VUL Experts Want To Trim Blowup Exposure
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Variable universal life insurance experts are keeping an eye on a problem they say could hurt VULs long-term viability.
This potential problem is the possibility that inadequately funded and/or poorly managed VULs might "blow up" some day, if and when certain conditions occur.
They are also proposing various preemptive strategies to help minimize chances the problem will ever occur.
"Blowup" is industry jargon for an actuarial no-no–i.e., a life policy "blows up" if its policy value drops to a point where it can no longer support the fees and charges needed to keep the coverage in force. Unless the owner sends in more money or takes other corrective action, the policy will crash, unleashing headaches for client, producer, and insurer.
It is important to note that no one is saying the wolf is at the door. But VUL leaders want to ensure it never gets there. When interest rates dropped in the late 1980s and early 1990s, they point out, the fixed universal life industry suffered a rash of blowups. "We dont want a repeat," they say.
So far, "I havent heard of any lawsuits concerning VUL blowups," reports Mark E. Thompson, principal of The Law Offices of Mark E. Thompson, APC, a Lancaster, Calif. firm that has dealt with many fixed UL blowups. But the point is, he says, "when policies are funded properly, the family comes out so much ahead, and its better for all."
Notes Ben Baldwin, president and owner of Baldwin Financial Systems, Arlington Heights, Ill.: "Its a very complicated problem if we dont look at it, but its a very simple one if we do."
This article highlights some key elements of that problem. The companion article lists some risk management strategies advisors and insurers might employ.
The blowup problem could surface anytime the policy value falls too low–say, in a stock market downturn and/or when key subaccounts yield poor results, says Baldwin. The risk is particularly strong if the VUL has been minimally funded, its assets have not been well diversified and monitored, and/or it has substantial policy loans.
Further, the threat rises as the policyowner ages, points out Richard M. Weber, president of The Ethical Edge, Inc., Carlsbad, Calif. Thats because the VULs cost of insurance (COI) charges rise with advancing age, and also with increased "net amount at risk." The rising COIs eat into policy values, he explains.
Net amount at risk refers to the financial exposure insurers take on in covering a life–i.e., the difference between the specified amount and the cash value. Generally speaking, when VUL account values rise, the net amount at risk declines and so do the COI charges (because there is less exposure). But in a falling stock market (or, say, times of heavy policy loan activity) policy values fall, so the net amount rises and so do the COIs.
Other pricing mechanisms may help adjust for the rising charges–for instance, asset-based fees will decrease, experts point out. But over time, if COI increases become steep enough and no funds are added, threat of blowup increases.
An in-force "no lapse guarantee" would avert a crash, says John Fenton, principal with Tillinghast-Towers Perrin, in Atlanta. Thats because a guarantee assures the VUL will stay in force for a set period, regardless of account value, if required premiums are paid.
However, not all VULs offer such guarantees, Weber says, and price-conscious buyers typically "dont want them, because they are expensive."
When threat of crash is imminent, the insurer notifies the owner and gives 90 days for deposit of additional funds, says Baldwin. But these notices often come as a surprise, he says. "People dont understand why the account value went down so fast."
When fixed ULs suffered blowups a decade ago, he recalls, people would arrive at his office holding contracts he didnt sell. They demanded to know: "Why did this happen? I was told that if I paid premiums for so many years, Id never have to pay again!"
Others would say: "I exchanged my old policy for this one, and I was told I have plenty of money in the new contract–enough to last for the rest of my life!"
With VUL contracts, Baldwin maintains, companies typically send out annual notices that show the account values and policy status. But this information does not come frequently enough to help avert the sudden news of an imminent lapse, he contends. "As the stock market of 2001 proved, fund values can drop very fast," he explains.
Weber says some VUL illustration systems, and some illustration percentages elected by producers, can lead to funding choices that set a policy up for trouble later on.
Many times, he explains, the producer may be in a competitive situation. Depending on the circumstances and the options the insurer has made available, this pressure may drive the agent to show the client the "best" illustration–i.e., the one producing the lowest premium. To do that, the rep "will illustrate, maybe, a 12% hypothetical return–as if it were a fixed return–and with current (not guaranteed) COIs," he says.
The premium to endow at age 100 then becomes a very low minimum premium, he continues.
