In the last few months, you may have received a letter from your insurance company about your Universal Life policy. The letter would have informed you that the company is increasing the monthly Cost of Insurance (COI) within your policy. Several life insurance companies have raised the COI at about the same time, and it’s likely that many other insurance companies will quickly follow suit. ¹
The problem is that most consumers have no idea what “COI” means when they receive the notice in the mail. COI is how the life insurance companies pay for the death benefit when you pass away. It is deducted from your policy’s cash value each month. In the past, life insurance companies resisted increasing the COI to avoid damaging the trust built up over decades with their agents and policyholders. Until 2015, the instances of insurance companies raising the COI were very few and far between.
This changed dramatically in the aftermath of the Great Recession in 2008 and 2009. Insurance companies typically invest premium dollars received in long-term bonds. During the recession, interest rates plummeted, and so did the returns offered by bonds. However, insurance companies were locked into paying the guaranteed minimum interest rates promised in their Universal Life policies, usually 4%, but sometimes much higher. Policyholders recognized that 4% was a good deal when they could only get 1% in a CD. Consequently, the rate at which they terminated their policies dropped. The insurance companies realized they were on the hook for a big liability.
Insurance companies seized upon COI as one way they could pass on this unexpected business cost to their policyholders. Even better, they could make this change without having to get approval from the state insurance commissioners. The insurance companies seem to be targeting policies owned by seniors over the age of 70, an expensive group to insure. The increases appear to range from 5% to over 200% in some instances.
What does this mean to your policy? You may have purchased your policy with the expectation that as long as you continued to pay the stated premium, it would stay in force to age 100 or longer. With the increased COI, your policy may run out sooner. I found that my own life insurance policies would run out at age 85 because of the increased costs. In order to keep them in force just a few additional years, I would have to double the premium payments immediately.
This may be different for you, depending on your age and how much your COI has increased. Nevertheless, this would be a good time to review your policy and get an updated in-force illustration that shows the impact of the increased COI. This will inform you about the choices that are most appropriate for you. The most common options are:
a) Do nothing, keep the policy going until it runs out of cash value, and then terminate it. This would make sense if the main purpose of having the insurance was to cover a short-term liability, like your home mortgage balance, or college funding for your children.
b) Reduce the death benefit. You might be able to keep paying the same premium but reduce the death benefit (“face amount” in life insurance lingo) so that your policy will last longer.
c) Increase premiums now in order to keep the policy going for the original intended period. If you wait to increase premiums until after the policy has run out of cash value, the cost may be so high as to be prohibitive.
d) Terminate the policy and receive the cash value. If you have had the policy for many years, the risk that you intended to cover at the beginning may no longer exist. The cash value (the savings component built into your policy) is typically yours when you terminate the policy. If you hold onto the policy until the cash value depletes to zero, you may receive nothing. There might be some taxation on the cash value, if it is more than the total amount you paid in premiums.
As you can imagine, consumer groups and life insurance associations have already written letters of complaint to state insurance commissioners. Lawsuits are likely to follow. Because the outcome of such lawsuits is uncertain, it will be important for you to act prudently now, and not ignore the issue. Contact the insurance company, or the insurance agent who sold the policy to you.
¹ Wall Street Journal, 8/9/2015 www.wsj.com/articles/cost-of-universal-life-insurance-stings-retirees-1439172119