Understanding disadvantages that come with any policy can help in making better financial decision. This article explains 5 of the major disadvantages of Guaranteed No-Lapse Universal Life Insurance.
- Lack of Flexibility. Any changes to NLUL policies such as loans, partial withdrawals, changes in the death benefit, changes in scheduled premiums, and adding riders may terminate the guarantee or reduce its duration. In most cases, policyowners may make additional payments to place the guarantee back into effect, but this will result in increased out-of-pocket costs.
- Limited Cash Values. Cash values may seem to be relatively unimportant for those who are only interested in a policy’s ultimate death benefit. But, circumstances can change, making cash values and living benefits more important. If a policy builds little or no cash value, the policyholder has no future ability to switch policies to a more competitive one without losing most of the initial investment or to use portions of the cash value for living benefits during the insured’s lifetime. Essentially, the purchase decision literally becomes a point of no return. Policy pricing a NLUL policy that is already competitive in a low interest rate period might fall even lower if higher interest rates over a sustained period prompt a further reduction in premiums. Those policyowners who buy at one premium price would be hard-pressed to make a switch to a lower-priced product several years later, even if their health permits. The high policy surrender charges and limited cash values would effectively lock them into their existing policies and make them forfeit most of their past investment of premiums if they attempted a policy exchange.
Especially if the insured lives a significantly long time, owner might desire to pass along some of a policy’s value during the insured’s lifetime. If a policy is owned in trust, for example, the grantor/owner can distribute portions of the cash value from traditional cash value policies to trust beneficiaries so they do not have to wait until the end of an insured’s long life to obtain some of a policy’s benefits. Most of the guaranteed death benefit universal life policies are expected to have little or no cash value in them at the life expectancy of the insured or beyond. This flexible use of a policy’s living benefits is not an option where no such benefits exist.
- Opportunity Cost. The secondary guarantees feature fix death benefits and pricing, but very limited cash value accumulation potential. Although nonguaranteed policies have some risk that premiums will rise or death benefits decline–or at worst–the policies lapse, studies show that the choice of guaranteed policy may well sacrifice a significant upside potential return from the best nonguaranteed policies structured in the most efficient way. The best nonguaranteed policies in most scenarios will produce much higher returns for most insureds who live long lives. If the policyowner’s goal is to maximize returns from an investment of insurance premiums assuming a relatively long life, the most competitive nonguaranteed policies will most likely be the better–as well as the safer–choice.
- Conflict of Interest between Insurers and Policyowners. One of the more troubling issues for the authors involves the role of lapse-supported pricing in the design of NLUL policies. The financial risks to insurers if owners retain policies in larger numbers than insurers have projected place the companies in a conflict of interest with their policyowners. A potential financial problem thus takes on an ethical dimension. This actuarial practice allocates profits and losses from policies in such a way that the profitability of a product for the company depends on a high level of policy lapses. The company and the minority of remaining policyowners gain because the departing policyowners are denied a fair return on the net premiums they have paid. The unfairness of lapse-supported pricing is extreme where the payments of the relatively high premiums required for permanent insurance yield little or nothing in the way of cash value for those who drop their policies. Worse, this policy design pits the company’s financial interest in maximizing the number of policyholders dropping or losing their coverage and forfeiting all or most of their premium investment against their customers’ interest in obtaining a reasonable return on those premiums.
- Regulatory Uncertainty and Insurer Insolvency Risk. As was discussed above, the regulatory environment surrounding NLUL policy pricing and reserving currently is in flux, although the NAIC is taking steps to resolve the issues. However, for the time being, the unanswered questions regarding the adequacy of reserves and the risk of insolvencies, on the one hand, and the possibility of setting reserve requirements too high and making the pricing of NLUL policies uncompetitive, on the other, is confusing the markets and making it extremely difficult to properly evaluate cost/benefit relationships of these policies compared to the more traditional whole life and universal life policy designs.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM