Maintaining Life Insurance With Periodic Reviews
When’s the last time you pulled out your life insurance policy and took a good, hard look at it? If the answer is seldom or never, join the crowd.
Many policyholders tend to keep their policies buried away in safe-deposit boxes or desk drawers. For them, out of sight is out of mind.
A much better approach is to periodically review your life insurance, as you would any other important document, such as a will or financial plan. This is particularly important in today’s low-interest rate environment.
Depending on the type of policy you have and when you bought it, falling interest rates may reduce your policy’s performance in the long run. In some instances, you may need to take some action to keep your policy running smoothly.
There’s no need to panic, however. Often, an increase in the premium may be enough to keep your policy’s performance on course.
– Keys To Measuring
With both whole life and universal life insurance, a portion of the premiums goes toward “cash value.” Life insurance policies that build up cash value are often viewed as attractive to own because growth in cash value is tax-deferred.
How well your policy performs is largely determined by three key ingredients: interest rates, the insurance company’s expenses such as administrative costs and commissions, and the insurance company’s mortality experience , the difference between how many policyholders die in a given year vs. how many were expected to die.
Whether you own a whole life or universal life policy, a minimum level of performance is guaranteed. When one or more of these ingredients outperform the built-in guarantees in your policy, policy performance may exceed guaranteed levels.
In that case, this extra performance may be used in several beneficial ways: to help pay future premiums , resulting in fewer or smaller premium payments down the line; to be borrowed against; or to increase benefits , either cash value, death benefits, or both.
Insurance companies, on balance, are able to predict their expenses and mortality experience with reasonable accuracy. But interest rates are a different story. Despite the best efforts of learned economists, stock market analysts and other experts, no one knows with certainty what direction interest rates will take in the future.
As interest rates, expenses, and mortality experience change, however, your policy’s performance may also be impacted. That’s why it pays to review your policy with your agent from time to time. Your agent can keep you apprised of these changes, tell you whether your policy is affected, and suggest ways of responding.
– Impact Of
Out-of-pocket premium amounts and premium durations on whole life and universal life policies are based, in part, on interest assumptions made at the time of purchase.
With whole life insurance, insurers credit the interest rate or dividends annually. The policy’s dividends or excess interest are typically used to buy more life insurance, known as “paid-up additions.” When enough paid-up additions have accumulated, the cash value of these paid-up additions can be surrendered to pay future premiums.
With a universal life policy , a flexible variety of life insurance coverage , the insurance protection is separate from the savings element. The policy’s cash value is credited investment income, and from which is taken the cost of the insurance.
Your earnings on the cash value of your policy will be determined by your insurance company’s investment performance, which is the rate of return it achieves on the investment of your premium dollars. As mentioned, your share of those earnings will be credited to your policy as interest.
The amount of interest will vary, of course, as market interest rates and investment performance change. As interest rates increase, insurers are able to invest new premium dollars at higher rates, and thereby credit more interest to your policy. Conversely, as rates decline, new premiums are invested at lower rates, which means less interest will be credited.
– The Drop
Back in the early and mid-1980s when many people bought whole life and universal life policies, interest rates climbed as high as 11 or 12 percent.
At the time policies were purchased, projections of future interest earnings on these policies’ investments were generally based on these then-current interest rate levels. Those projected interest rates were used to help policy owners determine the amount and number of premiums that were to be paid to adequately fund the life insurance protection.
But since the end of that decade and until very recently, interest rates have fallen dramatically. As a result, insurance companies’ investments of premium dollars have generally earned a lower return, which means less interest credited to those policies and a slower increase or possible decrease in their value today vs. their original policy projection.
Whether a reduction in your policy’s credited interest rate affects you depends on several factors, such as your age, how long you have had the policy, and your insurance company’s expenses.
– Rate Change Does
Not Affect Everyone
Certainly, not everyone who bought life insurance in the 1980s when interest rates were higher needs to be concerned.
The drop in rates does not affect people with term insurance , policies that provide a death benefit only. Those who bought traditional whole life policies with the intent of paying premiums out-of-pocket every year also may feel little impact. If they continue paying the fixed premium, they are guaranteed to have their coverage for life.
However, the policy cash value they could tap through loans or by surrendering the policy could be less than expected.
If you used a so-called “vanishing premium” payment design, lower interest rate crediting may concern you. Because of the life insurance industry’s experience with decreasing interest rates in recent years, regulators and the industry as a whole have discouraged the use of the potentially misleading term “vanishing premiums.” With this design, you were scheduled to pay premiums out-of-pocket for a set period of time , such as seven to 10 years , instead of paying premiums for life. After that, earnings on the growing cash value were expected to pay the premiums from then on. In order for the insurance to carry itself as intended, however, you may need to pay premiums for additional years before premiums can be paid from policy values.
Universal life policies may also be affected. These policies can be designed so that you can pay in as much or as little as you like, as long as the cash value of the policy can cover the cost of insurance charges. When it no longer can, you will need to make higher annual premium payments, or pay the same premium for more years to avoid having the policy lapse prior to your death.
Deciding which course of action makes the most sense for you depends, in part, on your age and sex, the size of the policy, the number of premiums paid to date, and the assumptions used by the company relative to future interest rates.
Whether you just purchased a policy, or are a long-time policyholder, it pays to review your policy with your agent every year. Your agent can run illustrations that provide details on how your policy has performed and how your policy is expected to perform in the future, based on current interest rates and other assumptions.
Like any other insurance product, your life insurance needs to be monitored as interest rates and other factors affecting your policy’s performance change. A periodic review and any necessary fine-tuning will help ensure that your policy continues to meet your expectations.
Honeycutt and Smith are registered representatives offering securities through Lincoln Financial Advisors Corp., a broker/dealer. Honeycutt and Smith have offices in La Jolla.