14 February 2014 0 Comments

The Cannibalized Whole Life Policy

shutterstock_148521944This is my second entry on the topic of Permanent Life Insurance policies that end up being less than permanent. First I discussed what can go wrong with Universal Life (UL); now I’ll deal with Whole Life (WL).

 Whole life insurance policies are intended to provide a level premium—either for life or for a stipulated number of years—with a guaranteed death benefit forever.  How could a policy like this go wrong?  Here are a few scenarios that could create a problem:

  • Unlike UL a WL policy has a stated premium that must be paid.  In order to safeguard from the policy inadvertently lapsing when a premium is not paid, an “Automatic Premium Loan (APL)” provision might be added.  When the premium is not paid within the grace period, an APL provision will trigger a policy loan sufficient to pay the premium.  Now, not only will the policy have a stated premium that must be paid, interest on the policy loan will also be charged.  If that interest is not paid it will be added to the loan, thereby increasing next year’s interest.  If  more premiums are also not paid the loan and interest increases and the cost of maintaining the policy skyrockets over time.
  • You don’t need to have an APL provision to get into trouble.  Many people make policy loans to cover an immediate contingency with the full intention of repaying it.  But they don’t get around to it and also don’t pay the annual loan interest, thereby increasing the policy indebtedness.  Premium loans gone untethered can ultimately cannibalize a WL policy.
  • You may have been sold a WL policy with the concept of a “Vanishing Premium (VP)”.  After several years you were going to stop paying premiums and the policy would go on without your ever having to pay another premium.  But the premium doesn’t really vanish; the premium obligation continues. It’s paid by a combination of current dividends and cash value of paid-up-additions created by previous dividends.  When actual dividends paid do not equal those projected, you must continue to pay and you may not be able to afford those ongoing premiums.

 Once again, do not discontinue or reduce the death benefit on any policy until you know whether you can currently qualify for insurance on as favorable basis as your current policy.  Once that has been done, here’s what should be done:

  • Repay the policy loan from cash if the dividends are substantial.
  • If dividends have been used to purchase paid-up additions, surrender those additions and use their cash value to reduce the loan.

Now it is time to decide what your options are with permanent insurance that has gone amuck.

Coming up…exactly how to repair or replace a permanent policy that is not performing as you had planned and is not meeting your needs.

Leave a Reply