Understanding the Hidden Risks of Life Insurance: Due Diligence for Policy Holders and Fiduciaries
Immediate cash needs at death range from general living expenses to buying out a business partner or providing funds to pay estate taxes. But imagine opening a letter one day from your insurance company to find that your equity-based life insurance policy may lapse due to lack of funding. Despite thousands of dollars in premiums dutifully paid over many years, market conditions may have quietly eroded the equity value of your policy. Over the past few years, universal and equity-based life insurance policy owners have found themselves asking, “How did this happen?” and “How could I have avoided this?”
The answer to the first question is fairly straightforward. Universal life insurance is still a relatively young product. It arrived in the marketplace in the late 1970s and saw explosive growth in popularity throughout the high-interest-rate era of the 1980s. Three decades and two recessions later, we find that the projections and assumptions originally used to illustrate the economics of the policy were not borne out in reality.
The low-interest, low-return environment that we have experienced over the past decade has resulted in the owners of universal life policies receiving considerably less interest on the cash portion of their policy as compared to the higher interest rates that were available at the time of purchase and were used in projections and illustrations. Meanwhile, the policy charges that were easily handled at the higher projected interest rates are now adversely impacting the originally projected policy cash values. This will result in less-than-expected cash values down the road, potentially reduced death benefits and/or in the worst case, policies lapsing years earlier than originally projected. The owners face the difficult decision of anteing up additional money to save the policy or losing their coverage and the years of premiums they have already paid. Even more problematic are the policies that have eroded to near worthlessness under the care of a well-meaning but uninformed trustee.
With regard to the second question, determining whether there might be a looming problem or opportunity requires some work, but may well be worthwhile for owners and trustees alike. Here are some suggested steps to getting at the issue.
The Metropolitan Corporate Counsel
December 2013 Issue
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