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Some Life Insurance Premiums are Skyrocketing: Why?

When was much younger, my dad, who was an insurance salesman, told me never buy a universal life insurance policy.  It was a bad deal, and you’d have to be crazy to buy any permanent policy other than whole life, he said.  I really had no idea why he said that and didn’t really inquire further.  A few years back, while speaking with another individual who sold insurance, he echoed my dad’s sentiments.  Older now, I was able to listen and understand his explanation of why anything other than a whole life policy was a problem.

life-insurance1_1Universal life insurance was invented in the 1970s as an alternative to popular, lower-cost term life insurance.  A term life policyholder buys coverage that expires at the end of a term, usually one to 30 years.

Universal policies typically cost more, but the coverage never expires and the buyer gets both a fixed death benefit and a “cash value” account, designed to earn tax-exempt interest.  Money in the account can be used to help pay the policy’s premiums.  But there is a risk:  If the account gets used up paying those costs, the policy can lapse and coverage ends.

An overly simple explanation goes something like this:  there are essentially two parts to a permanent policy, the investment portion and the death benefit portion.  Whole life policies are generally priced on your life expectancy and not on any particular investment return.  You will always pay high premiums and so long as you pay per the contract, the policy will always pay off.  Most universal life policies have lower premiums than whole life policies because they promise a particular rate of investment return.  The wonderful investment returns can be used to pay for your death benefit.  That is until the returns can’t cover the cost of the death benefit.  That generally leaves people with two options – pay higher premiums or let the policy lapse and forfeit everything they’ve already paid.

According to the New York Times, [a]round the world, life insurers are wrestling with . . . interest rates are near zero, and in some places have turned negative — unprecedented until recent years.  It is contributing to a crisis moment for a business once considered a bedrock of financial stability and an industry that supports the retirement of millions.

Companies that sell policies that run for decades, like life and long-term care insurance, face a twofold challenge: how to fund policies that were sold back when their actuaries couldn’t envision a world of interest rates below 8 percent, and what to sell now, when those same actuaries can’t envision an appreciable rise in rates anytime soon.

People who bought universal life or long term care policies in the 1980s and 1990s — some of which guaranteed a certain level of annual return — are seeing their premiums soar.

Low interest rates are a big part of this new pressure on insurers; their earnings are being squeezed.  But in recent years insurers have also undertaken various financial maneuvers to pay dividends to their shareholders despite their low earnings.

While the Federal Reserve bumped up short-term interest rates late last year, yields in the bond market continue to remain at depressed levels.  In recent weeks, the yield on the 10-year Treasury note slid to a record low of 1.358 percent.  For life insurers — where more than three-quarters of the industry’s $6.4 trillion in invested assets are parked in bonds — low rates like these can be calamitous.

If, say, an 8 percent bond from the 1990s matures, the cash must be reinvested in something new. But now, a similar bond may pay only 2 percent. The insurance policy sold to a customer back in the 1990s guaranteed a 4 percent return.  It adds up to a big problem:  how to back a promise of say 4 percent in a 2-percent-or-less world.

In the United States, in the hope of staving off a reckoning, some insurers have stopped selling certain products, and have raised what policyholders must pay for some existing policies.  And they have moved into riskier investments in search of higher returns.

But in recent years, even as low interest rates ate into the industry’s profits, some companies engaged in complex financial maneuvers that enabled them to pay hefty shareholder dividends. Normally, life insurers cannot pay shareholder dividends unless their balance sheets are flush. These maneuvers involve shifting a company’s future obligations to policyholders into special financial vehicles that do not appear on the insurer’s balance sheets.

Similar problems are playing out in the long-term care insurance business, which has sold policies designed to pay for nursing homes, assisted-living facilities and home health.  Today, however, long-term care insurers face accusations of badly under-pricing their policies as costs skyrocket.  Many have either left the industry or severely reduced benefits.  The remaining players, contending with low interest rates, are getting state regulators across the country to approve big premium increases.

In the end many holders of universal life or long term care policies will have to either pay up or let their policy lapse.

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