Your life insurance policy could expire before you do

If you bought universal life insurance in the late 1980s or early 1990s, plummeting interest rates and stock values in the past few years could mean your policy will die before you do.

In the heady days of the early 1980s when the prime rate was about 20 percent, universal life was marketed as a life insurance and investment product offering tax-free or at least tax-deferred cash buildup.

As long as interest rates stayed between 8 percent and 10 percent, stock mutual funds produced decent returns and policyholders paid their monthly premiums, everything seemed to be on autopilot for a death benefit payout.

A decade of bad stock market returns - coupled with interest rates at a 30-year decline to 4 percent - is causing many of the policies to lapse ahead of schedule, though. With the monthly premiums not earning enough interest or return on investment to maintain the death benefit, insurers tap the cash buildup to make up the difference.

Dwindling cash value

Steve and Joanne Carfrae of Cedar Rapids donated a parcel of land to the Greater Cedar Rapids Community Foundation with the understanding that it would be sold and the proceeds used to buy a universal life policy. The death benefit was to go to the foundation for charitable purposes.

“The policy that was taken out 20 years ago was supposed to survive until our 95th birthday,” said Steve Carfrae, 64. “It had been going down for some time, but the new projections showed the policy would become worthless when we're 79.”

The Carfraes didn't want to put more money into the policy, so they asked Loren Coppock with TrueNorth Cos. to look into a replacement policy.

With the remaining cash value, Coppock purchased a new life insurance policy with a substantially lower death benefit, but it was guaranteed until the couple turn 120. Both are in good health, a major factor that was considered by insurers bidding for the new policy.

“Many of these universal life policies - I believe as many as 50 percent - will lapse long before their owners die,” said Coppock, managing director and principal at TrueNorth. “When that happens, the cash value is zero, the insurance company keeps all the premiums that have been paid and there is no death benefit. It's perfectly legal, and insurers really have no incentive to make policyholders aware of the situation.”

Coppock learned of the problem in 2006 when policyholders began noticing the cash value falling month after month on their annual statements.

“We began looking at the universal life policies we had in force and found that the cash value was being eroded year after year,” he said.

Annual insurance statements outline the status of a policy, he said, but many people file the statements without reading them.

“By the time they get a notice that the policy is going to lapse in a couple of months, the cash value is just about depleted and they will need to substantially increase their premium to restore the death benefit,” he said.

 More than stock market at work here

Coppock said other factors are causing the policies to crash.

“With medical advances, people are living longer than they did when many of these policies were written, and that lowers the cost of insurance,” he said. “The lower costs were supposed to be passed through to all policyholders, but they're only available on newer contracts.”

Because the costs have not been lowered on those older policies, the insurers take more of the cash buildup to maintain the policy.

Unchanging premiums are another factor.

“Flexible premiums that were calibrated with very high interest rates have never increased. As interest rates fell to 8 percent and later much lower, the monthly premiums were too low to sustain the death benefit,” he said.

Coppock, whose firm has set up a separate unit to review universal life policies, said there are alternatives, even for those who do not qualify for new policies because of poor health.

“I have an 84-year-old man whose policy with a $400,000 death benefit will lapse in 2014,” he said. “He can cash out the policy and give the $75,691 that's left to the Greater Cedar Rapids Community Foundation. We also can let that cash drain out until there's about $20,000 left and then sell the policy to a viatical settlement company. We think we can get $150,000 or $200,000 for it.”

Viatical settlement companies sell the policies to hedge funds and other investors who are willing to make up the difference and receive the full death benefit, he said.

Coppock said the insurer that issued the universal life policy often will offer a replacement with a guaranteed death benefit, rather than see the remaining cash pay the premium for a competitor's policy.

Issue with lapsing policies not publicized

While insurers have not publicized the issue, there is a “growing concern” in the industry about lapsing universal life policies, said Donald Walters, general counsel for the Insurance Marketplace Standards Association. The Bethesda, Md.-based non-profit organization develops best practices for the insurance industry.

Joanne Carfrae, 63, said the couple was disappointed that the original value of their charitable donation was not going to be realized.

“We feel very strongly that people need to be aware of these issues so they can do something about it before it's too late,” she said.

Les Garner, president and CEO of the Greater Cedar Rapids Community Foundation, said donated life insurance polices are assets carried at cash value, rather than face value or the amount of the death benefit.

He said non-profits, universities and other organizations with donated universal life policies need to pay close attention to how they are performing.

“It requires active monitoring and management,” Garner said. “I think many charitable organizations have always assumed that you simply sat on the policies and held them, and that is not the case.”

Related information

Universal life policies were sold in two varieties:

• Basic, with a tax-free cash buildup from interest earned by the insurance company investing the premiums in bonds.
• Variable, where the policyholder usually chose stock mutual funds and the return on the investments helped create the policy's death benefit.

Is term life the same? No. If you own term life insurance - the kind of insurance that does not build cash value - this problem does not apply to you. As long as you keep paying the premiums, your insurance will stay in force