The Great Life-Insurance Temptation
April 4, 2014 by Leslie Scism at leslie.scism@wsj.com
Wesley Bedrosian
Life-insurance policies have gotten a surprising sales boost from a rising stock market. But if share prices sag, customers could be in for a shock.
The recent rally has increased the appeal of two types of life insurance that link benefits to stocks: “variable universal life” and “indexed universal life.”
Last year, when the S&P 500 gained 32%, including dividends, sales of variable universal life jumped 24% and indexed universal life rose 13%, by one measure of premiums, according to Limra, a research firm in Windsor, Conn., funded by the industry. Overall, life-insurance sales were flat.
Both types of insurance offer traditional death benefits. Yet policyholders also can log gains on money deposited into tax-deferred accounts, depending on how the stock market performs. Those gains, in turn, can help customers cover the often-steep annual policy costs down the road.
Buyers of variable universal-life policies are directly exposed to gains and losses on mutual-fund-like investments. Policyholders can place bets on stocks and bonds, though stocks feature prominently in many agents’ marketing pitches.
With indexed universal-life policies, policyholder money isn’t directly invested in the markets. Instead, insurers hold the money and typically pay interest into the policyholder’s account based on the performance of a benchmark index, often the S&P 500.
The policies can be useful for well-heeled consumers in certain circumstances, experts say. But they need to view the products primarily as life-insurance policies, not investment vehicles.
Variable universal life can benefit investors in the highest tax bracket who already have socked away the maximum allowable amounts in tax-deferred retirement accounts and similar savings vehicles.
Indexed-universal life policies can be helpful to a wider range of affluent buyers making long-term financial plans. For example, some policies allow for the death benefit to be used to cover long-term-care expenses.
Yet the products aren’t appropriate for many middle-class households, and even well-to-do consumers should be wary, according to experts and state regulators.
Insurance agents and brokers can collect rich commissions for selling variable universal life and indexed universal life, which means they can have a powerful incentive to promote the products.
Furthermore, the marketing materials can feature rosy projections of potential gains.
For example, the Securities and Exchange Commission and the Financial Industry Regulatory Authority allow insurance agents to show prospective buyers of variable universal life how the policies will perform if stocks return as much as 12% a year. Agents also must show what happens if returns are flat, and make clear the return figures are hypothetical, among other restrictions.
The more optimistic projections might not match reality. The compound annual return on the S&P 500 has failed to top 12% over the past 10, 20, 30, 40 and 50 years, through December, according to Chicago-based investment-research firm Morningstar. The past five years have been more favorable, with the index generating an 18% annualized return. Yet over 15 years, the figure has been a modest 5%.
“Beware of the sales illustration,” says Glenn Daily, a fee-only insurance consultant based in New York. “It is far too easy for agents to make a policy’s projected performance look good.”
The risks are significant: If the market underperforms—or worse, share prices drop—a policyholder may need to cough up additional cash to pay annual costs.
Projections that reflect investment gains are “a tool to help a consumer understand” how the policy works, but “are not a guarantee of future performance,” says Alyce Peterson, a vice president at Pacific Life Insurance Co., which is based in Newport Beach, Calif., and was one of the top sellers of variable universal-life and indexed universal-life policies last year.
Term or Permanent
For consumers seeking financial protection for their families, a type of life insurance known as “term” is usually the best option, according to many financial advisers and the Consumer Federation of America, an advocacy group in Washington.
Term life pays out a death benefit if the policyholder dies during the term of the contract, often 20 years. Insurers are able to keep premiums relatively low because few policies sold to people in their 30s and 40s ever pay out. Buyers of term life are often content to go without coverage once their children have graduated from college or gotten jobs, financial advisers say.
But consumers who want life insurance in place for the rest of their lives may be better off with what is known as “permanent” life insurance.
With permanent life, policyholders deposit money into an account from which the insurer deducts commissions, administrative and other fees, and the “cost of insurance,” akin to the annual premium for term life.
The remaining money in the account grows tax-deferred, which agents often promote as a way to help pay for the rising cost of the insurance as the policyholder ages.
The most basic forms of permanent life credit interest to policyholder accounts based in large part on the performance of insurers’ investment portfolios, which typically emphasize high-quality bonds.
The risk in those policies has become clear in recent years as bonds have delivered paltry returns. Many policyholders were counting on stronger gains to help cover the annual charges in their later years and some have been stunned by meager interest payments that have left them short of what they need. As a result, many face a dilemma: Pay more into the policies, cut the death benefit to reduce the annual charges, or drop coverage, experts say.
Low interest rates also help explain why some agents now emphasize variable universal life and indexed universal life, which are permanent-life policies linked to the stock market. U.S. stocks now have generated positive returns for the past five years in a row, as measured by the S&P 500. The return on the index so far this year is 1.4%.
