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When Is Whole Life Not Really Whole Life?

Whole life insurance has been held up as somewhat holy and unaffected by the travails of universal life insurance. This has got to stop.

Over the years, there’ve been innumerable pieces written on the failings of universal life insurance. However, if consumers paid attention when these products were explained to them, they’d be no more surprised by this when discovering their retirement plans weren’t going to pan out when they experienced only half the expected market return. None of this should be a surprise; if projections aren’t realized, results will differ.

That being said, there’s little discussion about the failings of whole life insurance. Now, when I say WL, I mean actual WL and not just permanent cash value life insurance. Somehow, WL has been held up as somewhat holy and unaffected by the travails of UL. This has got to stop because many policyowners and their policies are suffering for it.

Name Brand Companies Aren’t Immune

I rarely name insurance companies when I write but I’m going to make exceptions because it’s pertinent to the conversation. Northwestern Mutual is a top rated insurance company. It’s conservative, traditional and has a good reputation in the consumer market. What I’m writing about today isn’t a criticism of Northwestern or any other insurance carrier I mention, but a warning to the market that things aren’t always as they seem. I don’t want to risk a reader blowing this off because of an assumption these issues only affect marginal insurance carriers. Nothing could be further from the truth.

Guaranteed Whole Life

Most consumers I talk to believe life insurance is guaranteed when it seldom is. Even more believe their WL is guaranteed when it’s only sometimes. Before I go further, I’m going to make some differentiation so no one tries to come after me on technicalities. True, WL is guaranteed. However, policyowners who believe they have WL don’t necessarily have WL.

Let’s start with what a guaranteed WL is. A WL policy is guaranteed for the initial death benefit when a premium is paid out-of-pocket every year when it’s due, and the policy has no term blend incorporated. But many don’t understand this. Most clients believe that if they sign off on a policy designed to have 10 premiums, for example, when they pay the 10 premiums, they’re done and the contract is guaranteed. More often than not, this isn’t true. A true 10-pay contractual policy will work this way. Whereas most short pays are projections and not guarantees.

Real Life Stories

Just ask the 40-year-old Northwestern policyowner who came to me with a policy he purchased at aged 30 on a 10-pay basis and was trying to figure out why he now had to pay more than the 10 years. He had understood it to be a 10-pay contract, period. (Try to track with me because this is kinda funny.) When he came to me, I told him he couldn’t stop after 10 years; he now had to pay to aged 76. He was understandably floored. We then scheduled a meeting with his financial advisor so I could explain. By the time we met, the Northwestern dividend rate had been reduced again. So, I ordered a new ledger, and he now has to pay to aged 84. After the dividend was reduced again, he’d have to pay to aged 100. Then, after the dividend went down yet again, he had to not only pay to aged 100, he had to pay significantly more premium. (OK, not really funny.)

An attorney friend of mine has an Northwestern policy on his wife, and they have dutifully paid every single year on time for a couple of decades now. He asked me to review his policy; and I had to tell him the death benefit was decreasing every year and would be much lower than they thought it would be: half of the original death benefit by life expectancy.

A trust officer friend of mine was on the phone with me yesterday after I was analyzing his mother’s Northwestern policy. It’s a 33-year-old policy, issued in 1986, the death benefit is dropping every year and is now lower than when the policy was issued and will go much lower.

Lately, I’ve been brought in to evaluate some in-force and proposed premium financed transactions funded with Mass Mutual WL. These were highly front-end funded, non-blended WL policies. Some of them were projections so they haven’t had a chance to disappoint. But, I couldn’t advise to move forward with them because not only did the policyowner and advisor team not understand how the transactions really worked, they actively misunderstood them in ways to come and with the exact wrong conclusions when making decisions. The numbers didn’t really work how they were led to believe, and the plan prospects were unsustainable.

How about my client who owns and runs a global enterprise? He and his wife owned a $40 million New England/MetLife WL policy as part of a larger insurance portfolio in their irrevocable trust. It was only 15 years old and already falling apart. I ordered in-force ledgers that showed their $150,000 annual premium increasing to seven-figure annual premiums. So much for guaranteed, huh?

Whole Life With Term Blends

These policies were all sold projecting increasing death benefits and some as short pays though they need much more premium—and the death benefits are still sinking. Why? Term blends. TBs aren’t WL. TBs were layered in to reduce the premiums and make the policies more affordable and competitive in the face of ULs. The TB insurance was never intended to be in the picture after a number of years because the base WL was supposed to grow and replace it. However, when the dividend rates plummeted with the interest rate market, the WL portion didn’t grow as fast, and the TB stayed in the picture. Why is that a problem? Because the cost of term insurance increases as you get older. Basically, your client is paying annual renewable term rates as a 60-, 70-, 80- or 90-year-old individual. How’s that going to work out for him?

The TB starts getting so expensive that not only do the paid premiums and the dividends not cover it, the policy starts surrendering parts of itself to pay for the increasing TB costs. I know the definition of cannibalism, but what’s it called when you eat yourself?

