Read the Fine Print of Life Insurance Policy Maturity

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Twice recently families have come to me with life insurance policies for relatives approaching 100 years of age. After hearing rumors of potential issues and not being able to get solid answers, they came to me to figure things out.

For one, I had to deliver bad news, and for the other, I could offer good news, even if it was conditional. I’ve written about this before, and it seems to be becoming a more common problem. An associate recently let me know that he had also handled two such cases in the past few months.

A short story

There has been an evolution regarding what happens with life insurance at 100 years. Although the word is sometimes used endow generically, endowment is technically what happens with a traditional whole life (WL) policy at maturity. The maturity date is the date the policy ends and is often 100 years old, but not always. New policies have a maturity date that extends well beyond 100 years, usually around 125 years.

Maturity endowment means that the cash value of the policy is equal to the death benefit and the cash value is paid out, even if the insured is still alive. At first glance, this may not seem so bad. The insured receives the money during their lifetime and does not have to suffer the death of someone dear to them to benefit from the money, perhaps even themselves. However, there is a significant downside.

Almost certainly, the policy in question is in a position of significant gain, or so we hope. The basis of the contract is likely the accumulated premiums paid, and any cash value in excess of the basis is taxable. Due to the unique tax advantages of life insurance, the gain is taxed as ordinary income and not as a capital gain. For example, a $1 million policy with a base of $250,000 will be subject to ordinary income tax on $750,000. Even if it were for someone in a modest tax bracket, the year of politics wouldn’t be so modest. We are talking about massive taxation.

The inherent nature of WL is that the cash value must equal the death benefit at maturity. This is why some policies have a decreasing death benefit in later years. When dividends decline, as they have massively over time, cash outlays must either increase to bring the cash value to match the death benefit, or the death benefit must decline to reach the cash value.

Evolution of the maturity of universal life insurance policies

With universal life (UL), the policy does not have to contractually endow. Although it may seem strange, UL does not have an actual premium like WL and term. The “premium” is just a calculated contribution, based on current assumptions, to the policy achieving a given goal, much like planning for retirement. If the assumptions change, the premium must change to achieve the same objective. It’s more like a defined contribution plan. Furthermore, the policy can be constructed in several ways. This means that there must be a target cash value entry in the system to calculate the required cash flow. For a $1 million policy, the system can be instructed to calculate the cash flow needed (premium) to have $1 million cash value at 100 years, or $500,000 cash value, or $1 redemption value. It may even be designed to not even reach 100 years.

If the rates credited to the policy decrease or the policy charges increase, the calculated cash flows in the policy must be changed to stay on target. Although this was introduced over 40 years ago, the consuming public is still largely unaware, hence the multitude of failing policies.

Earlier UL policies often matured at age 100, and regardless of the cash value at that time, it was paid out. It may or may not have been taxable, depending on the basis. Some UL policies have a maturity extension feature that allows the cash value to remain in effect as a death benefit beyond the policy’s stated maturity date. That may sound good, but with interest rates and policy credits dropping dramatically, the cash value was usually much lower than expected, even as the policy matured. If the cash value was minimal, who cares that the $50,000 cash value of a $1 million policy remains in effect as a $50,000 death benefit?

The next generation of policies allowed the death benefit to remain in effect if the policy had at least $1 cash value at maturity. It is much easier to fund a policy to have $1 in cash at age 100 than to fund it to have a cash value equal to the full death benefit. Massive mortality costs late in life often made it impossible to do so. In many situations, it is not even financially possible to reach the age of 100 with a dollar of cash value. Think of the mortality costs on a million dollars of insurance for a 99 year old!

Next comes a generation of policies with a premium guaranteeing that the policy will reach policy maturity and beyond, regardless of its cash value. You can look at an in-force ledger and see zeros in the cash value column, with the death benefit still in effect.

With this history lesson, we can see that the first requirement is to read the policy contract to determine what chassis it was built on. Next, we need to know how the policy was designed and funded. This is beyond the ability of most policy owners, and most of their advisors don’t know where to look and how to read what they find. It’s a familiar story that I was told that a policyholder’s family asked many questions, only to receive a lot of conflicting information, if not blank stares.

Who can you trust?

If that wasn’t too much, another wrinkle is too often added. Does the person the family speaks to at the police headquarters in question know what they are talking about? We should certainly be able to rely on information from headquarters. It may seem like I’m trying to scare people, but the number of cases of misinformation is frightening. It’s disappointing that I know more about the policies of a life insurance company than too much at the home office. I have more institutional knowledge and memory than some customer service reps, many of whom haven’t been alive since I’ve been in the industry.

For the family I could tell good news to, it depended on taking a step. Mom was 99 and a half when they came to see me. They were scared to death that the policy would fail on his birthday. It was implemented 20 years earlier with a single seven-figure salary, so we are talking about a significant death benefit.

The original issuing insurer is no longer in the life insurance business and another insurer owns the policy. Also, the new carrier does not manage the policy. Management is provided by a third-party carrier.

I was able to determine that the policy was on track to reach age 100 due to a death benefit guarantee rider, even though the cash value had dropped to zero a few years prior. I wanted to check that out, so I ordered an effective register. The company sent a register to the trustee showing a seven-figure bonus at 100 years. I determined it was a mistake and requested a new corrected registry. Weeks later we got it.

It’s interesting

Ready for a surprise? It is not uncommon for a policy to have the aptitude remain in effect beyond 100 years, but it does not always do so automatically. The wording of the policy gives the policy owner the right to send a request to the insurance company to keep the policy in force beyond the stated expiry date. Did you get that? The company will maintain the life insurance policy and the death benefit, but only if you ask them to. The alternative is for the policy to expire at 100 worthless years, rather than remaining in force for millions of dollars without requiring an additional premium.

In the policy, I noted that the policyholder must submit the extension request 30 days prior to the policy anniversary nearest the insured’s 100th birthday. Fair enough. I drafted the letter and sent it to the trustee for signature and submitted it. Along with the submission, I requested a response assuring the family that everything was in order and that the policy would remain in effect. What I got back is disappointing. I was informed that the application could not be submitted until 60 days before the deadline. It wasn’t stated in the insurance contract, so I started arguing.

Let’s review. The policy, with a lifetime guarantee, would become worthless unless the policy owner sends in a request, and then the multi-million dollar death benefit would be clawed back. However, this request should have been submitted within 30 days just before the expiry of the policy. The syndic had to know this and do something, 20 years after the entry into force of the policy, otherwise all was lost.

I’m just spitting here, but I’m suggesting that’s wrong. If there was ever proof that an insurance company would go to great lengths to fuck a policy owner, I don’t know how that couldn’t be the case. No wonder people don’t trust insurance companies. At least I understand, so I treat them accordingly.

Bill Boersma is CLU, AEP and Chartered Insurance Advisor. More information can be found at www.OC-LIC.com, www.BillBoersmaOnLifeInsurance.info, www.XpertLifeInsAdvice.com or by e-mail at [email protected] or call 616-456-1000.

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