BUSINESSWEEK ONLINE : AUGUST 30, 1999 ISSUE
BUSINESSWEEK INVESTOR

Life Insurance: So You Think You're Covered
Your policy may lapse if you can't pay higher premiums

If you bought life insurance in the 1980s or early 1990s, your mail may bring you unpleasant news: Your policy may be about to implode. A spell of low interest rates has undermined millions of cash-value life insurance policies sold when rates were at historic double-digit highs. Insurers designed these policies around the promise that healthy investment earnings could reduce, or eventually eliminate, the premiums policyholders had to pay.

But as rates fell, insurers' investment returns couldn't keep up with the low-premium promise. The result: More holders are getting notices that their policies' cash values are spiraling downward, forcing hefty boosts in costs. ''I've seen premiums double, triple, even quadruple--it all depends on how far off the mark the sales presentation was,'' says Stanley Hargrave, a certified financial planner and insurance consultant with IMS/CPAs in Riverside, Calif. The alternative to paying more: Let the policy lapse--an option that may mean going without insurance for clients whose age or poor health make them uninsurable.

Given those ugly choices, it's little wonder lawyers are circling. Class-actions charging Prudential Insurance and dozens of other insurers with misleading sales practices have already reaped billions of dollars in damages--and millions in legal fees. The biggest suits involved so-called ''vanishing premium'' policies, where agents promised that high investment returns would make the policies self-funding in just a few years. Most of those cases have been settled, and policyholders are getting notice of their awards, which are usually in the form of discounts on new policies.

Imploding policies are next, says Robert Scott, a Newport Beach (Calif.) attorney who chairs the American Bar Assn.'s life insurance panel. ''The insurance industry sold these policies with expectations that the companies now can't meet,'' he says. ''So class actions are popping up.''

The policies most likely to implode are those called universal, or adjustable-premium, life. Introduced in 1979, universal life lets a customer vary the policy's face amount--the death benefit--and the premiums paid. Most universal life buyers took high interest rates as an opportunity to buy more insurance for less cost, paying the minimum premium necessary, based on rates when they bought the policy.

Trouble is, those low premiums aren't guaranteed: If the insurer suffers rising mortality costs (the funds needed to pay death benefits), or falling interest rates, the customer may be forced to pay more premium or cut the death benefit. Mortality costs have actually trended down, but rates have fallen faster: 10-year Treasury notes, a proxy for the intermediate-term bonds insurers like to hold, averaged 13.91% in 1982 but fell to 8.55% in 1990. They now yield about 5.8%. Subtract a few points for expenses, and insurers are earning little more than the 3.5% to 4% minimum they guarantee policyholders.

How do you know what your insurer is paying? The policy itself is little help: Insurers aren't required to spell out how they compute the earnings they credit to policyholders. ''Universal life should be like an adjustable-rate mortgage: The bank tells you how it computes its rate, based on a published index,'' says Ronald Parry, an attorney with Arnzen, Parry & Wentz in Covington, Ky., who is pursuing two class actions over imploding universal life policies. But insurance ''is an industry allergic to disclosure,'' says Joseph Belth, professor emeritus of insurance at Indiana University. ''Insurers say their investment returns are trade secrets.''

SIGNS OF TROUBLE. If you have a universal life policy, you should receive an annual statement showing how your policy is faring. Dig up your latest statement and, if you can find it, the sales illustration--the forecast, prepared by your agent when you bought your policy, that shows how its costs and cash value were projected to build over time. The illustration was probably based on a rosy view of interest rates at the time of purchase; the annual statement uses actual current rates. Compare what the illustration says your cash value should be by now with the actual cash value from the statement. If your cash value isn't keeping up with the projection, your policy is headed for trouble. (Two other flavors of life insurance allow fluctuating investment returns. Those policies--called variable life and variable universal life--allow self-directed investments: The owner tells the insurer how to split the cash value among mutual fund-like pools, called sub accounts. Because these policies are sold as investment accounts, holders keep a better eye on how they're faring.)

The average policyholder, of course, can't recall what type of insurance he or she bought--and annual statements ''usually go straight into the shoebox where you keep your policy,'' says Judith Maurer, president of Low Load Insurance Services, a Tampa firm that helps financial planners buy low-cost insurance for their clients. So the first sign of trouble is a notice that a policy's cash value is nearing exhaustion. By that point, ''the cost of resuscitating the policy may be overwhelming'' says Ben Baldwin Jr., president of Baldwin Financial Systems in Northbrook, Ill.

Whether you've gotten a notice or unearthed signs of trouble in your annual statements, your first stop should be the agent who sold you the policy. Ask for a set of ''in-force illustrations'' that recalculate the policy's future. You want to know two things: How long the policy will last if you keep paying the current premium, and how much more you'd have to pay to maintain the current death benefit until your target age. You also can ask for illustrations based on a reduced death benefit. If your insurer is crediting your policy with more than the minimum guaranteed return, ask for a guaranteed illustration so that you will have a worst-case scenario.

Those calculations will help you figure out your options. If your need for life insurance has changed, you might get by with a smaller face amount--or no policy at all. More likely, though, your choice will be either to boost the premiums or to shop for a new policy.

Some experts suggest you hire a fee-only insurance consultant to analyze your situation and represent you. Low Load Insurance Services (877 254-4429; E-mail: lowload@gte.net) or the National Association of Personal Financial Advisors (www.napfa.org) can give referrals. But ''many good insurance agents are independent enough to defend your interests,'' says Charles Ratner, national director of personal insurance consulting for accountants Ernst & Young.

Insurers are constantly introducing new products. Today's policies may cost less than your 10-year-old plan--even though you're 10 years older. But if your health has deteriorated or your policy is near exhaustion, you might have to lean hard on your insurer to give you a replacement. ''Almost every insurance company has a low-cost policy that they never advertise but can use when they're under the gun,'' says consulant Hargrave. And having just been through nasty litigation over unkept sales promises, insurers are under the gun--which should work in your favor.

Today's insurance buyers have it better: 35 states have moved to adopt rules that would require more realistic sales illustrations, including a worst-case scenario and a projection based on interest rates halfway between current and the minimum rates. And universal life policies bought at today's low rates could produce pleasant upside surprises. But holders of older policies may still be sitting on ticking time bombs. They need to act now--or that ''boom'' they hear may be the sound of their life insurance protection collapsing.

By MIKE MCNAMEE

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