Federal Employees News Digest

Informed Investor: Premiums increasing for many universal life insurance policies – Part I

Mainly as a result of a prolonged period of low interest rates, many insurance companies are increasing premium rates on some universal life insurance policies sold to individuals many years ago. This column is the first of three columns discussing the reasons behind these premium rate increases and what this means to both existing and future policyholders.

During the latter part of 2015, several insurance companies notified thousands of individuals who own universal life insurance policies that the companies are using their little used and known contractual rights to increase premiums. To understand why these companies are increasing premiums, it is important to review how universal life insurance works.

Universal life insurance policies combine a death benefit with a tax-advantaged savings account. When these policies were first sold in the 1980s, interest rates were in the double digits. Insurance companies touted these policies for individuals not only as a death benefit for beneficiaries but as a great tax-advantaged way for future saving. Insurance companies encouraged policyholders to contribute additional premium dollars into their policies in order to take advantage of the high interest rates and to save for the future in a tax-free manner.

Some insurance company agents made the promise that if enough money was contributed to these policies, policyholders would eventually not have to pay premiums. Many policyholders borrowed against the accumulated cash value in their policies without paying back the loans.

Throughout the late 1990s and continuing into the 2000s, interest rates decreased, and so did the accumulating cash value in these policies. The insurance companies received low investment yields on their bond portfolios, forcing them to raise premiums on universal life insurance policies in order to pay just for the policy’s death benefit. Individuals who bought these policies in the early 1980s when they were in their 40s and 50s are now in their 70s and 80s and face higher premiums. Furthermore, this could be just the beginning as industry experts expect many insurance companies to raise premiums for other types of cash value life insurance policies.

Many individuals who purchased universal life insurance policies in the 1980s erroneously believed that they locked in the high interest rate their policy received at the time of purchase. The high interest rate would result in sufficient interest income to pay for some or all of the policy’s future expenses as the policyholder aged. However, many cash value accounts contained far less interest income than was projected at the time of purchase because insurance companies reduced interest payments to policyholders as U.S. Treasury obligation yields declined.

Policyholders should be aware that premium rate increases are permissible under many policies, although the circumstances under which premium increases are allowed vary by contract.

The fact that an insurance company has the contractual right to raise premiums does not mean that the company will. Among some companies, there is the fear that increasing premiums will create mistrust among consumers and adversely affect future insurance sales. Given the current prolonged period of low interest rates, insurance companies feel that premium increases are not worth the risk of alienating future policyholders.

Financial advisers estimate hundreds of thousands of policyholders will have to pay more to keep their universal life insurance policies. According to ITM/Twenty First, which provides policy-management services to trustees and institutional clients, the extra annual costs for policies bought in the past will vary by insurance company. The extra annual cost ranges from $150 for policyholders with $250,000 death benefits to six-figure amounts for policyholders whose death benefit exceeds $10 million.

The question then becomes: What happens if a universal life insurance policyholder cannot afford to afford to pay the extra premiums to keep their policies in force? For individuals who are retired and on a strict budget, paying for increasing basic living expenses such as medical care takes precedence over paying additional insurance premiums for a policy they may not need at this stage of their lives.

Lapse or Surrender

For universal life insurance policyholders who intend to abandon their policies, letting a policy lapse or surrender are two of the most common solutions. A policy lapse occurs after a policyholder stops paying premiums, and policy expenses or premium requirements eventually consume the remaining cash value in a whole or universal life policy. If there is a loan against the cash value of the policy, a lapse results in taxation of the outstanding balance of the loan.

In contrast to a policy lapse. in which a policyholder does not receive a payout, a policy surrender allows the policyholder to receive a payout or surrender value which is often only a small fraction of the death benefit. Any amount of surrender value that is greater than the “cost basis” of the policy—that is, the total premiums paid less any prior distributions—will be taxable to the policyholder. 

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Edward A. Zurndorfer Certified Financial Planner
Mike Causey Columnist
Tom Fox VP for Leadership and Innovation, Partnership for Public Service
Mathew B. Tully Legal Analyst

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