Life Insurance Consumer Advocacy Center

A flexible premium life insurance policy, like most universal life policies, can offer significant benefits to consumers. However, it can also lead to false expectations among those who do not understand what a flexible premium means.  Many consumers, unaware of how flexible premiums work, are surprised when, after paying premiums faithfully for many years, they are told by the insurance company that their policy will lapse if premiums are not increased, sometimes by large amounts.

 

What is a “Flexible Premium?”

Unlike many kinds of policies with which the consumer may be familiar (such as auto insurance, homeowner’s insurance, or term life), universal life insurance policies do not have a carrier-specified premium that is guaranteed to keep the policy in effect Nevertheless, regulations require that whatever you do pay into the policy must be referred to as a “premium.”  That can make the idea of “flexible premiums” very confusing!

Universal life policies combine death protection (which is what term life provides) with a special type of savings account (referred to as cash value).  The policyowner earns interest on the cash value at a rate determined from time to time by the insurer. The “premiums” paid into the policy plus the earnings on the cash value must exceed policy expenses (including “cost of insurance” charges that can increase rapidly as the insured ages), or the policy will terminate.

 

How is the “Flexible Premium” determined?

The policy owner usually agrees to pay the “premium” listed on a policy sales illustration at the time of purchase.  That premium results from a computer calculation that identifies – given a host of assumptions such as the insured’s current age and state of health, the desired death benefit, the current crediting rate to be paid by the insurer, and the expenses to be charged by the insurer – the amount of money the insured must pay into the policy each year (the “premium”) in order keep the policy in force (i.e., pay all policy charges) until a specified “end age” such as 95 or 100.   The illustration may also make assumptions about the levels of “income” the policyholder may want to withdraw or borrow from the policy —for example, to supplement retirement income—and those assumptions would increase the “premium” calculated by the sales illustration software.

What is often not explained at the time of sale is that the “premium” established when purchased is likely to change because the variables in the formula above are expected to fluctuate.

What can prompt those changes?  Some examples:

• Skipping a payment – or even varying the timing in which payments were assumed to be made.
• The way the account is credited with interest is typically under the carrier’s control. Notwithstanding the sales illustration’s assuming a constant illustration rate forever, the interest credit will fluctuate over time.  Perhaps it will be higher; sometimes it’s lower.
• And while the expenses paid from the account value are based on a current schedule, they are not guaranteed. The carrier can reduce them – but more likely, they may increase them – above the currently planned level of expenses.

All of these factors are likely to change the amount of “premium” needed to adequately fund the policy over time – the policy owner just didn’t realize that was how it worked. The reality is that managing a flexible premium is the policy owner’s responsibility to ensure there’s enough money in the cash value account to cover the policy expenses until death or the specified end age.

 

If the right amount of “premium” is my responsibility – and I still like the basic idea – how do I optimize my benefits and minimize my risks?

1. The most frequently determined “premium” is the one established at the time of sale.  Ask the agent to run a second policy illustration using at least 1.5% lower assumed interest – and then calculate the “premium” it would take if that scenario persisted forever.  That’s not a realistic assumption, but it demonstrates that the premium must change if any element of the policy becomes less effective (such as interest earnings) or more expensive (like policy charges).
2. With that awareness, consider paying the higher “premium” to start the policy on a better trajectory than the best price suggested in the initial sales illustration. Or at least increase the sales illustration “premium” by 10%-15%.  Small differences in premiums at the outset can have a very positive effect over time.  And, if the optimism of the sales illustration actually does materialize, you can always pull back on your “premium” contribution.  But before you do …
3. Periodically review the adequacy of the flexible premium. If you chose the “premium” calculated by the sales illustration, consider asking the agent or the insurance company for an IN-FORCE illustration shortly after each policy anniversary. Your question should be: “With the current account value, please calculate the ‘premium’ that will meet my end-of-age goal.” This is the single most important way to manage your policy and successfully meet your objectives.
4. If the answer to the question in #3 is that you need to increase your “premium” – ask for more information. Why has this occurred?  Is this the result of lower-than-projected performance – an increase in expenses not anticipated in the sales illustration – or both?  Disappointing answers aren’t necessarily an indication of a bad policy that needs to be replaced – policy replacement has its own issues that often don’t benefit the policy owner.  A good agent will provide the appropriate answers.

5. If the answer to the question in #4 is that you’re paying enough – or even a little more – to meet the long-term objectives: Bravo! You might consider doing the annual IN-FORCE calculations every other year. But don’t celebrate just yet. This is a year-by-year or every-other-year exercise to ensure your policy will likely deliver the benefits you expect.

 

Example

1. A 37-year-old healthy woman wants $1 million in insurance coverage to last regardless of her lifespan. She receives an Indexed Universal Life policy illustration that assumes a 5.5% annual credit to her policy. Considering current policy expense projections, the illustrated premium is $8,300. Following the advice in this article, she requests a second policy illustration using a 4% annual credit. The resulting “premium” for that scenario – remember, it’s just a current estimate against a lifetime of possible changes – is $10,200. She decides to pay the higher amount into the policy.
2. Five years later, our now 42-year-old woman asks for her annual IN- FORCE illustration. Because she chose to pay more than she “had to,” she finds that the trajectory of account values minus expenses is still on track to keep the policy in effect to at least age 95 – and in fact – her account value is a little larger than the original growth projection would have suggested.  At the advice of her agent … she keeps paying $10,200 with the potential for additional death benefit accruing at some point beyond her age ~ 80.

 

Read more: https://lifeinsuranceconsumeradvocacycenter.org/our-issues/the-problem-with-flexible-premiums/.