How to protect yourself…

Many insurance companies are in trouble — hurt by higher-than-expected claims and soured investments. Even if the government does bail out some insurers, will yours be one of them? And even if your insurance company is sound, your policy could be at risk because of plummeting stock values and record-low interest rates. Key question for policyholders: Is my life insurance policy secure? Pitfalls…

  • Your insurer could fail.
  • Your policy could lapse unless you pay higher premiums. (You’ll get a notice from your insurer.)
  • Both your cash value and your death benefit could shrink.
  • You may have to pay premiums longer than you expected to.

With this in mind, now is a good time to check on both your insurer’s financial health (see next page for advice on how to do this) and your individual policy’s viability. A little research today may save you from a devastating surprise down the road.

INVESTMENT RISK

For many kinds of life insurance products, financial market conditions can have a direct impact on the value of a policy.

With the three basic kinds of “permanent” life insurance — whole, universal and variable — your policy either accumulates a cash value or includes so-called separate accounts in addition to its face value (the amount of the death benefit). Although each type can come with different bells and whistles, in general, whole-life policies guarantee a cash value and level premiums. Universal-life policies offer flexible premiums and a cash-value account that accumulates tax deferred at a guaranteed minimum interest rate. And variable-life insurance is a hybrid insurance/investment product, with nonguaranteed separate accounts that the policyholder manages, flexible premiums and an adjustable death benefit.

Variable life carries the most investment risk, because its separate subaccounts are mutual funds. Typically, policyholders choose among 25 to 30 such accounts, and the premium is determined by the anticipated rate of return. If investment returns drop dramatically and your premiums don’t rise to compensate, you may be told by your insurer that you’re not contributing enough to sustain the policy long term.

To avoid such a shock, write to the carrier and ask for an in-force illustration (a computer projection of future premiums, cash values and death benefits) incorporating certain assumptions. For example, ask specifically for a projection showing what will happen to your policy if you pay a certain amount per year in premiums for the next 15 years and your subaccount earns 5% or 7% annually instead of 8% or 10%. You will receive a detailed projection showing whether the policy would still be in force when you’re 80, 85, 90, 95 or 100 years old and how high your cash value would be. You might need to boost your premiums to sustain the policy.

Whole-life policies generally depend on dividends paid by the insurer. To achieve them, the carrier invests in conservative investments. If that portfolio’s returns drop, dividend growth could fall too, meaning your cash value may not be sufficient to fund the portfolio in later years. In addition, many popular whole-life policies were projected to be “paid up” at a particular point in time based on the dividend rate at the inception of the policy. If these dividends have gone down from the original assumptions that were projected, the policy might require additional premiums. Again, ask for a projection to find out whether you’ll need to pay more premiums to sustain the policy. A 10% dividend growth assumption, which was common during the 1980s, is probably too high now.

Universal-life policies are highly sensitive to interest rate changes. Especially if you bought such insurance in the 1980s, when rates were in the double digits, you may find your policy underfunded today, as rates have dropped to 4% or lower. Be sure you are paying sufficient premiums to sustain the death benefit — by requesting an in-force illustration in writing.

Once you get the in-force illustration from your insurer, study its assumptions and projections. If your policy is at risk of lapsing, discuss options with your insurance professional. As an alternative to boosting or lengthening premium payments, you may be able to modify the policy — for example, by lowering the amount of coverage or postponing the date when you’re paid up.

IF YOU SWITCH

Insurers rarely fail, and even when they do, state guarantees protect policyholders up to a point. But if your carrier looks vulnerable or if you can keep your policy from lapsing only with significant premium adjustments, you may decide to switch insurers. If you do, make sure that the insurance professional for the new company completes a detailed comparison form — which is required by regulators for cash-value policies — showing the new and old policies’ features in a way that lets you evaluate them accurately.

An independent comparison may help you with the decision. For $75 to $85, you can request a detailed assessment of a cash-value policy from the Consumer Federation of America’s Rate of Return service (www.evaluatelifeinsurance.org).

Replacing a life insurance policy can be stressful and expensive. The underwriting process starts from scratch, meaning that you will have to take a medical exam, and you may not be insurable at your previous rates.

Then there is the IRS. In order to avoid owing income tax on the old policy’s gains, consult your accountant to be sure you are making a Section 1035 exchange. Under this part of the Tax Code, switching life insurance or annuity contracts isn’t a taxable event, provided you meet certain requirements.

Unless your insurer is in serious financial distress, in many cases, you’ll be better off sticking with your current policy and adjusting your premiums if necessary.

STATE GUARANTEES

State insurance commissions regulate the industry and provide a safety net in the event that a carrier becomes insolvent. Most states guarantee at least $300,000 in life insurance death benefits per policy, $100,000 in cash surrender or withdrawal values for life insurance and $100,000 in withdrawal and cash values for annuities. These guarantees are per person per company, and maximums vary from state to state. To see how much your state covers, visit www.nolhga.com, the Web site for the National Organization of Life & Health Insurance Guaranty Associations.

You can build a second safety net by buying more than one policy. That way, you won’t exceed the state maximums for guarantees on each individual contract.