A reader suggested a post dealing with two of his concerns with purchasing a Life Insurance Policy. These concerns were the same as many of my clients had. So let’s discuss them.
His first concern was that the insurance company could “jack” up the fees once the policy was in place. There are limits put in place on the amount of fees insurance companies are allowed to charge and there are contractual limits. Now, first off I need to point out that with Minnesota Life they have never increased the fees associated with a life policy on policy owners since at least WWII. So, even though they could increase some of them, they never have [the exception is insurance charges]. The reason they haven’t is pretty simple, they manage their risk well and have never found themselves in the position of having to make up for poor reserve management by extracting more money from their policy owners.
There are several classifications of “fees.”
The largest of which [policy issue charge] is set at the time of delivery of the policy and will not change. The next largest is insurance costs and only changes when the new actuarial tables change. This doesn’t happen very often, last happening in 2005, as the changes in mortality happen very slowly. The actual increase, if any, is pretty small.
Finally, there are “administration expenses” which is really small and insignificant, that is charged when you make changes to the policy.
However, there is another class of issues that is more significant than the fees. That is the participation rate and cap rate. Participation rates can change by contract, but never has. This affects the interest you earn on the cash value in your policy. Currently, there are three different options for this that range from a participation rate of 100% to 140% of a stock index.
The other part that does move is the cap rate. This is the highest interest credit you could get each year. Currently, this is set at 15% for ML. In the past it has been 17%. The overall interest rate climate is the controlling factor here. Since the insurance company is backing the interest rate credit by a combination of fixed rate securities [treasuries, AAA corporate bonds, etc.] and by purchasing options in the market on the index if the overall interest rate environment is low [like now] then more money is needed to purchase fixed rate securities to cover the guarantee [3%] and less money is available for the options. Assuming the interest rate environment goes back up in the future to a more normal rate then the cap rates should raise along with it.
So far in the industry no one has ever raised expenses on current policy owners of EIULs nor have they lowered participation rates. The only part that has moved is the cap rates which moved down in 2009 -2010 after the interest rate environment moved down.
In short, EIULs have worked exactly how they have been advertised to work.
The final issue is the ability of ML to be a viable entity in the future. The commenter suggested that if AIG could go belly-up so could ML. And yes that is true, any entity could go belly-up. In the past 100 years there have been a handful of life insurers that have run into financial problems. When this happens the other insurers have rushed in and bought the life insurance book of business.
Writing life insurance is a very old business and by now the companies know how to price them so they are considered very valuable. Berkshire Hathaway just bought a large book of life insurance business last year. I have heard of no policy owner not getting paid on his or her life insurance policy because of insurer financial problems. That is a long positive history. In addition I only use companies that have a high Comdex rating [combines all the ratings]. Currently ML is rated a 94 [out of 100], which puts it in the top 6% of all insurance companies worldwide for financial stability and adequate reserves. Finally, I liked to point out that we just went through the worst recession since the great depression and ML is still solid. Of course, the government heavily regulates these companies if that is of any relief to anyone!
Philosophically, I am more concerned with the risk of higher taxes than I am worried about life insurance companies going out of business. I have owned an EIUL for about 6 years now and it has worked exactly as it was advertised. I sleep well owning and selling EIULs for companies that have been around for over 100 years. On top of that with a 9 year son the LI aspect is appealing. And when he hits college age, the life insurance policy, which should have several hundred thousands of dollars of cash value is not counted in the matrix for scholarships. It is a protected asset from lawsuits in my state. All those positive aspects overcome the negatives for me [there are always negatives].
I think that understanding how they work and being prepared for the parts that do change [cap rates] is the best antidote. At least it works for me!
Please ask any more questions you want to along these lines or any other.
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David:
Great post! Jeff does a lot of “scenario” posts where he walks through a real-life (or even imagined) situation where someone might work with him and change their plan.
Can you do a scenario for someone with say $5,000 to invest with the object of retirement and 3 kids (all under 10) heading to college at say 18 years of age? I think it would be neat to see how that might work out just as Jeff’s examples do. Thanks David!
Joshua, there are too many factors [age, health, premium paying ability, etc.] that preclude me from anything but a very general example. Your very specific needs outlined in the above post are best addressed after a conversation as I have pointed out to you last week. By the way, $5K put into an EIUL and left there for 15 years is not going to fund much of a college fund for three kids. The numbers just don’t work out. Better to continue to invest in RE where you might be able to get a higher rate of return. You would have to carve out around $400/month to put in with an annual increase of 3% to account for inflation! You have my contact info if you want to explore this possibility. Hope you continue with your RE investing as it seems to be your passion!