How life insurance policy performance affects coverage
Key takeaway
Premium funding, policy charges, investment performance and conditional lapse protection affect whether life insurance coverage continues.
Research notice: The Minnesota examples below have specific coverage limits. Other states differ. NAIC consumer guidance and SEC variable life guidance are identified separately.
Premium flexibility and funding risk
NAIC explains that universal life permits flexible premium payments as long as enough is paid to keep the policy in force.
Premiums for many life insurance policies are sensitive to the insurer's investment earnings, claims costs and other expenses. Worse than expected results may require a much higher premium. These general statements do not establish any particular policy's required premium or guarantee.
Which policies the Minnesota examples cover
In Minnesota, for example, §§61A.70 to 61A.745 apply to group and individual life insurance policies and certificates, subject to the following exclusions. Other states differ.
- Variable life insurance.
- Individual and group annuity contracts.
- Credit life insurance.
- Life insurance policies with no illustrated death benefit on any individual exceeding $10,000.
The $10,000 threshold is fixed and is not indexed for inflation. Every Minnesota reporting and illustration example below uses this scope and these exclusions.
What to look for in a policy report
In Minnesota, for example, annual reports are required for covered policies designated as policies for which illustrations will be used. Other states differ. For universal life policies, the report must include:
- The beginning and end dates of the current reporting period.
- Policy values at the ends of the previous and current reporting periods.
- Total credits and debits during the current period, identified by type, such as interest, mortality, expenses and riders.
- The death benefit on each covered life at the end of the current period.
- Net cash surrender value at the end of the current period.
- Outstanding loans, if any, at the end of the current period.
For policies that do not build nonforfeiture values, annual reports are required only for years when the insurer changes nonguaranteed policy elements. The funding warning examples below retain this reporting limit and the illustration designation requirement.
Funding warnings and changes in assumptions
See whether an annual report must warn of a funding shortfall for the separate fixed premium and flexible premium tests.
In Minnesota, for example, a covered policy's annual report must prominently disclose an adverse change in nonguaranteed elements made by the insurer since the last annual report that could affect the policy. Other states differ.
The notice must describe both the fact and nature of the change. The annual reporting requirements and limits above apply.
Lapse protection depends on conditions
SEC guidance explains that an optional variable life lapse protection benefit can keep coverage in effect despite insufficient account value to pay fees and expenses.
Optional benefits require extra payment and may carry risks and limitations. Availability may be limited to specified years or premium levels. Electing lapse protection may significantly reduce the death benefit.
What Minnesota illustrations must show
Read the illustration assumptions
In Minnesota, for example, basic illustrations within the scope above must identify assumed payment receipt and benefit payout dates within a policy year. Other states differ.
Assumed payments must be identified as contract premium or premium outlay, as applicable. Policies without a specific contract premium must label illustrated payments as premium outlay.
Guaranteed death benefits and surrender values, if any, must be shown and clearly labeled guaranteed. Those figures must correspond to the illustrated premium outlay or contract premium.
Nonguaranteed elements, when shown, must be clearly labeled nonguaranteed. Their scale cannot be more favorable than the insurer's illustrated scale at any duration.
The illustration must disclose that nonguaranteed benefits and values are not guaranteed. The insurer may change the assumptions, and actual results may be more or less favorable.
Projected premium payments and continuing charges
In Minnesota, for example, sales illustrations within the scope above cannot imply that nonguaranteed elements are guaranteed. Other states differ.
An illustration cannot imply that using nonguaranteed elements for future premiums makes a policy paid up. Premiums may be represented as unnecessary to maintain illustrated death benefits only when that is the fact.
A basic illustration offering payment of policy charges with nonguaranteed values must disclose that charges continue. Depending on actual results, the premium payer may need to continue or resume premium outlays.
Similar disclosure is required when illustrated premium outlays are smaller or last for shorter periods than the contract premium.
If a contract premium is due, the premium outlay display cannot be blank or zero without an asterisk or similar mark. The mark must draw attention to the policy not being paid up.
