Universal life policies came into the market offering premium flexibility and transparency that was unknown in whole life policies. However, universal life policies lacked one thing those whole life policies had – death benefit guarantees. If you paid your premium on a whole life policy, the policy death benefit was guaranteed to be paid.
The earliest universal life policies (current assumption) were fixed investment products developed because interest rates were lofty. The crediting rates assumed in sales illustrations were as high as 12%. This created attractive, low premium, high-cash value products with assumptions that were doomed to fail – and they did.
The life insurance industry reacted, creating a new product – guaranteed universal life, or GUL, which just like whole life, guaranteed the death benefit. But with GUL the policyholder loses one of the most popular features of a universal life policy – premium flexibility. These policies have a set premium that must be paid in full and on time, or the policy death benefit guarantee will be shortened or lost.
One of the common problems trustees rarely catch is when a GUL policy is purchased as a replacement, and the required premium in the as-sold illustration includes 1035 Exchange money coming over from the existing policy. For the policy to maintain its stated guarantees, the 1035 Exchange amount coming over needs to equal or exceed the expected amount. Often, during the underwriting process, the existing policy’s cash value drops because of charges coming out of the policy, or in the case of a variable policy, a drop in the equity markets. Our solution: when the exchange occurs, verify with the carrier the exact amount coming over from the existing policy and make any adjustments needed at that time. Also, with a variable policy, place the cash value in the current policy in a money market or fixed account while the underwriting occurs on the new policy so that a market correction does not cause the cash value to swoon.
Once the GUL policy is in force, your administrators will have to make sure the premium is paid in full and on time. This means that gift notices must go out on time and if gifts are not received, following up aggressively, making sure the grantor understands the consequences of a late gift. Note: This should all be spelled out in the document you provided to the grantor for signature when the policy is placed in the trust.
GUL payments are sometimes tricky. Over five years ago, we pointed out that one carrier found that after only four years of selling the product, 31% of the policies sold were already off track. The reasons: 8% were because of insufficient premiums, 29% because of skipped premiums, but the majority – 53% – were because of early payments. That is right, 53% were off track because the premium was paid early. This particular carrier has different crediting rates in their shadow accounts depending on funding levels and paying early resulted in a lower credited rate.
Other carriers have higher sales loads in the early years, so paying early can cause more of the premium to go to fees and charges with less to the policy – again, creating an issue with the guarantees. This can be especially troublesome in the first policy year when charges are highest. A while back, I came across a report by a life insurance analysis firm that claimed you could lose up to “30% of your original guarantee period” by paying the second year’s premium in the first year. According to the report, in a little over half the policies they tested, paying early did not make a difference, but the others “on average lost anywhere from 10 to 20 years off the life of the guaranteed policy.” (1)
Guaranteed universal life takes the market risk out of life insurance, but it adds additional risks that sit squarely with the TOLI trustee. For all GUL policies you take in you should understand all of the policy nuances – or hire someone who does.
- Early Premium, Sydney Presley, LifeTrends, October 29, 2018