David H. Kinder, RFC®, ChFC, CLU
Life Insurance Myth #4: The costs of insurance in a UL or IUL policy will grow too expensive.
Updated: Jan 18
This myth comes from those who believe that whole life insurance is the ONLY cash value life insurance policy one should own... because of the guarantees. And these advocates of "whole life only" use the past as an example of what can happen with Universal Life insurance.
As someone who pays attention to life insurance headlines over the years, it's not hard to find lawsuits about various "imploding" universal life insurance policies.
Here are just a sampling of the recent headlines over the past couple of years: Two More Lawsuits Filed Against AXA For Cost of Insurance Increases
Transamerica sued for cost increases on universal life insurance contracts
Universal life insurance lawsuits underscore product risk
Most recently, the California Insurance Commissioner, Dave Jones, had sponsored a bill that was signed into law on September 19, 2018 regarding more advanced notifications to California insurance policyholders regarding costs of insurance increases so policyholders can have more time to make more informed decisions about their policies.
Obviously, it has been a problem.
However, I want to take you back in time to the 70's and 80's about how life insurance (particularly the new universal life insurance policies of the time) were sold. Back then, the pitch was "Same coverage, half the premium" or "Double your coverage at no additional cost."
Why was this?
1) Interest rate assumptions: Back then, the interest rate assumptions were very high (somewhere between 9% - 12% EACH YEAR). Obviously, the interest rate environment has changed.
2) Death benefit focus: While there certainly was a discussion about the cash values in life insurance, it wasn't necessarily a heavy focus. It was "over time it will build a cash value that you can borrow against" kind of discussion. The focus was on how much protection could be put into place to protect your family.
Fill the box... or pay the curve.
Some time ago, I discovered this video on YouTube by Guy Baker. Guy Baker is not only a lifetime veteran of the life insurance industry, but he holds some of the most advanced education available in the field of financial planning. He recently completed his doctorate at The American College and is now a Doctor of Financial Planning, in addition to some of the most advanced studies one could pursue including CFP, CLU, ChFC, and Masters of Science in Financial Services.
This recorded video, probably in the mid-90's or so, shows how life insurance works today and how it really has always worked since the mid-1850's or so when insurance companies began to hire actuaries in product design:
Universal life insurance was sold in such a way that consumers end up "paying the curve". They ended up doing a minimum funding situation with their policy counting on the interest rate environment to be maintained to keep the policy in force.
Why do I believe that Indexed Universal Life (or IUL) will not have these problems? Well, almost. The reason is very simple: If the policy is structured properly, there is every incentive for the policyholder to maximum-fund this policy to maximize its benefits! After all, it's only the amount after the costs of the policy are factored in that you earn your indexed interest. This policy was designed to be maximum-funded for a given death benefit to take advantage of its benefits. What do I mean by "maximum-fund"? Let's assume that you are a 35 year old, male, non-smoking, standard insurance risk and you want to put $10,000 per year into a life insurance policy. - If you fund a minimum-funded, maximum-death benefit, the amount of level death benefit you could secure for $10,000 per year would be about $1,404,761. There's a lot of insurance costs built in to a $1.4 million dollar policy.
- If you fund a maximum-funded, minimum-death benefit, the amount of level death benefit you could secure for $10,000 per year would be about $874,071. Now, between these two policies, which one would build cash value faster? It's the one with the smaller death benefit.
This is technically called "funding up to the MEC guidelines". MEC is a technical term standing for "Modified Endowment Contract". Contracts funded UP to these levels are still considered life insurance and retain their tax-advantaged status. Some agents call these a different kind of 'MEC' - a Maximum Efficient Contract. Contracts funded OVER these levels begin to lose some of these tax-advantaged benefits.
Investopedia discusses Modified Endowment Contracts here: https://www.investopedia.com/terms/m/modified-endowment-contract.asp
This was what was generally NOT happening with these policies back in the 70's and 80's. To use Guy Baker's terminology, they were set up to "pay the curve". If you have a properly structured IUL policy that is set up to "fund the box", then the earnings can help to "pay the curve"... instead of you doing it out of pocket to keep your coverage.
Why would I want to pay the same amount for a smaller death benefit?
There are MANY advantages to cash value life insurance, when the policy is properly structured. I'll be writing some additional blog posts about some of these advantages.
Managing Return Expectations with IUL
One major advantage to Indexed Universal Life is the notion that you won't have perfect returns every year. You can reap a decent gain when the market goes up and you don't lose anything (other than costs of insurance) if the market is flat or goes down. While illustrations have tempered some of the return expectations by keeping the annual expected returns more conservative, it's also knowing that the returns will vary year to year. This helps to keep policyholders active with their policies and enjoy its benefits.
Have these advantages always been around? In one form or another, these advantages that I'll be writing about have always been around. (Indexed interest has been around in insurance policies since about the mid-90's.) However, I like to compare today's policies and strategies to baking soda. Huh?
Arm & Hammer has been around since 1846. Up until the 1970's, they primarily sold baking soda for baking purposes. Now think about this: How much baking soda do you use when baking? A tablespoon at a time? You don't sell a whole lot of baking soda if that's its only use. Today, baking soda is not just used for baking, but for deodorizing as well. It's used in laundry soap, deodorant, toothpaste, cat litter, and more. I know every once in a while I sprinkle it on my carpets to deodorize them before I vacuum. I keep ventilated boxes in my refrigerator and freezer and change them out regularly. Here's a link for 55 special uses for baking soda lifehacks.
For over 125 years, baking soda was used in a particular way. Now it's used for many different things.
And so can today's life insurance policies. To paraphrase an older advertising line: "This ain't your father's life insurance."