Suppose you’re in the market for a cash-value life insurance policy, such as universal or total life insurance. In that case, you should be aware that the quote for life insurance you receive could be significantly smaller than the amount you’ll have to pay. What you pay can dramatically increase over time.
How can this be possible? The reason is that life insurance quotes for cash policies could be based not just on assured projections in the illustration of the policy but also on highly optimistic, non-guaranteed projections.
In the end, numerous quotes for all kinds of universal life insurance and whole life insurance are founded on a not-guaranteed portion of the illustration, according to Barry Flagg, founder of independent life insurance research firm Veralytic. (This isn’t the case with the term insurance, which is a type of insurance that has the same cash value.)
It’s a bait and switch. You believe your life insurance quotes are the amount you’ll have to pay for as long as you have insurance. However, many years later, you may be greeted by a sudden need for additional costs.
“Why would you purchase an insurance policy with the lowest cost . . . and then have to pay more to pay it later?” asks Flagg. What’s the problem? Why are insurance companies allowed to conduct this?
What Is Cash Value Life Insurance?
Life insurance is typically designed to safeguard those who depend on your financial security. However, some insurance agents also promote cash-value life insurance as a retirement plan tool.
Life insurance that is permanent, like the whole-life and variable life varieties of universal life insurance, comes with the option of cash value.
If you pay universal or whole life insurance premiums, the amount is first used to cover the insurance cost, the fees charged by the insurer, and operating costs. The remainder goes towards the cash value element of the policy.
The cash value is usually a source of interest and can grow tax-free. Cash value policies are popular for planning retirement because they could be a source of income during retirement when you make the option of a loan or withdrawal out of the value.
The Sales Pitch
With the help of an experienced insurance broker, a cash-value life insurance policy – particularly an index universal life policy — can appear attractive. In a typical pitch for sales, the agent may declare that it’s an excellent financial product for accumulating money to save for retirement, and it can take advantage of the gains of equity investments. It will never fall, as per Larry Rybka, the CEO of Valmark Financial Group.
The agent will inform you that the investment return of the cash value will never fall below the 0% mark.
The more advanced pitch, Rybka says, will require arranging for the bank to lend the money needed to purchase an even more extensive coverage (known as premium finance). The agent claims that the extensive policy will cover the cost of the policy. The plan is based on highly optimistic assumptions, which indicate that the policy will accumulate enough value to cover this loan back to the lender and remain with several hundred thousand dollars in the policy that you can retire tax-free.
By using this method, it is believed that you won’t need to pay out of your pocket for the insurance. The majority of premium finance policies Rybka’s team has examined use index universal life insurance policies.
How Cash Value Life Insurance Quotes Are Calculated
The price you’ll have to pay for life insurance with cash value is dependent on these three elements:
- Cost of insuring
- Costs (policy costs, charges for insurance costs, and administration expenses)
- Rate of return on the value of cash
In most cases, 85% of the premium you pay is used to cover the cost of insurance, with the remaining 15% going to costs, Flagg says. Interest on the cash value could help offset these costs and lower the premium you’d need to pay. Therefore, the premium formula could be as follows: Cost of insurance plus the cost of insurance minus expenses. The greater the interest rate and the lower the interest rate, the lower the insurance cost.
How the Quotes Can Be Misleading
State insurance laws permit agents to offer Life insurance policies with illustrations of the non-guaranteed elements provided that the equivalent guaranteed value of these elements is first displayed, according to Whit Cornman, who is representative of the American Council of Life Insurers.
“A policy illustration uses text and graphics to provide consumers with an example, based on certain assumptions, of how a policy’s costs and benefits may develop over time,” the author states.
The illustrated values have to pass specific requirements to prove they are based on a reasonable basis and can be substantiated.
But, Flagg says it’s common for agents to display projected results on the cash value at the most permissible level. That makes the price supposed to be used to pay for the insurance costs and other expenses appear lower.
