Don’t Get Burned by ‘Fire Sale’ Term Insurance

Buyers of term life insurance have had one common complaint: Their premiums rise each year. One of the newest innovations in life insurance solves the problem by allowing term life policyholders to pay a fixed premium for their policies for as long as 20 years.

But now the availability of these “guaranteed premium” term life policies may evaporate--or at least their premiums may rise--if a complicated proposed regulation goes into effect later this year, as expected. The threat of the new rule has some agents pushing these policies with a vengeance, claiming that 1994 is a “fire sale” year for this type of insurance.

However, industry experts say you should be wary of the sale. Some of the companies that are offering the lowest prices and longest guarantees may be flirting with financial disaster--and could take your money with them. Moreover, while guaranteed premium policies may prove attractive if you need a lot of life insurance for a sustained period, they’re a waste of money if you don’t.

To understand the debate, you need to know a bit about term and whole life policies, because guaranteed premium term policies are a hybrid of both.

Term life insurance covers you for a set period, usually a year. If you die within that year, the policy pays off. If you don’t, the policy expires. This type of policy does not build up any cash value. But most insurers allow term policyholders to renew at the end of the term--without regard to the insured person’s health--by simply paying another premium.

Generally speaking, premiums for term insurance start out small and rise as you grow older. But if you stay healthy, you can reduce the premiums in later years by taking another physical examination. If the exam shows you’re in good health, the premiums will drop substantially in the year following the physical, says Kenneth L. Ingram, president and chief executive of TermQuote, a Dayton, Ohio, insurance service.

Whole life policies usually offer level premiums over the life of the policy and build up cash value over time. If you die while the policy is in force, the policy pays a death benefit. If you live and continue paying premiums, you can eventually withdraw or borrow against the policy’s cash buildup.

The problem with whole life policies is that they are comparatively expensive and their cash value builds slowly. Where a 45-year-old male non-smoker would pay a $418 annual premium for a $250,000 term life policy with Transamerica Occidental Life, he’d pay $2,100 for a similar whole life policy from that company, says Bernie Weinberg, an insurance agent with Shadur, Weinberg & Associates in Encino. After four years and $8,400 in premiums, this whole life policy would have a cash value between $1,570 and $2,045, depending on what happens with interest rates.

Most consumer advocates maintain that term insurance is a better buy. But some consumers are wary of it because of the steadily rising premiums. A policy that costs $300 when you are 45, for example, may cost more than $1,000 when you’re 55. As a result, some fear that the premiums will prove too costly to handle down the road.

Enter guaranteed premium term life, a hybrid policy that emerged in the past few years to combine the low premiums of term life policies with the fixed-price elements of whole life.

These policies work just like other term policies, but their rates are guaranteed to stay the same for up to 15 to 20 years. How they do that is simple: The insurer averages out the premiums. You pay more in the early years and less later.

And, just like the fixed-versus-adjustable mortgage question, consumers need to consider how long they’ll need the insurance before buying a guaranteed premium policy. If you buy such a policy and find you don’t need the insurance for the entire term, you’ll have wasted a significant amount of money, says Ingram. Indeed, according to rate quotes provided by several insurance quotation services, guaranteed premium policies pay off only if you keep them until the very end of the so-called guarantee period.

It’s important to note that most insurance experts maintain that your need for insurance actually diminishes over time. Usually you need more insurance when you’re starting out and have young children and few assets. That’s to sustain your family over a long period should you die. But as you accumulate other assets and your children become financially independent, your insurance needs fall. At some point, the insurance proceeds become a windfall for your spouse, rather than a necessity.

When you buy guaranteed premium policies, you must also be concerned with the insurer’s long-term financial health. You are paying extra money up-front for a long-term commitment from the insurer. If the company isn’t around to follow through, you’ve wasted your money.

The proposed insurance rule that’s causing the fire-sale fuss is designed to keep insurers healthy. Some of these companies are playing financial roulette, says Joseph Belth, an Indiana-based insurance analyst and editor of Insurance Forum. The new rule, proposed by the National Assn. of Insurance Commissioners, would force these companies to put more money aside for possible losses on guaranteed premium policies.

By keeping reserves artificially low, companies can offer low-premium policies. (Reserves are a fixed cost of offering insurance.) That generates business for the insurer but presents serious risks for consumers, says Belth.

That’s because policyholders suffer when insurance companies topple. Consider what happened to policyholders of Executive Life Insurance Co., which failed in 1991. Policyholders who had been promised double-digit returns had their policies frozen for three years while insurance regulators worked out a sale. Then they were given the choice of staying with Executive Life’s successor company or opting out. If they opted out, they would face a serious loss on the policy. If they stuck with the successor company, they had to accept radical changes in the terms of the deal, including lower rates of return and higher fees.

Comparing Costs

Here is a comparison of what a 35-year-old male non-smoker would pay for a $250,000 traditional term policy versus a guaranteed premium term policy for the same policy value. The cost of the policy is shown in five-year increments. In this instance, the annually renewable policy is less expensive for the first 15 years but more costly in the final few.

Annual renewable Guaranteed premium 5-year Accumulated 5-year Accumulated Years cost cost cost cost 1-5 $1,221 $1,221 $2,085 $2,085 6-10 1,796 3,017 2,085 4,170 11-15 2,141 5,158 2,085 6,255 16-20 4,441 9,599 2,085 8,340

Price Check

Where can you check life insurance prices to see if you’re getting a good deal?

Several firms research the rates of many term insurers to find the lowest prices. Two firms that offer particularly thorough searches are Quotesmith at (800) 556-9393 and TermQuote at (800) 444-8376. Quotesmith charges $15 for the service; TermQuote doesn’t charge consumers. They get paid by the insurance companies they recommend.

Source: TermQuote