Dealing with universal life premium increases

It's hard to find any good news in the recent spate of premium increases for older universal life (UL) policies.

Policyholders face difficult decisions they didn't anticipate when they bought the insurance. Advisors must explain to clients why their policies are at risk, and seek possible solutions. And, insurers seeking rate hikes are experiencing bad publicity and lawsuits.

We asked several advisors and insurance experts how to explain and approach the problem with clients.

Multiple moving parts

Nancy Bennett, FSA, senior life fellow with the American Academy of Actuaries in Washington, D.C., says three primary factors go into life insurance pricing:

- projected investment returns;
- mortality expectations; and
- current and anticipated expenses.

Additional assumptions include expected policy lapse rates, taxes and reserve requirements, among others.

The distinguishing quality in universal life is that the major pricing elements are unbundled, she explains. While most life products provide little breakdown in how the factors contributed to the premium, universal life provides that information.

"With universal life, the policyholder can see how much they're being charged for their cost of mortality in any given year," she says. "You can see how much investment gain is being credited to a policy."

Bundling insurance policies may present a fiduciary challenge as it can be more difficult to distinguish between product fees. (Photo: iStock)

Bundling some insurance policies may present a fiduciary challenge as it can be more difficult to distinguish between product fees. (Photo: iStock)

Unbundling inadvertently creates a "dark side" in product design because insurers make guarantees for each component, says Glenn S. Daily, CFP, a fee-only insurance consultant in New York City.

For example, many UL policies have minimum interest rate guarantees in the 4 percent range. Insurers' portfolios previously exceeded that level but that situation has changed.

"As interest rates have come down," Daily says, "the companies claim that they have been squeezed on the interest rate spread that they expected to earn so they haven't been earning as much on the interest rate as they expected."

As a result, they're increasing cost of insurance rates to restore profitability.

In contrast, traditional whole life is a bundled product. Policy holders see their annual dividend but don't know how the pricing components contributed to that amount. Provided the dividend is considered fair under applicable standards, Daily says, an insurer with whole life business can adapt to a low interest rate environment more readily.

"It's easier for the company to manage its traditional whole life block in a low interest rate environment because it's able to offset one component against another, which you just can't do in the case of universal life," he says.

Not a new problem

Concern over consumers' potential reactions has prevented insurance companies historically from increasing UL premiums on existing policies even though they're contractually allowed to, Bennett observes. "But I think after so many years of low interest rates, there really are no levers or switches left for insurers and, so, if they're going to retain any profitability on these products, they need to start increasing the premiums," she says.

Although UL premium increases have been garnering headlines lately, the problem has been developing for years. Consider that this past April, professor Joseph Belth blogged about a class action cost-of-insurance lawsuit filed in June 2009 against Lincoln National Life Insurance Company.

UL policies' funding status has often been problematic. (Photo: iStock)

Even before then, UL policies' funding status often were problematic, according to Roger Seim, CLU, ChFC, with MassMutual Financial Group in Minneapolis, Minnesota, and a Million Dollar Round Table member, who has been dealing with UL-funding problems for 10 years. UL contracts have guaranteed and current costs of insurance plus guaranteed and current interest rates. Because most consumers want the greatest death benefit for the lowest premium, they minimally fund their policies, which reduces the available resources to absorb premium increases. In addition, many policyholders and agents overlooked UL contracts' long-term financial viability in the event of interest rates trending lower for as long as they have.

UL contracts have two deposits — the premium amount and the interest credited are deposit — and the withdrawals are the cost of insurance, says Seim, and buyers need to understand the interaction. "We really try to make it pretty clear if we're working with a client that we need the two positives to be higher than the cost of insurance that's coming out. I try to do at least an annual review and say … here's what's happening with these contracts."

Limited options

Clients can respond in several ways to premium increases, subject to constraints that can include available cash flow, insurability and contract charges. Daily says that the first step is to review the UL policy's section that discusses the cost of insurance rates and the insurer's ability to change rates. That section's language might provide a way to avoid the increase although Belth notes that insurers have been tightening up their contracts: "Life insurance companies have learned the hard way that the wording of the clause is critical. Thus the companies have rewritten COI (cost of insurance) clauses in more recently issued policies to provide the companies with maximum flexibility on the imposition of COI charges, while at the same time trying to minimize the likelihood of a successful legal challenge."

The next step is learning if litigation has been filed, and in some cases it makes sense to retain an attorney, Daily suggests. "What does your contract say and is there any hope that the cost of insurance rate increase is going to be rescinded because of regulators or because of litigation?" he says.

Kevin Couper, CFP, with Sontag Advisory in New York City, starts the policy review by obtaining an in-force ledger, which lets him develop the best and worst case scenarios the client is likely to encounter and determine whether they can afford to maintain the policy. He also reviews the need for the insurance and the policy owner's insurability. Seim takes a similar approach and asks owners if they can fund the higher premium either with a lump sum deposit or through larger annual payments. If the client has money in a low-yield savings account, for instance, transferring funds to the UL policy can increase their earned interest and help cover the increased premium. Clients in good health can consider looking at an alternative contract with stronger guarantees; another option is to maintain the current premium but reduce the existing policy's face amount. Doing a 1035 exchange to an annuity is another option if the client doesn't need the insurance; viatical settlements are a last resort, says Seim.

Avoiding future blowups

Interest rates will eventually move higher, and that will relieve pricing pressure but prospective buyers will still need to understand that UL policy projections are not guarantees. Richard Stumpf, CFP, with Financial Benefits Inc. in Wichita, Kansas, shared a recent conversation with an insurance company marketing rep who was promoting the company's index UL product. The policy showed a 6.9 percent interest rate in its projections because that was the index's average return over the last 25 years. Stumpf agreed it would be nice to earn that return but he wanted to see a reduced projected rate.

"A lot of that was earned in the 15-to-25-year period," he observes. "You look back over the last 15 years, (and) you haven't earned that over the last 15 years."

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