Our Analysis:
Universal or Flexible Premium Life Insurance Policy Gone Bad
In the example above we mention the term "Target" premium. This premium is the amount necessary to take a policy through maturity. According to the most recent cost of insurance and mortality calculations, "Maturity" can only be one-of-two things; the death of the insured or age 95 (or in some cases, age 100). Back in the early days of U/L, the target premium only had to be met for one year before it could be voluntarily "flexed" by the policy owner. Thus, if the target premium was $1,200 per year, this goal could be reached any number of ways - either from a single $1,200 deposit, $100 per month, $300 per quarter, or $600 semi-annually. By any means, if that $1,200 goal was met at least once, the following year's premiums could be reduced to as little as $0.
In the early 90s, some companies solicited a U/L policy to change their "Target Premium" requirement from one year to two years. Referencing the example above, this meant that now, $2,400 needed to be placed into the policy before the premium could be altered. It did not matter what your desired payment method was - lump sum, annual, semi-annual, quarterly or check-o-matic; as long as that required amount was paid, your premium could be lowered.
Using this flexibility option to their advantage, agents would "roll, transfer, kickstart, bind, shift or churn" the sometimes large cash values from much older policies into new U/L policies in a practice called, "frontloading". By doing this, they could place more than enough money into the new policy to cover the target premium requirement. Usually at the point of sale, the agents would often have the policy owner sign blank Service Request Forms which could be later used to withdraw the cash values or dividends needed to alter future premium requirements; often without the policy owner's knowledge. Then, lastly - but certainly not least - came the promise of "much better insurance coverage for far less money".
Once the "frontloaded" money is exhausted and the lowered premium is insufficient to cover the cost of insurance (which was usually just a few years), the policy owner would often get a rather large bill directly from the company. Shaken, he / she would immediately get on the phone to find that their agent is no longer with the company (or that he/she has been promoted to management level) and cannot be found. From here, the excuses would vary. "Poor interest rates, the policy owner misunderstood the agent, clients only recall what they want, decreasing dividends and poor economic times" are the more common excuses for an agent's dishonesty.
We have found numerous cases against the same agent - thereby establishing a pattern and practice - the company (while never admitting any form of responsibility) would call him/her a "rogue agent not acting in the company's best interest". Call it a "hunch" if you will but, we found that when agents "strip" older policies of sometimes tens - of - thousands of dollars, making more in commissions than some people earn in a year, then leaves the policy owner without any coverage whatsoever in just a few years, they are certainly not acting in the best interest of the policy holder either!
Most economic experts can use terms like, "Mortality, Exposure, and Risk Tolerance" to prove that companies do actually benefit from "churning." Over the years, we have found that the number of ways in which a life insurance policy can be "sold" is limited only by the imaginations of the agents. Please remember: not every representative from every company needs to use "questionable" sales methods.
Universal or Flexible Premium Life Insurance
Universal or Flexible Premium Life insurance policies were introduced to the insurance marketplace back in the early 80s when interest rates were in the 10 to 12 percent range. This type of policy is a form of whole life insurance -- but with much greater flexibility. Like whole life insurance policy, you have two components: a term insurance policy and an investment account from which the term insurance premiums and administrative charges are paid. But with universal life, you get to choose your options in which the agent will show you.
It is not difficult to see how the premiums (or lack thereof) affect the death benefit and cash value. It's also much easier to see how much of the premium goes toward your insurance protection, cash value and administrative expense (including commissions). Beginning with a planned death benefit that you have probably worked out with your agent, you determine your planned premium based on how much you can afford and the cost of the insurance. The company subtracts an expense charge based on its fees (usually a fixed percentage of the premiums) and you're left with a cash value that generates interest.
Some companies will pay a "terminal dividend"-- a type of bonus, if you will -- upon the death of the insured. Of course, a company makes no guaranty that it will pay this dividend (or any dividend, for Universal or Flexible Premium Life insurance policies were introduced to the insurance marketplace back in the early 80s when interest rates were in the 10 to 12 percent range. This type of policy is a form of whole life insurance -- but with much greater flexibility. Like whole life insurance policy, you have two components: a term insurance policy and an investment account from which the term insurance premiums and administrative charges are paid. But with universal life, you get to choose your options in which the agent will show you. It is not difficult to see how the premiums (or lack thereof) affect the death benefit and cash value. It's also much easier to see how much of the premium goes toward your insurance protection, cash value and administrative expense (including commissions). Beginning with a planned death benefit that you have probably worked out with your agent, you determine your planned premium based on how much you can afford and the cost of the insurance. The company subtracts an expense charge based on its fees (usually a fixed percentage of the premiums) and you're left with a cash value that generates interest.
From the cash value, the company subtracts the current cost of insurance (the mortality charge), including the charges for any options (or riders), and monthly administrative expenses. And then the company adds in interest that your investment money earns. Your ending cash value is the accumulated value that belongs to you when you cash out (or in some cases, to your beneficiary).
Often, companies charge you a termination fee or surrender charge to cash out (known as back-loading), leaving you with the surrender value. The surrender charge, which usually decreases over 15 or 20 years, is most often a percentage of the total cash value. I have seen cases where agents have advised people to surrender old policies, representing that the earning potential of a new policy is more than enough make up for the loss. This is very seldom true and policy owners usually lose a great deal of money.
Here are a few of the "hi-lights" are:
- If you decide to stop paying premiums, the company will continue to pay the premium for you by deducting from your policy's accumulation fund. The company will continue to do so until no cash value is left. This is another way to continue coverage without paying premiums.
- The interest rate is usually tiered, in which part of the cash value earns one rate while another part earns a different (usually higher) rate. For example, your interest rate may be 4 percent for the first $1000 and 6.5 percent for the balance.
- You can also borrow against the cash value of your policy at a fixed interest rate, usually below market rates.
When you turn 40 years old, your new cost of insurance will be $40.00 per month - so only $60.00 will go towards your accumulation fund. At 60 years old, your monthly cost of insurance will be $70.00 per month - so only $30.00 will go toward your accumulation fund. For all intents and purposes, your cost of insurance will increase each and every year. It goes to figure that - as you get older - you get closer to death. This is called a mortality calculation. Based on this calculation, understand that at some point in the life of your policy, your premium will be $101.00 per month. If you are only paying $100.00 per month, where will that "extra" dollar come from? - Why your cash value, of course. At this time, you are theoretically, "robbing Peter to pay Paul."
However, this is not a bad thing, this is the way the policy was designed to work. Once you have become unable to afford the constantly increasing cost of insurance, the policy will do it for you - internally. Again, for the purposes of this example, this is how policies become "paid-up" - when the increasing value of the accumulation fund surpasses the increasing cost of insurance.