If the life insurance industry is truly in a state of crisis, why isn’t this fact being reported every day in the media. Now that’s a good question.
I suspect their are a couple of good answers.
Until regulators start sounding the alarm bell the average reporter wouldn’t have a clue a problem exists. It’s not like the media pundits are sitting up late at night wondering how things are going in the life insurance industry. After all, that’s a subject far more likely to evoke yawns of boredom among the public, as opposed to stimulating readership. After all, very few people have any real grasp how the life insurance industry works. And most could care less and prefer to assume all is well.
So then why aren’t regulators ringing the alarm bell. Another good question and one where the answer gets a bit more complicated.
First, the crisis is like a slow moving glacier as opposed to an erupting volcano. The forces causing life products to implode are subtle, not dramatic. So awareness on the part of regulators that a crisis is brewing is minimal for the time being, not because the crisis isn’t real, but because it’s not occurring in a glaringly visible manner.
Insurance department regulators tend to be focused on politically popular matters since the departments are run by either elected officials or political appointees. The idea they are intimately in touch with the realities of how life products work or life insurance companies operate is humorous at best. The only thing most of the people who run this office are interested in is setting the stage to run for governor in their respective State.
Second, if the life insurance industry were to collapse it would be a disaster for the State Insurance departments. The reason being each State has a guarantee fund intended to make policy holders whole when a life insurance company that sold products in that State fails.
These guarantee funds do not consist of piles of cash held on hand to ward off problems. Instead, when a company fails the State regulators tag the remaining surviving companies doing business in their state with an assessment to fund the salvaging of the failed companies policies. Then they find a healthy company willing to take over those salvaged policies. That process will only work if there are healthy companies left to assess fees against.
So, if the industry is truly in crisis and its one that will impact all or most life insurance companies, it puts the regulators in a very difficult position. If they sound the alarm bell they actually aggravate the problem by causing those owning these policies to cash them in. Thus creating a self fulfilling prophecy.
The risk is they would create a run on the bank scenario as policyholders cash in their cash value life polices to salvage remaining cash values. If enough policies are surrendered the respective life insurance companies are forced to sell assets, often at a loss. Should this occur often enough the life company’s capital would be wiped out. If it were to occur on a wide spread basis because the public was alerted to the risk that exists today, who would the regulators assess for the funds needed to support the guarantees in those policies not surrendered at the point these insurers are deemed insolvent.
Finally, and less than faltering is the fact regulators are typically clueless to the fact a problem exists until the situation blows up and hundreds, if not thousands of complaints come rolling in to alert them. This is not intended to be insulting. It’s just an observation based on years of evidence I’ve observed.
Making matters more difficult for regulators when it comes to spotting problems is the fact regulators accept financial statement reports prepared by life companies as fact until proven different. Regulators lack the funds, stall, time and or expertise to audit the books of every life company doing business in their State and verify the value of the assets reported in its financial statements. If those assets are actually worth less than the amounts reported they are supposed to be written down to current values. And that process can wipe out the companies capital and reserves.
It’s neither unusual or unheard of for the management of a life insurance company to obscures the facts while attempting to solve problems and remain in business. When that happens the regulators have no way of knowing a problem exists until the house of cards finally collapses. While many in the industry are aware of and talking about what is bound to result, it seems the regulators simply turn a blind eye to the problem until the bomb explodes.
The reason a crisis is unfolding has nothing to do with misdeeds on the part of the life insurance industry or any given company within the industry. In fact, the opposite is true. The companies themselves are actually the victims of an economic reality they never envisioned when the products they designed were sold were created.
That economic reality is a period of unprecedented low interest rates that has persisted for decades. These low interest rates are decimating the earnings generated by life insurance companies on the premiums their policyholders have paid. Average earnings rates in the general accounts of the nations life insurance companies have been in free fall for decades now.
The premiums people pay and earnings thereon are supposed to allow companies to deliver illustrated cash value accumulations in whole life and fixed interest universal life. Those illustrated accumulations were run at interest rates of 6%, 7%, 8% and higher over the last few decades. Interest rates that were historically reasonable at the time products were designed and illustrated to buyers are now a thing of the past. And when that situation persists for long enough, even a return to prior interest rates won’t help.
The damage has been done, and it’s fatal. If a policy that was supposed to have a $100,000 cash value after twenty years only has $50,000 it would have to produce earnings rate twice as high as those illustrated to get back on track with predicted earnings. Even if that occurred the policy would still be $50,000 short. You can imagine what earnings rates would have to be to not only equal what was illustrated for future years, but to make up for the existing shortfall in the policy as well.
