Caution: Your policy may self-destruct
By Pat Curry • Bankrate.com

Is your life insurance policy self-destructing even as you sleep?

If you haven't checked on your universal or whole life policy recently, you may have a lot less insurance than you think.

"Due to low interest rates and the stock market performance, the value inside policies may not be doing what you thought it was," warns Randy Herz, vice president and chief financial officer of Connecticut-based Herz Financial Advisors. "If they don't look at it, and most consumers are not even bothering, they may be in trouble in the future."

The value in permanent life insurance comes from the investments the insurance companies make with the dollars that policy holders pay in the form of premiums. Those investments are affected by changes in the stock market and in interest rates.

The insurance benefits offered, and the premium dollars required to achieve them, are based on predictions that the investment portfolios will perform at a certain level, often 8 percent, 10 percent or even 12 percent. With the decline in interest rates over the past two years and the instability of the securities market, the money paid in premiums may not be enough to keep the policy in force.

"The insurance company may send you a letter saying you need to put in more money or it's going to lapse," Herz says. "A guy I talked to had a policy that would have been paid up in 10 years. Now they're telling him, 'No, you have to keep paying forever.'"

Lynne Rosenberg Kidd, president of Innovative Solutions Insurance Services, a national brokerage general agency, says consumers should monitor their policies annually because insurance agents aren't going to do it for them.

"I'm disappointed how many agents abandon the process once the sale has taken place," she says. "There are a lot of fantastic agents that have wonderful systems to (monitor performance), but that's the rarity, not the norm."

Virginia-based certified financial planner Bard Malovany agrees that the value in a permanent life insurance policy needs to be carefully tracked, and recently may have lost a good deal of its value.

"The illustrations are based on an assumed rate of growth over time," Malovany says. "If you're putting in $5,000 a year, part of that is the cost of the insurance and the rest goes into the investment bucket. If that's shrinking, there's less money to pay the premiums."

Premiums for permanent insurance are based on a set of assumptions: the mortality expense, the cost of the insurance and the interest rate. All of those variables can change and most people don't have current information on any of them, mainly because most insurance companies don't spell them out in their statements.

To get the information you need to make an informed decision, ask your insurer for what's called an in-force illustration. That will tell you both the current rates and what the company is projecting now for the rate of return on the policy. You'll want to go over the information with your insurance agent or your financial planner to decide how to proceed.

You have a few options, based on the information you get. If the policy has lost money, and there's a good chance that it has, you could add more money to it, cut some years off the end of the policy, or reduce the amount of the death benefit, which is the amount of money paid to your family if you die while the policy is in force.

Or, you might decide that no amount of money will make the policy worth keeping.

"The cash was put somewhere into the market," Herz says. "If you were projecting a return of 10 percent and all of sudden, they got negative returns, those policies may never catch up without more cash. Sometimes it's worth just trashing them and chalking it up to a mistake."

If there's cash value remaining in the policy, you might be able to surrender it, or cash it out, and use the money to buy something else. If you do this within the first seven to 10 years of coverage, you'll probably be hit with a surrender charge so find out what that charge is before making a decision.

You'll also want to keep your policy in force until you have signed a contract for other coverage, especially if you've had a change in your health since buying the first policy.

Also talk to your financial adviser about any taxes that might have to be paid from the income.

To avoid the tax implications, you may be able to roll over an old policy into a newer one that performs better, Malovany says, through a section of the tax code called a 1035 exchange. It allows you to take the tax-sheltered gains from the first policy and move them to another policy, as long as the value is equal to or greater than the first one, without paying capital gains on the earnings.

"It's often the case that the cost of insurance has dropped," he says. "If there's no surrender charge, it could reduce the premium or increase the death benefit. There's no reason you can't get rid of it and roll it into a new one."

The expanded availability of insurance is one of the primary reasons that Herz encourages consumers to regularly review their policies.

"There are policies now that are better and offer more guarantees than there were 10 years ago," he says. "It used to be that heart bypass surgery was a decline (a denial of coverage). Now, it's a standard (a rate classification of insurance). As long as medical science keeps getting better, costs keep getting lower."

-- Posted: July 28, 2004