Vol 2 No 2		April 2000

Katt & Company is a fee-only life insurance advising firm. We work with clients throughout the U.S. - primarily by phone, mail, email and telecopy. Typically, we assist clients buying life insurance, those who need existing policies reviewed and managed, and in support of litigation. For references please contact us.

Alert

Many whole life (WL) and universal life (UL) policies have been sold on a vanishing-premium basis that projected the policy would become self-sustaining after the payment of premiums for a specified number of years. For almost every so-called vanishing-premium policy the original number of years premiums were projected to be paid has increased dramatically as historically high insurance company investment yields have returned to more normal levels. I routinely observe insurance agents recommending that failed vanishing-premium policies be rescued by replacing them with variable life (VL) whose cash values can be invested in high-flying equity sub-accounts that will out perform the modest interest rates of WL and UL. Illustrating VL performance using 10% and 12% constant returns will make it appear that the vanishing-premium promise can come true after all. However, replacing WL and UL with VL policies should be examined carefully. First, there are certain kinds of policy designs that are not compatible with VL. (See my July 1999 AAII Journal column). Second, the policyowner may not have the risk tolerance to invest the policies cash values in volatile and unpredictable equity funds that can suffer year-to-year losses. Finally, a policy replacement exposes the policyowner to another round of policy selling expenses that can be as much as 125% of the target premium. The use of VL should be based on more rational criteria than its promised delivery of imprudent vanishing-premium promises.

Tip

Because life insurance is complicated policyholders or their advisors do not see many looming problems until disasters strikes. For example, a universal life policyholder who has faithfully paid the billed premium suddenly gets a notice from the insurance company that if he doesn't immediately send in a payment his coverage will terminate and if he doesn't quadruple his future premium payments his coverage will not last until policy maturity. The policyholder and his advisors not only hadn't understood the affect lower interest crediting would have on the policy's premium structure, they didn't even know to look out for it. Astute monitoring of permanent life insurance is absolutely essential both for major issues like a policy becoming terribly underfunded, but also for less important factors. To follow are several examples of problems I have found reviewing permanent insurance:

1. Five years after a policy was purchased the insurance company began charging a female insured male mortality rates that are considerably higher. This occurred following a change in their computer system. Had I not found this error it is doubtful the policyholder would have ever known the policy was being charged much higher expenses.

2. During a policy review I increased a client's policy premium because crediting rates had declined. My memo to the insurance company was very clear that I wanted the quarterly premium increased to $2,000 ($8,000 annualized), but the insurance company mistakenly interpreted my instruction to mean an increase in the annual premium to $2,000. Therefore, they billed the policyowner $500 quarterly and my client paid this amount because they didn't know any better. Fortunately, I immediately picked up this error during the next bi-annual review and corrected it. Had this error not been picked up this policy would have become terribly underfunded.

3. I was hired by an attorney to help him understand why his client's life insurance policy, purchased five years before, appeared to be doing much worse than had been expected. Knowledge of poor policy performance was gained from reviewing an in-force illustration the policyowner had obtained from the insurance company. Indeed, the projected performance shown in the in-force illustration was very poor. The attorney had been inclined to have the policy replaced; however my analysis and discussions with the insurance company disclosed the problem. The insurance company's in-force illustration software had a serious glitch that double charged the policy for mortality. This double charge wasn't actually happening. It was only in the projections, but without correction policyowners would have been motivated to replace a policy whose only problem was faulty projections.

Information

Last year congress passed a law to phase out the estate tax (to be completed three presidential and five congressional elections later), but it was vetoed. They promise to do it again this year and another veto has been assured. Although I believe proponents of repealing the estate tax are either politically tone-deaf or using it as a bargaining chip in broader tax-reform efforts, you can read what I think about life insurance in a world without estate taxes. See my April 2000 AAII Journal column.