The Hottest Thing in Life Insurance Has Serious Risks
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Here's your money briefing for Monday, January 6th. I'm J.R. Whalen at The Wall Street Journal in New York. Life insurance is a tool that people often use to save money over time, especially indexed universal life insurance policies, which can generate earnings based on stock market performance. But there could be risks lurking for policyholders if the market takes a downturn. Wall Street Journal reporter Leslie Sism will explain in a moment. First, some money and market news you should know. The unemployment rate is at a 50-year low, but the number of layoffs announced in 2019 due to bankruptcy filings hit the highest level in more than a decade. The global outplacement firm Challenger Gray and Christmas says that bankruptcy led to more than 62,000 job losses, or about 10% of all job cuts last year.
The majority were due to retailers closing locations, but other cuts were in the transportation, mining, food, technology, and healthcare sectors as well.
Indexed universal life insurance policies promise annual interest based on formulas tied to stock indexes and protection against losses.
What is indexed universal life insurance and why is it popular now?
Right now, with the market on a historic run, they're among the industry's hottest products. So what's the catch? Wall Street Journal reporter Leslie Sism is on the line with us to discuss. So Leslie, this is a very popular life insurance policy. What's the allure?
This product is a combination savings and death benefit product, and the savings earns interest that is tied to the broader U.S. stock market. That ability to earn some kind of stock market-like return is very appealing to many people. The insurance industry pitches this as a product that offers a market-like return or some portion of a market return, while at the same time, they won't pass on losses from the stock market. But in exchange for that protection on the downside, the insurance company will cap how much of the gain they will credit as interest in any given 12-month period. For example, they will perhaps cap at 10 or 11 percent interest as the maximum amount in a given year.
And with the market run up in the past three or four years, I can imagine how that has contributed to the popularity of these accounts.
One concern of some consumer advocates, regulators, and financial advisors who aren't big fans of these products is that people don't recognize the costs that are in these policies. People owe various policy fees every year. So if you have a flat or down year for the market, the insurance company won't be paying any interest that year or very minimal interest, yet the costs will continue to come out or have to be paid. So the cost factor is something that critics are concerned people don't recognize.
Now regardless of whether the market goes up or down, as a person ages and they hold these policies, do the fees increase?
How do indexed universal life policies tie returns to the stock market?
The fees typically do increase annually. In essence, the buyer of one of these policies is buying a new term life policy every year. Term life is just a basic kind of insurance. Every year you get older, a term life policy costs more. In general, it will always cost more because there's a greater likelihood of death as you get older. So every year, an owner of one of these index policies will face a higher cost for the insurance portion of the contract. That's typical.
Now, the insurers can also change the interest rate over time.
Yes. Another concern that the critics have about the products is that the insurance companies can change numerous things about the policies under terms of the contracts. Their ability to change is subject to regulation and the contractual provisions. But nonetheless, the insurers can pay less interest. They can, you know, like I said earlier, a policy may cap the interest at 10 or 11 percent a year. Over the course of ownership of this policy, the insurer might bump that down to 8 or 9 percent. So that's a worry. Also, the insurers typically have the contractual right to raise the rates they charge for the death benefit portion. So the cost can go up and your interest can come down.
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