Most people would consider themselves fortunate to reach their 100th birthday. But for people counting on certain types of life insurance to meet specific financial planning goals, hitting 100 means their luck has run out.
This is still not a common problem, but it is apt to get worse over time. According to estimates from the United Nations, approximately 72,000 people age 100 or older live in the United States today, part of about 451,000 total worldwide. Some projections suggest this population could surpass 3 million by 2050.
A relative few of those people will discover that reaching age 100 means their “permanent” life insurance policies are not permanent at all; they automatically terminate at that age.
This is the situation Gary Lebbin faces. A recent article in The Wall Street Journal explained that Lebbin, who will turn 100 in September, stands to lose two universal life insurance policies whose death benefits together total $3.2 million. The policies include a built-in expiration, called a maturity date, after which the company terminates death benefits and pays out the policy’s net cash value.
Many people are familiar with the difference between term life and permanent life insurance. In short, term insurance covers only a defined period of time, typically a year (renewable in most cases until about age 80), while permanent insurance is meant to last until the insured individual’s death. But not all permanent insurance works the same way, and fewer people understand the difference between universal life insurance and whole life insurance, the two most common types of permanent insurance. That difference is crucial to understanding why insurers build in maturity dates on universal life policies.
Because permanent life insurance is guaranteed to pay out – at least under most circumstances – it cannot run on the “pure” insurance model that underpins term policies, letting the insured pay a low, certain cost to protect against a high but uncertain cost. It is perfectly possible – in fact it is likely – that a 40-year-old will not die in the following 10 years. But it is not possible that a 40-year-old will never die. In order to function, permanent insurance incorporates an investment component as well as an insurance component.
The most important difference between types of permanent life insurance is how much risk the insured takes on, which directly affects the cost of the policy. Traditional whole life insurance policies usually guarantee fixed premium levels and a set death benefit, meaning they represent the least risk (at least in theory). In exchange, policyholders pay top dollar and sacrifice flexibility. Whole life policies gradually but steadily accumulate cash value, which really represents the policyholder’s own money. When the cash value equals the death benefit, the insurance company is no longer on the hook at all; it is merely holding the insured’s money until death. This economic model works reliably when the policies are properly funded.
Universal life insurance, on the other hand, unbundles the investment component from the insurance component, allowing policyholders to apply investment earnings and accumulated cash value to what are essentially term insurance premium payments, within certain parameters. The cash value may never rise to equal the death benefit, in which case the insurance company’s risk never goes away. It may actually increase as the insured person gets older.
Transamerica, the company which issued Lebbin’s policies in the early 1990s, used actuarial tables that set the terminal age at 100. While Transamerica updated its terminal age to 121 in the mid- to late 2000s along with the rest of the industry, the change did not retroactively apply to older contracts.
The Lebbin family filed suit in federal court, accusing Transamerica of knowingly using a too-low mortality age when it sold the policies. The complaint also alleges that the insurer misleadingly marketed the policies to Lebbin and his wife, since deceased, as “coverage for life.” The suit further claims that loss of the policies will trigger adverse tax consequences for Lebbin and his family. This is surely true; death benefits are exempt from income tax, but the payment Lebbin would receive upon termination of his policies will be taxable to the extent it exceeds the total of the premiums that were paid.
Other insurers have been known to offer extensions to older policyholders, under varying financial terms. According to the complaint, Lebbin wrote to Transamerica and asked for an extended maturity rider, but the company declined the request.
The problem that led to this unhappy situation was obvious way back when I did my first insurance analyses for clients in the early 1990s. Most whole life policies eventually endow; that is, the policy’s cash surrender value reaches or exceeds the stated death benefit, and the death benefit rises with any subsequent increases in surrender value. Insurance companies have no reason or incentive to cancel such policies, since by the time the policy endows, the company is no longer on the hook for any insurance cost.
But since universal life works differently, the policy’s cash value may or may not be equal to the death benefit at age 100. Companies designed the policies to self-limit to avoid being on the hook for insuring a person 100 years old or older (or, now, 121 years old or older). This is one reason why I never considered universal life to be well-suited for use as a wealth transfer vehicle in irrevocable life insurance trusts (although sometimes, when there was no opportunity to choose a different insurance design, I have reluctantly used them this way). Universal life policies are also much more prone to self-destruct prior to age 100 due to underfunding or underperformance in the investment account, though that hazard does not seem to have been a problem in Lebbin’s case.
I was not the only one to notice the “age 100 problem” for life insurance. Joseph Belth, a professor emeritus of insurance at Indiana University’s Kelley School of Business and the former editor of The Insurance Forum, has written about the problem since 2001. Belth noted in a recent blog post about the Lebbin case that insurance companies, the Internal Revenue Service and other parties connected to the life insurance industry have all avoided discussing the issue to this point, and that a serious legal challenge may be the only way to dislodge this avoidance.
For now, the Lebbins face the prospect of losing a death benefit they had thought was a sure thing after paying more than $1.5 million in premiums. We don’t know the particular policies’ current cash value, but many policies have performed tepidly in the ongoing low interest rate environment. Even if the cash value was near the death benefit, the net payout amount will be reduced because the payout will not be tax-free.
As Belth observes, the best-case scenario for Lebbin and his family is probably a settlement with Transamerica. For now, he serves as a cautionary tale, reminding insurance customers to understand what they are buying and to beware the fine print when an insurer promises “coverage for life.”