Understanding the surrender value shown
In Minnesota, for example, basic illustrations within the scope above must identify surrender value using the policy's name for it. Other states differ.
The displayed surrender value must be the lump sum available after applicable surrender charges, policy loans and policy loan interest.
If an account or accumulation value is displayed, it must use the policy's name for that value. It must appear near the corresponding surrender value.
The policy valuation question covers valuation beyond the surrender value shown.
For a current illustration, see the Minnesota request rule, required notice and receipt requirements.
Investment returns and policy loans carry separate risks
For variable life insurance, investment value and returns depend on the selected investment options. SEC guidance explains that insufficient cash value to pay policy fees and expenses can cause lapse.
Fees, expenses, poor investment performance or loans can contribute to that shortfall. Lapse terminates the policy without value, and the beneficiary receives no death benefit. Some policies offer lapse protection for an additional fee.
Variable life policy loans typically reduce cash value and increase lapse risk. Loans may reduce the death benefit, are typically not subject to surrender charges and typically carry interest.
SEC guidance calls for reviewing the policy prospectus and each underlying fund's prospectus before making an investment decision. These investment mechanics describe variable life insurance.
The policy loan tax question covers loan taxation after lapse. The transfer for value question covers transfers and death benefits.
Reviewing a policy over time
NAIC recommends reviewing an existing policy every few years with an insurance agent, financial adviser or insurer representative. Policy statements and illustrations can help examine changes in premiums, benefits and coverage needs.
These reviews follow consumer guidance, rather than a statutory annual audit requirement.
Questions to ask
NAIC suggests asking the following questions:
- What might be the highest premium I would have to pay to keep my coverage?
- Have the premiums or benefits changed since my policy was issued?
- Do the death benefits still meet my needs?
Replacing a policy
When considering replacement, NAIC recommends comparing the current and proposed policies. Changes to existing coverage may provide the desired benefits. Changes in health may affect eligibility for a new policy or the premium charged.
NAIC advises keeping the current policy until the new one is obtained. SEC variable life guidance specifies keeping existing coverage until the new policy is in effect to avoid a coverage gap.
The insurance and liquidity hub covers related planning topics.
Common questions
Does a Minnesota annual report warn of a funding shortfall?
Yes, for covered universal life policies, a report must warn when net cash surrender value fails the applicable funding test. In Minnesota, for example, the scope exclusions and annual reporting requirements and limits above apply. Other states differ.
For a fixed premium policy, the test assumes guaranteed interest, mortality and expense loads, plus continued scheduled premium payments. A notice is required if net cash surrender value would not maintain coverage until the end of the next reporting period.
For a flexible premium policy, the test assumes guaranteed interest, mortality and expense loads. A notice is required if net cash surrender value would not maintain coverage until the end of the next reporting period unless further premiums are paid.
Can an owner request a current policy illustration in Minnesota?
Yes, an owner of a covered policy may request an illustration of current and future benefits and values using the insurer's present illustrated scale. In Minnesota, for example, the scope exclusions above apply. Other states differ.
The illustration must comply with §61A.715(a) and (b) and §61A.72, subdivisions 1 and 5. No signature or other acknowledgment of receipt may be required.
If an annual report omits a current illustration, it must prominently notify the owner of the right to request one annually without charge. The notice describes calling or writing to the insurer, or contacting the agent.
The notice must advise contacting the state insurance department if the owner does not receive a current illustration within 30 days of the request. That instruction is part of the Minnesota notice, rather than a nationwide deadline.
Resources to check out
- NAIC: Life Insurance Buyer’s Guide: Coverage needs, premium affordability, policy reviews and replacement considerations.
- SEC: Variable Life Insurance: Investment risks, expenses, loans and conditional lapse protection.
- Minnesota: Annual Reports and Illustrations: The state example supporting report contents, funding warnings and illustration requests.
- Minnesota: Standards for Basic Illustrations: The state example supporting guaranteed and nonguaranteed disclosures and surrender value presentation.