Guaranteed Life Insurance

Look Beneath the Covers

by Barry Boscoe, CFP

We’ve all heard the saying “There is no free lunch.”  This statement has never rung more true than when looking at insurance policies and the elements that make up their pricing.  If you have had an opportunity to look at today’s insurance illustrations, you are probably aware that they create an impression of predictability.  However, when you look between the lines, you will discover that the non-guaranteed elements (which may account for as much as 70 percent of the benefits) can perform only as well as the external conditions affecting those elements will allow.  The very components that make the illustration look good can also have a devastating impact if they should change in the future.  These are: interest rate fluctuations, long term trends in life expectancy, expenses, taxes, and the cost of regulation and litigation defense.  These will all affect future policy cash values regardless of illustration expectations.

Over the years, we have seen policyholders express their displeasure over these unfulfilled expectations via complaints, lawsuits or participation in class action suits.  All of this is due to unfavorable publicity about un-vanished whole life policies and under-funded universal life policies.  This has brought about consumer wariness and a tendency to under insure, or to insure with policies that are not appropriate for the purpose or duration of the need.

These developments have brought about a desire for a new policy design.  Insurance companies are looking for an approach that could mitigate the concern of consumers.  One such marketing design is the “no-lapse” permanent life insurance, available for both individual and second to die life products.  These policies are designed such that as long as you pay the stipulated premium (typically less than 50 percent of a comparable whole life premium), the policy will not lapse, regardless of the crediting rate, or mortality charge changes.  Remarkably enough, the policy is guaranteed to sustain itself, even if the underlying cash value reduces to zero and never increases.

This design is similar to that of long term guaranteed term insurance.  Term insurance premiums can be guaranteed for 10, 20 and sometimes even 30 years in the future.  In both cases (the new “no-lapse” and term policies), the insurance company is guaranteeing coverage, even though it may result in little or no long-term reserve to cover the possibility that premiums charged are insufficient to make the block of policies profitable.  If these low premium products aren’t sufficiently reserved and the block of business becomes unprofitable, the insurer could encounter financial problems.  Since both kinds of policies have been on the market for a relatively short time (in a 200 + year old business, even 20 years can be short-term), there is insufficient experience to tell whether these under-reserved products will perform as illustrated.

Hence, it is critical that one look beyond the illustration to the fine print in order to understand under what conditions the “no-lapse” feature may be lost.  Some of the obstacles that must be overcome in order to prevent the loss of the “no-lapse” guarantee are as follows:

1.  Requirements that the minimum premium stipulated be paid and paid on time.  Missing even a single due-date is sufficient to void the “no-lapse” guarantee.  Once lost, it is lost forever.

2.  Some products maintain that the minimum premium is a lifetime cumulative premium.  Some companies may offer a catch-up provision to pay sufficient back premiums to meet this cumulative premium requirement, as long as the policy is in force.

3.  Changing the death benefit may void the guarantee.

4.  Taking a loan may void the guarantee.

5.  The need for ongoing service, i.e. if a policy premium is forgotten under a traditional whole life policy, the automatic premium loan provision will kick in and keep the policy in force.  There are no such provisions in these “no-lapse” guaranteed policies.

6.  The significant benefit of cash value life insurance, is the ability to use the cash values.  Unfortunately, this may not be available in a “no-lapse” policy.

7.  In exchange for the “no-lapse” feature, policy values usually will not be enhanced by future favorable economic and mortality factors to the same degree as the traditional policies.  Thus the cost for the “no-lapse” policy is policy value performance.

8.  The advantage of a universal life policy is the flexible premium.  This flexibility is not inherent in “no-lapse” policies.

Insurance products sold with aggressive pricing assumptions – including low premium/”no-lapse” guarantees – have more inherent risks for deterioration than more conservatively priced and funded policies.  As an example, if the aggressive pricing doesn’t work out the way it was intended, what does the insurance company do with its mistakes?  Typically, that block of business is separated and new policies are designed by the company in hopes of correcting the problem.  This walled off business with the “no-lapse” guarantees will certainly be honored.  However, as the company begins taking corrective action (raising the cost of insurance, or lowering the interest-crediting rate), policy values are affected negatively.  The healthy policy owners detecting the negative results will end up replacing their coverage, leaving a greater percentage of insurers in less than perfect health.  This will only exacerbate the affected block of business experience, and in turn instigate a new wave of pricing corrections and resulting defections by those healthy enough to obtain alternative coverage.  This negative spiral can quickly drive the pricing elements of a policy to its guarantees.

While the “no-lapse” feature technically prevents economic loss to the policyholder, many policyholders will become disenchanted with the deteriorating values in spite of the guaranteed coverage.

As good as the guarantees sound, consider the recent demise of Mid-Continent Life, which encountered difficulties with its life insurance reserves.  Pricing and marketing strategies also played central roles in the collapse of this company.  The failure of Mid Continent differed from the downfall of other insurance companies, which were caused by poor asset quality.

Without necessarily suggesting that “no-lapse” policies per se suggest carrier collapse due to insufficient policy reserves, it is a possibility.  Therefore, it is critical that you understand this is a potential issue and you consider the following questions before purchasing this type of contract:

1.  What would be your concern if the cash values dropped to zero?

2.  Do you have any use for this insurance other than for pure death benefit?

3.  Are you comfortable with the fact that there is no premium payment flexibility (below the minimum premium stipulated) to maintain the guarantee of “no-lapse”?

4.  Do you understand that the policy likely will not perform as well as a policy that does not include the “no-lapse” guarantees?

The “no-lapse” concept does bring peace of mind.  Especially to those who fear the negative effect of their policies from reduced future dividend scales, or lower future crediting rates and higher costs of insurance.  In addition, extremely competitive premiums are a key selling point for this type of policy.  However, it is important for you to match your risk tolerance with the inherent risks in this policy design or illustration concept.  While these policies seemingly provide substantial guarantees to the buyer, remember “all that glitters is not gold.”