Welcome back to our fourth and final video in our life insurance series. If you haven’t watched the other three videos I would recommend you spend some time and go back through those. We will be referencing those during this video. In todays video we will be discussing what to look for in existing life insurance contracts. Quick disclaimer, at Financial Design Studio, Inc. we do not sell any life insurance to our clients. However we do review it as part of our client’s financial plans because of how critical it is.
So far in our life insurance series we have talked about the difference between term and permanent contracts, how to put money into a contract and how to get it back out, and the difference between face amount and death benefits.
Today we are going to talk in a little bit more detail about other things we should be looking at as we are evaluating contracts on a regular basis. We often get asked how often should you be reviewing your life insurance contracts? I always like the rule of thumb, every time you get an annual policy statement. This means you will be doing it once a year. Once we have our statement what should we be looking for?
What to look for in Existing Life Insurance Contracts?
First and foremost look at the insurance costs. Are the insurance costs we are seeing on our statement lining up with what we would have anticipated otherwise paying. To find out we would look back at the cost per thousand calculations we talked about in our prior video. We would match that up with the net amount of risk, which is the death benefit, not necessarily the face amount of the contract we talked about before. Then we would figure out how much insurance company money we are buying and compare that with the cost of insurance to figure out the cost per thousand.
If we do the calculation and see that number is really high I would encourage you to check your math. It’s really easy to make a quick calculation error in this stage. Next, after we verify the math maybe it’s still a little higher than we expected. In this situation we would recommend you reach out to a trusted insurance agent. Ask about quotes on maybe a replacement policy that would make sense for you and your family.
If you purchased a policy in the past seven years, chances are you are in a surrender charge period. A surrender charge is an additional withholding back on your cash value in case you want to surrender the contract. Why would the insurance company do this? When the contract was sold to you the insurance company paid a commission to the agent. That means they were not able to apply all the proceeds in your first few premium payments into the cash value or the insurance costs as they would otherwise. This charge allows them to make up that money if you decide to change your mind within that time period.
That said surrender charges themselves are not inherently bad. However they can be quite expensive to pay. A situation we would consider making changes during this period is if there is something seriously amiss with your policy.
Mortality & Expense charges
Now if you have a policy that is a variable type policy, for example, a variable universal life, a variable life policy, or maybe a variable annuity. You may have heard this term M&E. It stands for mortality and expense. This is actually an additional charge on top of any sub account within the contracts. Let’s say another sub account had an expense ratio of 0.7% per year. Then let’s say there is an M&E charge of 0.9% per year. If you have a $10,000 investment into that fund you would be paying $70 just for that expense ratio and $90 just for the M&E charge.
We want to be aware of this because it’s important to minimize costs wherever we can. If we have too many costs built up in these contracts is it really benefiting us? We likely are not going to see the return that we were anticipating. We may not see the return that was illustrated when the contract was originally sold to us.
Now what can we do about it? There are some things we can do with certain contracts. One option is to place more into the cash value. Another is to wait the certain time period to allow M&E’s to reduce or eventually even expire. Another thing we can do is compare the net expense ratio charge with other contracts as well.
If we are past our surrender period and find another contract with lower M&E and expense ratio on the individual funds there is a good chance we could look at choosing a replacement policy. This could save ourselves a lot of money in the process.
What else can you look for in existing life insurance contracts? You will notice there is a consistent theme here with our policies and the costs. Unfortunately one challenge we see with insurance contracts is the cost. When contracts get too expensive they outlive their usefulness. Instead they end up becoming more of a drain on your finances than a help. We want to be sure it is intentional and really clear that this contract is working well for you.
What other charges are we looking out for here? Other costs are admin charges. These are very common in a lot of insurance policies. Essentially it is an additional charge to cover the back office paperwork for the insurance company. We are finding more and more carriers trying to reduce or eliminate these admin charges. It’s important to be mindful of what admin charges are on your contract. Maybe there is a way you could replace it with something that doesn’t have an admin charge.
After admin charges be on the lookout for state premium tax charges. Every time you make a payment into your contract the insurance company actually has to send a portion of that back to your policy’s originating state in the form of a tax. Now some policy carriers will actually apply whatever the state’s premium tax charge is. In Illinois it is .5% a year. Other carriers might actually apply a flat rate across all their policies, regardless of which state the policy originated in. It’s important to know what the state premium tax charge is because this can range all the way up to 4% on every premium payment made.
Meaning if you added $1,000 to your contract that means $40 of that could be withheld from the cash value or the insurance costs and not be applied directly to the benefit of your contract.
A big reason why you chose a permanent policy over a term contract is the fact that there was a cash value associated with it. It offered some future life protection, the ability to defer taxes, and obtain some creditor protection along the way as well. While that is great and there is nothing wrong with that we want to make sure the policy is performing along the lines of what we were anticipating. If it’s not then this is a time to say hey we are past our surrender charge and we could look at a new policy with potentially lower costs and better investment options underneath.
The way to compare this is to take a look at the investment options that you have in your contract and compare that with a consistent benchmark. If we have a large cap fund in our policy and we have a large cap benchmark maybe like an S&P 500. If our fund is not performing close to the S&P 500 then that is an issue. We need to be aware of that and say this is not performing. We need to look at something better.
All of that to say there are a lot of details and variables that we need to be looking through as we are evaluating different life insurance contracts. We hope this has helped you see what to look for in existing life insurance contracts. If this has brought to light some different questions you may have or you have been reviewing a policy and there are questions you have about that and would like to chat through let us know. We would be more than happy to help you with that.
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Trevore has nearly a decade helping families with their financial planning needs. He is incredibly passionate about helping folks visualize and explore what their ideal lives look like and following it up by helping them get there.