Tackling cost of insurance charges in life policies

In the last few years, I have been reading more frequently about owners of permanent life insurance policies being subjected to rate increases based on cost of insurance charges, or COI. Permanent policy COI charges are what insurers factor in to their premium structures. How an insurer defines “cost of insurance” can vary a lot.

Depending on the definition used, variables that are taken into account when recalculating future COI charges can include: future mortality experience (projections of when someone will die); lapse rate (the number of policy owners who drop coverage); underwriting expenses; claims administration; sales charges; premium taxes; reinsurance expenses; and interest rates (on the insurer’s investments). Most of these will change at some point.

A major factor that affects cash values, from which COI charges are taken, is how much premium you pay and how often versus what is needed to keep the policy “healthy.”

Permanent products offer some flexibility that can indeed be helpful, but they can also be a major source of trouble.

By paying less than needed to avoid policy problems, you start a process that can accelerate the rate at which cash values are consumed by COI charges. Loans taken against cash value will further accelerate this.

Permanent life insurance products and associated COI problems are not to be confused with guaranteed universal life, or GUL.

If a GUL product is poorly designed or poorly explained to the buyer, it too will have problems. But a well-designed GUL product can and will avoid COI increases.

GUL products work because of what is called a no-lapse guarantee or a secondary guarantee that is intrinsic to it. So even if cash value drops to zero, the policy is in no jeopardy.

If there is a downside to a GUL product, it is that the premiums must be paid in full and on time, meaning not early and not late. Meet that obligation and your well-designed guaranteed universal life product will perform perfectly with no risk of COI increases out to whatever age you need it to last to.

Life insurance policies held in a trust are often prone to COI problems because the trustee, who is supposed to have your best interests in mind, neglects to keep a close eye on policy behavior.

Many trustees and consumers simply don’t realize that all life insurance policies (term and permanent) are a dynamic, ever-changing financial instrument. It is not a set-it-and-forget-it purchase, and this is where problems often start. Perhaps they don’t pay the premiums on time. not in full or not at all. They might not respond to notices from the insurer indicating something important needs attention. Perhaps they just don’t have the staff with the critical associated skills to handle the life insurance aspect of trust assets, especially COI problems. Perhaps your brother-in-law, who while being a trustworthy individual, is way out of his league as a trustee as it relates to insurance.

Even if you have no reason to believe that a permanent life policy you own has issues, I suggest you annually request a very useful document from the insurer called an inforce illustration. Think of it as a current financial statement for the policy. In it, you will find very important information, not all of which most people will understand, but you must start there.

Possible solutions to COI-related premium increases include selling the policy in the secondary life insurance market through a life settlement, surrendering the policy for what cash value may be left in it, converting it to a policy with a reduced but paid-up death benefit, paying the higher premium and evaluating options for buying a new policy altogether.

As for cash values, most owners don’t realize that at the death of the insured person, the beneficiary does not collect both the death benefit and the cash value. It’s one or the other, with rare exceptions. This means taking the cash value out prior to death or taking the death benefit after death. The greater the cash value, the lower your leverage is because an increasing cash value decreases the obligation of the insurer. They will pay the death benefit but keep the cash value. When this happens, you need to take a look at what you have and why you still have it. Whole life insurance can be especially prone to this problem because it tends to maximize cash values.

Hans Hug Jr., an Exeter-based independent insurance broker, can be reached at 603-778-8939 or hhug@apache1.net.