This is the most severe issue when it comes to indexed universal life insurance policies, Flagg says. They are marketed to the public as an insurance policy that claims to have a high interest rate and will have a lower cost. But if the higher yield on cash doesn’t seem to show up, the policyholders might need to add more money into the policy to keep it in force, mainly when they’ve made a withdrawal or loan that drained the cash value.
To be clear, insurers must disclose the potential for higher premiums in the chart. “By showing the values based on guaranteed maximum charges and minimum credited interest rates for universal life or based on $0 dividends for whole life, the risk of additional premiums down the road are disclosed since these values are the worst-case scenarios for the policyholder,” Cornman declares.
But suppose the consumers ignore the guarantee parts of the policy. If the worst-case scenario occurs and the policy doesn’t work as expected, they’ll be shocked when they receive a letter from the insurance provider that the interest rate calculated at the time of sale has been changed to lower.
“If it doesn’t work out, the client has to pay more,” Flagg declares. Most of the time, it’s a lot greater, he adds.
When universal life insurance purchases that are indexed are financed by bank loans to purchase extensive policies, the policy images can be even more appealing due to the leverage between the expected high rate of policy accumulation and the bank loan’s lower interest rate Rybak said in a piece published in the year 2019.
If these forecasts don’t come true, the consequences for consumers could be more severe for those who borrowed money to buy their policies. They could lose not only the policy but they could also lose other collateral that they have pledged as part of their bank credit.
The cash value may not be sufficient to cover the loan cost from the bank that is being used to pay premium payments. In the absence of the required premium, the policy may be canceled, and those who took out loans on the balance of their insurance to pay off their bank loans could end up having a large tax bill and a huge bank loan to repay.
How Insurance Regulators Have Responded
The problem of selling life insurance using inaccurate policy images isn’t new. The National Association of Insurance Commissioners (NAIC) established an advisory group in 1992 to respond to a letter sent by a U.S. senator questioning life illustrations of insurance sales.
The NAIC group found various issues, such as the ineffective illustration used to evaluate the future performance of policies and the absence of a uniform design for life insurance illustration. Additionally, the group discovered that state laws didn’t address the issue of sales fraud in the insurance types sold.
The outcome of the working group’s efforts was the adoption of NAIC Life Insurance Illustration Model Regulation 582, which, according to the regulation, is “to ensure that illustrations do not mislead purchasers of life insurance and to make illustrations more understandable.” However, Flagg says the regulation did not stop the misleading practices it sought to curb.
If there’s a rule to follow, you’ll find an alternate solution,” Flagg says. “Insurers found a workaround to calculate premiums to look as good as possible.”
Thus, the NAIC adopted Actuarial Guideline 49 in 2015 “to bring uniformity to the illustrations of policies tied to an external index or indices by providing a reasonable cap on the illustrated credited rate,” according to the NAIC website. But this did not solve the issue.
Indexed universal life insurance policies are linked to a stock market index. However, the cash value isn’t placed in an index. Instead, insurers invest a tiny portion of the account in derivatives, which track the performance of indexes in the market and provide credit interest to the policy. Thus, a policyholder can profit from part of the market’s upside in an index, such as one S&P 500, but the insurance company isn’t directly investing in the index.
In his article of 2019, Rybka wrote that, under AG 49, businesses could take an 85% profit from derivatives when they projected the interest rates of their illustrated policy. This allowed the projections of rates to be higher than what people could make.
At the time Rybka wrote her article, businesses were exaggerating these projected returns using features known as multipliers and bonuses. In the end, insurance companies showed the projected return to be more than double the rate shown.
How To Protect Yourself When Buying Life Insurance
For clarity, Life insurance is an excellent option to protect your family members, Rybka states. The consumer must be aware of what they purchase with the cash value life insurance policy, not the information misleading images offer them.
The issue of life insurance quotes linked to non-guaranteed sections of illustration for policies is not applicable for term life insurance, which has no cash value.