It doesn’t take a rocket scientist to realize if a policies cash values were illustrated when interest rates were 8% and current interest rates are 4% that cash value accumulations won’t materialize as illustrated. What compounds this problem is the impact of insured people dying on whole life policies and term insurance charges deducted in universal life policies.
This drains cash values from life insurance policies although the way this occurs is dramatically different in whole life policies versus universal life policies. The original design of these policies and assumed earnings rates and premiums charged were intended to create earnings more than sufficient to offset the impact of insureds dying with whole life and term charges in universal life.
And that just isn’t happening and hasn’t been happening for some time now.
When earnings rates fall below a certain level and remain there for an extended time the unfortunate reality is life policies sold decades ago are doomed to collapse.
The reasons, or better said the internal mechanics in whole life are very different than those in universal life. And the consequences of decades of lower than anticipated interest rates and how they impact each type policy are also different.
With whole life, the resulting lower earnings means the dividends that were illustrated as paying premiums from inside the policy in later years will not materialize. That means policyholders who were shown a policy that became self funding after just ten or fifteen years of paying premiums will instead find they need to continue to pay premiums for twenty or thirty years, or more.
The fact is interest rates have been abysmally low for decades now. As a result, there will never be enough dividends available in a whole life policy to pay the premiums due each year from policy values. And whole life policies require premiums be paid each and every year for the life of the policy, or they lapse. Oddly enough, what lapse means in the world of whole life is somewhat different than what it means with a universal life policy, but trust me its not the result the policyholder had in mind when they purchased their policy.
What this means is the whole life policy owner may have to pay premiums for the life of the policy to keep it in force. As people age and retire their ability to pay those premiums declines. And, in many cases, it means they will have no choice but to let their policies be transitioned to dramatically reduced paid up face amounts.
The only good news when it comes to the whole life policy design is the premiums the policy owner must pay as time goes on will never increase, no matter how old the insured gets. So, while the originally illustrated premiums may need to be paid for many more years than the owner expected or was shown, at least they will never go up.
This level lifetime premium feature is a major advantage of the whole life design versus the universal life policy design. With universal life there is an actual term insurance charge deducted each year, and it increases annually as the insured ages. This means if a policy lapses the premium required to keep it in force goes up each year.
The reality is with fixed interest universal life the impact of low interest rates is even more dramatic and far more problematic than it is with whole life. Making matters worse when universal life is sold the agent typically illustrates a lower premium level than whole life, which makes it appear universal life is cheaper to the uninformed.
The payment of lower premium levels means the cash value accumulations will also be lower unless substantially higher interest rates are being earned. And that isn’t going to happen, since interest rates in the market dictate what rates will be earned on invested premiums by any given insurance company no matter what type policies it sells.
The payment of reduced premiums puts an ever increasing strain on universal life policy cash values when earnings rates are lower than illustrated. When this strain is offset by high earnings rates on growing cash values things can work out well. But when low interest rates translate to lower earnings rates and therefore reduced cash value growth a double edge sword type impact occurs.
What happens with universal life policies in this situation is each year there is less cash value than originally illustrated as being invested and earning a return. And, that cash value is earning at a lower rate than was originally illustrated. That’s the double whammy referred to above. This actually produces a reverse compounding effect, where lower invested cash values earn lower than illustrated rates resulting in progressively lower cash values than illustrated in each future year.
Making matters worse is the fact term insurance charges deducted from policy cash values are going up each and every year.
So when a universal life policy suffers from reduced cash value accumulation caused by lower than illustrated and anticipated earnings rates, and term charges are constantly going up, and the policy owner continues to pay the same illustrated premium level they are being billed; only one result can occur. The policy will run out of cash value.
At that point the policy will lapse unless the policy owner begins to pay the true cost of term insurance at the insureds current age. As people age that cost can be tremendous and it becomes totally unaffordable. These policy owners really have no choice. There policies will lapse and all the premiums they’ve paid to date will be wasted.
There is much, much more to all of this, but from the little bit of information provided above even a person with very little knowledge of how life insurance policies work can see there’s a big problem facing the life insurance industry. The fact is thousands, if not tens of thousands of life policies are lapsing every month and the problem is growing worse with each day that goes by.
People have no idea this is happening until they open their mailbox one day and find a lapse notice from their insurance company. And many people don’t even read these notices and end up completely stunned when they find out their policies have lapsed.
To date I’ve only seen one article discussing this problem, which was published several years ago in the Wall Street Journal. You can google “lapsing life insurance policies wall street journal” and it is likely this will come up as a choice you can click on.
So for anyone who doubts what I’ve said above, I welcome you to locate and read this article.
