in focusing on the lack of guarantees in other types of cash value polices, though there is lifetime premium and death benefit guaranteed universal life, guaranteed indexed universal life and guaranteed variable universal life.
The Impact of Loans on Premium Payments
In this instance, a substantial loan resulted from the increasing term premium component of the policy borrowed annually and compounded at above market rates. While it’s accurate that the whole life portion has not changed and the term portion of the product was never guaranteed to go away, what is crucial here is not the understanding of the advisor but rather the lack of comprehension on the part of the client.
I’ll undoubtedly hear that the increased cash flow incorporates loan interest and is not premium, but I’ll counter if clients must write checks significantly exceeding initial premium expectations due to accruing loans that amassed to pay unexpected term premiums, all cash flow associated with those payments should be considered premium costs, regardless of terminology used. Attempting to convince a check writer that it’s not really a premium they’re paying will generally not end well.
Navigating Client Conversations
It’s essential for advisors to communicate clearly about these complexities when consulting clients who have never received cash value from their policies. If they face increased payments, under threat of adverse and potentially devastating income tax consequences, without understanding why, it’s imperative we address these issues transparently.
Now on to the policy owner and her failing whole life policy
Hi Sue,
Thank you for your time the other day. It was a pleasure meeting you. I am writing this note to ensure that you have a clear understanding of certain aspects of your policy.
Has it been explained to you why the policy now requires an additional premium? Furthermore, after thirty-five years, were you only informed of this change this year? This situation should not have come as a surprise if your agent had been monitoring the policy’s performance and keeping you informed. This issue has been developing over many years.
The primary reason for the increasing premium is related to the term component of the policy. When you purchased it in 1990, the dividend crediting rate was nearly twice as high as it is today, and in recent years, it has fallen to less than half of its original level (there was no reasonable expectation that it would remain that high). The policy relied on these dividends to grow the base death benefit sufficiently to eliminate the term portion, which becomes more expensive each year. Due to the reduced dividends, this growth did not occur, leaving the term insurance in place when it was never expected to be there, and its cost has become significant relative to your overall premium.
Even though you’ve been paying premiums out of pocket every year without borrowing against your policy, there is still a substantial loan associated with it. This may seem surprising, but unfortunately, it’s true. The cost of the term portion has increased significantly, meaning that your premium payments have not been sufficient to cover it. While your dividends are purchasing additional whole life coverage, they are not accumulating as much value as originally projected. Consequently, the term insurance remains with an increasing premium, and the insurance company has effectively loaned you money each year to cover this shortfall. I understand that this information may be new to you; however, it should have been communicated earlier. While somewhat insidious, this is how the system operates.
To complicate matters further, your loan interest rate is 8%, which remains unchanged even as you’ve refinanced your house at a lower rate of 3%. I anticipate your next question: yes, someone should have informed you about this. The insurance company offers both fixed and variable loan options; your current 8% rate applies to the fixed loan. The variable loan rate may be available at a more favorable rate—has that option been discussed with you?
Given that the term insurance portion significantly contributes to rising costs, have any options for reducing or eliminating it been presented? How important is that portion of the death benefit to you?
As we briefly discussed, there are several ways to address these concerns. I have reviewed all the ledgers provided and found some options more appealing than others. There are additional ledgers I believe we should order so that all available options can be presented.
Please let me know if you have any questions. Enjoy your day!
Best regards,
BillBill Boersma is a CLU, AEP and LIC and the founder and owner of OC Consulting Group. More information can be found at www.OC-LIC.com, www.BillBoersmaOnLifeInsurance.info or email at bill@oc-lic.com or call at 616-456-1000
