When individuals purchase life insurance policies, they are often told that if they make a certain sized premium payment for a certain number of years, their policies will be fully paid with no additional payments required for a lifetime of coverage and death benefits for their heirs. With this information, many people “set if and forget it” – they continue to make their payments and rely on the false comfort that they have the protection of life insurance. However, this approach could result in unpleasant and expensive outcomes for the insured, the beneficiaries, and the trustee.
The reason that individuals often cannot count on their life insurance policies as being a “sure thing” is because many life insurance policies cannot be adequately funded by the scheduled premium payments alone. Many life insurance policies are designed with an assumed rate of return. The life insurance provider takes the premium money paid and invests it – the premium amount PLUS the return on the premium is what keeps the life insurance policy going until the insured’s death. The premium payment amounts are essentially estimates based on the return that the insurance company expects to earn. For many of these policies, the rate of return is left to the discretion of the agent selling the policy.
So, in instances like this, the life insurance policy is built with a balance between the premium and the return, operating much like a pulley system. If an agent sells a life insurance policy with a low premium, then the rate of return will need to be higher. In the converse, if the premium payment amount is higher, the agent can build in a lower rate of return. Depending on the life insurance policy type, the assumed rate of return can be set as high as 12% annually compounded – a rate that most advisors would find unsustainable over time. When the life insurance policy cannot be sustained, any cash value that the policy had built up will begin to diminish based on the need to fun new premium payments.
In the event that the assumed rate of return that was built into the life insurance policy cannot be sustained, the insurance company has the contractual right to elect to increase the premium to a level which will sustain the life insurance policy – more often than not, this is an unaffordable figure for the insured. The policyholder is then left with two options: 1) pay the sizeable additional payments, or 2) let the life insurance policy lapse. If the grantor is unable or refuses to pay this increased rate, the insurance company may then rescind the life insurance policy – resulting in a loss of all premiums paid as well as loss of coverage.
Here is an example of what this might look like: An 80 year old woman thinks that her $3 million universal life insurance policy was paid up 15 years ago. She is comforted that her three children, whom she has named as beneficiaries, will receive $3 million dollars when she dies. However, one day she received a letter in the mail notifying her that she will have to pay an additional $50,000 per year for 10 years in order for her life insurance policy to pay out the death benefits she had thought were already in place.
When planning to provide for loved ones after death, many individuals turn to life insurance policies. When done correctly, they are a great estate planning tool and can be well worth the money invested. However, it is important that individuals are regularly checking on their life insurance policies. A thorough and meaningful life insurance policy review is a necessary precaution to ensure that your life insurance policy is functioning as it is intended to.
Schromen Law, LLC can work with clients to conduct life insurance policy reviews. By working with advisors and other professionals, necessary information can be obtained from life insurance companies and a policy analysis done to determine if the policy should be continued, funded at a higher level if needed, or discontinued in favor of a newly negotiated policy that may better serve individual clients’ goals and needs.
The material contained herein is for informational purposes only, and is not intended to create or constitute an attorney-client relationship between Schromen Law, LLC and the reader. The information contained herein is not offered as legal advice and should not be construed as legal advice.