An insurance specialist recommends buying directly from TIAA-CREF, a money manager and life insurer. Associated Press
Variable Universal Life
For consumers who need life insurance, are in the highest tax bracket and have ample financial resources to smooth over any rough spots, variable universal life can make sense, according to financial advisers.
Insurers typically offer a menu of investment options, often managed by well-known mutual-fund companies. Policyholders choose how to allocate the money in their accounts among those options, and have the ability to change the allocations, as with a 401(k) retirement-savings plan.
The risk is that the investments could tank and the insurer would still be deducting annual charges. Policyholders should regularly assess how the investments are doing.
In addition, consumers should think carefully before taking advantage of a widely promoted feature of the policies: the option to skip some annual payments with the intent to make them up down the road. Those missed payments can quickly throw off growth projections, because there is less money in the account to generate investment gains.
Consumers often complain that agents pitch the policies as retirement-income or college-savings plans, according to Finra’s arbitration files.
Keith Kriewall, a 51-year-old software developer in the Seattle area, says a financial adviser pitched him a variable universal-life policy as “a new kind of investment vehicle that allowed tax-free growth” and other benefits, with insurance that was “incidental.”
Much of his money subsequently “was lost to the ‘inconsequential’ life insurance premiums, which turned out to be anything but,” he says in an email.
He filed a claim against the adviser and his firm, Centaurus Financial. A Finra arbitration panel last year ruled against the adviser and the firm, awarding Mr. Kriewall about $42,000. A lawyer for Centaurus, which denied the allegations in its filings, declined to comment.
James Hunt, an insurance specialist at the Consumer Federation, recommends buying directly from TIAA-CREF, a money manager and life insurer located in New York, or Ameritas Life Insurance, located in Lincoln, Neb. Those options allow consumers to avoid some sales charges typical of the industry.
Indexed Universal Life
Consumers who opt for indexed universal life don’t have as much of an opportunity to benefit from a stock-market rally as variable universal-life policyholders, but they get protection from market losses.
The interest that the insurer credits to the policyholder’s account typically is linked to stock-market benchmarks, but the interest generally is capped. The caps currently average about 12% a year, according to Moore Market Intelligence, a consulting firm in Pleasant Hill, Iowa, specializing in indexed products.
Policies also typically let consumers opt to have their money generate an interest payment that isn’t tied to stock-market performance, but policyholders tend to allocate only a small amount to that strategy, at most, according to Moore.
If markets decline, insurers promise to protect policyholders from any declines in the benchmark. That largely insulates policyholders if the stock market plunges, as it did in 2008.
Insurers are able to provide such guarantees because they back the policies mostly with high-quality bonds and purchase a sliver of financial derivatives to help provide payouts tied to stocks, according to experts. In addition, insurers generally reserve the right to make certain changes, such as lowering caps on the payouts, in an effort to protect themselves.
Though buyers get protection from market losses, their indexed universal-life policy accounts still can decline in value because fees and insurance charges still come out.
There are other catches, too. For example, insurers typically exclude reinvested dividends when determining how much of the gain in a benchmark index to credit to policyholder accounts.
Thomas Santolli, managing director at advisory firm Paradigm Financial in Parsippany, N.J., says he recently sold a $6 million Pacific Life indexed universal-life policy to a wealthy couple.
“The first thing I told them was that the insurance company reserved the right to lower the cap to 3%” from 12%, he says.
He also reviewed how the insurer could seek regulatory approval to raise the cost of insurance, among other potential drawbacks. “Then they bought because they knew and understood the downside and it fell within their risk-tolerance levels,” Mr. Santolli says.
But many consumers don’t understand indexed universal-life policies, regulators say. Iowa Insurance Commissioner Nick Gerhart says he has “several complaints on my desk, as we speak.”
Customers aren’t the only ones who struggle to get it. “We’ve had situations where the agents don’t understand the product,” he says.
In December, Mr. Gerhart urged the National Association of Insurance Commissioners, a group of state regulators, to discuss whether to establish new rules on growth projections and agent training. Discussions on growth projections are under way already.
Nevertheless, he says, indexed universal-life policies can be useful to people who need a permanent-life policy, provided they aren’t counting on robust gains to subsidize the policy’s future costs.
Mr. Gerhart helped his mother-in-law, Rita Dette, buy an indexed universal-life policy in 2012. Ms. Dette, who worked in the insurance industry for 41 years, says she “was flabbergasted” by the complicated sales and policy documents.
The materials included a projection of what would happen if the stock market marched steadily upward, Mr. Gerhart says. His advice to her: “Don’t even look at this column.”
