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Life Insurance Lapse Risk in a Covid-19 World

April 28, 2020

Though the “bear market,” brought on by the coronavirus pandemic has increased the risk of life insurance policy lapses, there are three steps you can take to make sure your policy meets your needs. Read on.

Attention life insurance policy holders: as insurance companies are forced to raise premium prices to maintain profitability in the wake of economic complications brought on by the COVID-19 crisis, there is an increased risk of a life insurance policy “lapsing”. When an account lapses, the life insurance policy will no longer pay a death benefit or provide any insurance coverage for the insured person. If you are having difficulties with your policy or need assistance reinstating, we can help. Below is a helpful review of the different options available, and how current events are impacting them.

Types of Life Insurance Companies

Life insurance companies come in two flavors :

  1. stock companies and
  2. mutual companies.

A stock life insurance company is a publicly traded company owned by its stockholders. The objective of a stock insurance company is to make a profit for its shareholders; who may or may not be policyholders of the company.

Conversely, mutual insurance companies are owned by their policyholders. The sole purpose of a mutual life insurance company is to provide insurance coverage for its members. Profits from the mutual insurance company are distributed to its member policyholders in the form of dividends.

Types of Life Insurance

  • Term Life Insurance, also known as pure life insurance, is a simple form of life insurance where an insurance company agrees to provide a certain amount of death benefit for an agreed upon annual premium for a specified period of time.
  • Universal Life Insurance (UL) was introduced in the US in 1980, when the 10 yr. Treasury and corporate bond yields were above 12%. Originally promoted as “unbundled” by separating the three components of the insurance contract; (1) mortality, (2) expenses and (3) investments; UL was essentially term insurance with an investment side fund. Using money market funds with a 10% - 12% return provided the substantial build up of cash value and an ever-increasing death benefit. However, when interest rates started to decline in the 90s, there was not enough cash accumulation to keep these policies in force as the insureds aged and mortality costs increased. By tying the performance of the insurance policy to a market based risk (interest rates or corporate bond yields) the insured could find themselves in a position where the universal life policies required increased premiums to keep the policies in-force, or risk that the polices would lapse.
  • Guaranteed Universal Life provided a solution to the policy lapse risk dilemma by offering universal life contracts that had guaranteed premiums with guaranteed death benefits for a specified period of time. These contracts were no longer dependent on cash value accumulation for product performance. In fact, many had little or no cash accumulation but had competitive internal rates of return on the guaranteed death benefit. However, new product offerings with long-term guarantees are now imperiled by ultra-low Treasury rates and may not be available in the future. Many carriers will no longer underwrite any person over age 70, regardless of health.
  • Indexed Universal Life Insurance, first introduced in 1997, takes advantage of the equity markets through index funds or an optional fixed account, typically paying 2.00% for one year. The upside return will be capped by the insurance company at a predetermined rate, but if the stock market has a negative return in a given year, the index credited to the account will be zero, theoretically, all upside and no downside for the policy holder.
  • Participating Traditional Whole Life – underwritten by mutual insurance companies, these contracts have guaranteed premiums, guaranteed cash values and guaranteed death benefits. They are typically designed to endow at age 100, meaning the guaranteed cash value will equal the guaranteed death benefit at age 100. The only component not guaranteed in these contracts are the dividends. The three largest mutual insurance companies are NY Life, Northwestern and Mass Mutual, and they have issued dividends every year for the past 150 years. Unlike stock companies, all three of these mutual companies are extremely well capitalized with each having assets of over $150 billion and a statutory surplus in excess of $15 billion. Insurance regulators limit the amount of surplus a mutual insurance company can hold and therefore excess surplus is distributed to the policy holders in the form of dividends.

Stock Market’s Impact on Life Insurance Policies

As previously stated, stock life insurance companies are publicly traded and the value of its stock is determined by the stock market. With the bear market caused by the Covid-19 pandemic, the market capitalization of the stock life insurance companies has decreased as much as 40% recently. Under state insurance regulations life insurance companies are permitted to increase their non-guaranteed cost of insurance, which helps the insurance company maintain profitability. These increases negatively impact the life insurance policy performance, which can lead to increased premiums or the risk of lapse on non-guaranteed policies. Mutual insurance companies do not have the same profitability pressure as any excess profits are paid directly to the policy holders in the form of dividends.

Recommended Action

If you have any life insurance policies it is prudent to perform an annual review of the policy performance and also to make sure that the coverage meets your current needs and that the insurance will be there for your beneficiaries when you pass away.

Our insurance specialists at KLR Insurance Advisors are available to meet with you and review your current coverage at no cost to you.

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