But if WL is guaranteed, then why’s this happening? Because WL, as it’s often purchased, isn’t guaranteed. The increasing death benefits aren’t guaranteed. The dividends aren’t guaranteed. Most of the short pays aren’t guaranteed. The TBs aren’t guaranteed. So many of what are referred to a paid-up policies aren’t really paid up; it’s just the vernacular people use.

Effects of the Interest Rate Markets

OK, so those features aren’t guaranteed, but why is everything going downhill? Because interest rates have gone downhill and everything follows. A policy referred to earlier was issued in 1986—possibly the worst time in the history of the world to buy a traditional WL policy on a budget basis. It sure looked attractive but the Northwestern dividend rate peaked at 11.25 percent that year, and Northwestern’s 2018 dividend rate was 4.9 percent. When’s the last time something projected to credit at 11.25 percent and dropped to 4.9 percent worked out?

The other WL companies were in the same boat. All dividend rates have sunk by many hundreds of basis points since the mid-1980s. You think that’s bad? Wait, it gets worse.

Short Pay Policies and Loans

In many of these short pay scenarios, where policyowners thought that after paying their 10 premiums, their policies were paid up, the owners had another kick in the gut in store. Because the premium was often unknowingly payable, and the policyowners didn’t pay it, the payment had to come from somewhere. Here’s where loans come in. Many, if not most, WL policyowners have no idea that a loan can accrue on a policy even when they don’t take money out of the policy. Yes, that premium that wasn’t paid out-of-pocket may have been, and often was, paid by an automatic internal loan. Many times, this was a default action chosen for the policyowner and not at the time when the policy was being designed, which may be how the policy was designed

When the dividend rate is much higher than the loan rate, this is doable. But, when the dividend rate drops to well below the loan rate and it’s not serviced, bad things will happen. Unfortunately, most policyowners aren’t informed of this, and because they were never taught to actively manage their policies, and relatively fewer are being actively managed by agents and trustees, these loans grew out of control. Ultimately, the policyowner may get the insurance equivalent of a margin call. Imagine getting a margin call when you don’t believe you have anything out on margin. I regularly inform people of loans they had no idea existed.

Increasing Premiums

I’ve seen a policyowner’s premium increase from $40,000 to $400,000, from $150,000 to $7 million and from nothing to thousands a year. Time out. I hear howling, so let me explain. No, the base WL premium doesn’t increase but the payments increase. Does it sound more palatable when I say you only owe $40,000 in premium and $360,000 in loan interest? Much better, isn’t it? Good heavens, of course not! So now I’m going to refer to premium as base WL premium, term premium and loan interest collectively, because that’s what honest people do: forget the technicalities. How many understand what happens when out-of-control loans tank a WL policy? The loans are forgiven. That sounds so sweet, doesn’t it? However, the dastardly Internal Revenue Service considers that forgiven debt and taxes it as ordinary income to the extent it exceeds basis in the contract.

I’ve witnessed the most devastating circumstances you can image. How bad? How about a policyowner being driven into bankruptcy by a lapsing, loaned-out WL policy? A tax bill due on a failing contract that exceeds the entire net worth of a family? I’ve seen it happen. Dramatically negative consequences come home to roost more often than you might think.

Cash Value and Death Benefit Shortfalls

Even when devastating results don’t occur, it doesn’t mean that all’s good. Many policyowners who were funding a WL policy for supplemental retirement funding or deferred compensation plans will be surprised to discover the policy won’t provide the expected funds. Death benefits that were projected to be significant will be substantively tempered.

Does any of this mean WL is bad? No. If your car runs out of gas does that make it a failure? Really, it’s more your fault, isn’t it? What it does mean is that you’d better understand WL insurance and not envision a quaint 1960s-era guaranteed product.

Whole Life Isn’t Bad But It’s Not Infallible

It’s not all bad news. The insurance carriers referenced above are fine. Some policies are doing fine. They’re almost all underperforming expectations, though they have to be in a decreasing interest rate environment. Dividends aren’t magical. They’re predominantly driven by the interest rate markets. Oh, and don’t expect them to recover quickly as interest rates start to edge up. First of all, they may never get to where they were before, and time value of money is a bitch when it’s working against you.

I read a lot of articles regarding life insurance, and sometimes the most illuminating aspects are found in the comments section. Invariably, there will be an agent or two who simply recommend sticking with mutual WL to avoid problems and may even admonish those who have strayed elsewhere (often with a bit of a condescending attitude). I don’t know if they understand that many of the people who end up working with me to fix what’s gone wrong thought they were doing exactly that. There’s nothing magical about WL, and there’s nothing simple about life insurance.

Bill Boersma is a CLU, AEP and LIC. More information can be found at www.oc-lic.com, www.BillBoersmaOnLifeInsurance.info and www.XpertLifeInsAdvice.com or email at bill@oc-lic.com.

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