The idea behind this post comes from an article by Gordon A. Schaller

Several years ago you purchased a life insurance policy. You did this even though you always thought life insurance was a bad investment with returns of only 3-4%. However, this policy was supposed to be different; the premiums could be flexible and you could invest the cash value in the stock market where returns had historically averaged 10%. The promise of “stock market returns” would reduce the premiums you were required to pay for the insurance death benefit. Life insurance finally seemed attractive, and so you bought into the idea of owning “variable universal life insurance.”

The stock market performed well for several years and the cash value of the policy increased. There were some market “corrections,” but the stock market recovered and continued to prosper, and so did your variable life insurance policy.

Then a significant prolonged stock market decline occurred; one that caused 401(k) and 403(b) accounts to shrink dramatically.

However, you probably did not notice the impact on your variable life insurance contract. You thought you just needed to keep paying the premium, the amount you agreed to when first sold the policy. The stock market recovered over time and so did your retirement accounts and the cash value of the life insurance policy seemed to bounce back. What you didn’t do was carefully review the insurance company’s statements and notice that the insurance policy’s cash value did not recover nearly as much as the other retirement accounts.

Years pass and the stock market went into another prolonged decline, with substantial negative returns, followed by a period of significant volatility. Your retirement funds and subsequent retirement seemed extremely vulnerable. One day you get a letter from the life insurance company that captures your attention; the policy may lapse unless you pay substantial additional premiums.

The advisor who sold you this contract has retired or moved on to another company. But he contacts you. You confirm the grim facts: You must pay substantially greater premiums for the rest of your life, or you may have no life insurance. You cannot afford the huge premium increase, as you are trying to save enough over your last working years to retire; or maybe you have already retired, and the required premiums are impossible.

The only apparent solution is to decrease the face value of the life insurance policy and continue to pay the same premium or just let the policy “lapse” if you cannot afford additional premium payments.

How could this happen? When you purchased the policy years ago, your financial advisor showed you how it would work if the stock market continued the historic trend of a 10% return over time. Of course, there was no guarantee, but after all it had been true for 70 years. Your financial advisor gave you a very thick disclosure document required by federal securities law that explained it all. Another massive legal document not read or understood.

The devastating, insidious truth is that your variable life insurance policy was never guaranteed to last and to provide the death benefits counted on for your family. You bought in part because of the appearance of lower “premiums” and stock market returns. No one, not even the federal securities law prospectus, disclosed the hidden and toxic effects of negative stock market returns and volatility on your variable life insurance.

Many policy owners have faced this dilemma in recent years. Some have surrendered or reduced the face value of their policies or exchanged into safer types of policies. Some have died and their families have not received the death benefits they expected and needed. Why?

The hidden truth about variable life insurance is that mortality and expense charges (“M&E charges”) have been deducted from the cash value of the policy by the insurance company every month. This was true when the stock market flourished and when it sank. However, when the stock market “rebounded” after a significant decline, life insurance cash values rebounded less, since it had been reduced by M&E charges. The same was true when the stock market suffered prolonged volatility. Negative returns, volatility and M&E charges created a death spiral for many variable life policies. Computer analytical tools could have predicted the probability of this result, even when the policy was originally acquired.

Even if this has not yet happened to your variable life policies, you should ask for immediate help to review the status of those policies and your financial and legal choices now. If you are considering a life insurance product (paraphrasing Aristotle), “the less attractive probability is preferable to the attractive impossibility.”

If you’ve read this far, take a few more minutes and watch this presentation:

Beyond Buy and Hold