7 Ways Permanent Life Insurance Isn’t Permanent

I was reading Clarifinancial’s post about whole life insurance that doesn’t last a lifetime.  That got me thinking about writing a blog post myself to get into more specifics about how permanent life insurance might not be permanent.  I then read Suburban Dollar’s request for more information. This made me make an outline for a blog post myself.  Then, Clarifinancial posted an other article in hopes of addressing parts of this question.

While I think that conceptually Clarifinancial is a very interesting concept and truly one-of-a-kind, I’m worried that this blog post doesn’t go far enough to answer some of the outstanding questions regarding his original post and permanent life insurance.  If you want people to compete for your life insurance policy (especially term insurance) Clarifinancial is a great first stop.  However, permanent life insurance policies need more design work to structure the policy for your personal situation (I’m right here).

1.  Guaranteed For A Certain Time Frame

Some life insurance policies are only designed to last for a certain period of time.  The prime example of this is term life insurance.  You pay your premiums for the duration of the term and the life insurance company guarantees that your policy will stay in force for the duration of the term you selected, usually 5, 10, 20 or 30 years (don’t forget about Annual Renewable Term and everything else in between).

With permanent life insurance things may change, more specifically Universal Life insurance policies (UL).  Traditional Whole Life insurance policies are built with internal guarantees that guarantee if you continue to pay the premium the coverage will be in force until you pass away or it endows.  Before January 1st, 1985 things were different but we’ll cover that later (#6).  Universal life insurance  policies are often marketed for their flexibility.  This is due to the structure of Universal life insurance policies and the way in which the cost of insurance, as well as other charges, are levied against the policy itself.  Whenever you purchase any type of life insurance policy the person helping you place the policy is required to show you an illustration.  With a Universal Life insurance policy illustration they will show you two types of projections:

• current assumptions – gives you how long the policy will last using the current assumptions in the illustration (i.e. cost of insurance, returns, charges, fees)
• maximum charges – this is the important number, it shows you how long your policy is guaranteed if the maximum amount was charged for cost of insurance, charges and fees AND the minimum return was earned within the policy.

It is important to note that Variable Universal Life insurance policies (VUL) may or may not have guarantees because of the varying returns within the policy.  Some VULs will have separate accounts, to allocate a portion of your excess premium to in order to have some built in guarantees.

Also Universal Life insurance policies are available with secondary guarantees which can give up the flexibility of your permanent life insurance policy.

2. Charges Go Up

With Universal Life insurance policies, insurance companies give you a bucket with holes in it.  This allows them the ability to change certain charges within your permanent life insurance policy.  Also with Universal Life insurance policies, the cost of insurance is going to increase slightly each month because you are getting older.   It is easy to account for the increases to the cost of insurance because the increases are pretty uniform.  However, you never know when the life insurance company is going to increase the administrative fees and charges associated with the policy.  If these charges eat away at the cash value more quickly than you originally thought, you’ll receive a lapse notice – more money or no policy.  To avoid this, check your guarantees with maximum charges as mentioned above.  The exception are secondary guarantees, just make sure to stay on top of those premium payments.

3. Returns Go Down

Again this doesn’t apply to all Whole Life insurance policies because they have a built in guaranteed rate of return, but it could be illustrated with a higher return than guaranteed.  Universal life insurance policies, however, may become dependent on the rate of returns within the policy to support the cash value and charges.  This was the problem with Universal Life insurance policies back in the late 1980s when there were double digit interest rates.  When interest rates started to be cut and the earnings within those policies went from 15% down to 5% it wasn’t enough to outpace the charges within the policies.  The result was that people were asked to put more money into their Universal Life insurance policies or risk losing their permanent life insurance policy.

Make sure to understand your guarantees.  Even Whole Life insurance policies sold during the 1980s had dividend protections that became unrealistic with a deflating economy.  Dividends are not guaranteed.

This is even more prevalent with Variable Universal life insurance policies because now you add the ability to have negative returns within the cash value of the policy.

4. Don’t Pay Premiums

This is a no brainer.  It doesn’t matter what type of permanent life insurance policy you have, if you stop paying planned premiums it’s just a matter of time until you lose the policy.  Remember to keep a close eye on your policy if your planned premiums rely on non-guaranteed elements of your permanent life insurance policy.  There are two ways to plan ahead so that you don’t have to continue paying premiums:

1. reduce paid up – this is when you reduce the face amount of a permanent life insurance policy to the maximum amount the cash value will guarantee for the rest of the policy.
2. policy loans – this brings us to #5

5. Policy Loans

Permanent life insurance policies today have changed; both Universal Life and Whole Life insurance policies allow you to miss premium payments.  They do have differences though.  With Universal Life policies nowadays, some policies will treat missed premiums as loans while others will just continue to take the charges out of the cash value.  Most Whole Life insurance policies, however, treat missed premiums as loans.  Watch out for those interest charges.

You are also allowed to take out policy loans from the cash value of your life insurance policies anytime.  In order to not be taxed on these distributions, loans need to have interest charges, which if not paid will add up over time and eat into the cash value of the policy.  Watch out for those interest charges.

Once loans and withdrawals begin in your life insurance policy it also now becomes extremely important to keep this policy in place for the rest of your life.  If not, there could be some adverse tax consequences.

6.  Endowment (or as Clarifinancial called it, maturity)

January 1st, 1985 marked a huge change for the life insurance industry.  This is when the Tax Reform of 1984 went into affect.  This tax reform stated than any policy that endowed before the policy owner reached the age of 95 would no longer qualify as life insurance.  This meant that the proceeds of an endowment policy became fully taxable.  Older policies were grandfathered in but it has virtually eliminated endowment policies in the life insurance industry.

An endowment policy is is an agreement that at a set period of time, usually an attained age, whether the insured has died or not the policy will pay the death benefit.  Sometimes the payouts if the person is still living could vary but it is previously agreed on and disclosed within the permanent life insurance policy.

7. Human Error

In #4, I mentioned planned premiums.  This is an important concept because the life insurance guy that you are working with is someone you are relying on to properly design your permanent life insurance policy.  If they make a mistake or don’t know what they are doing, you’re the one that has to deal with the consequences.  Unfortunately, you probably won’t realize for a while after the policy has been put in place.  It becomes that much more important to work with someone who specializes in designing permanent policies.  Every successful insurance person can tell you horror stories and messes they have of cleaning up other people’s mistakes.

Get it done right the first time, either let the insurance people compete for your business or work with a specialist.

Related posts:

1. What Every Life Insurance Policy Shouldn’t Be Without
2. Life Insurance Secret
3. Whole Life Insurance is Stackable
4. Life Insurance Audit
5. Life Insurance’s Recent Overhaul

Tagged as: cost of insurance, guarantees, permanent life insurance, universal life, whole life