Market blow to UL

Both partners in a high-net-worth couple had each taken out a universal life insurance policy with the accumulation account linked to the Dow Jones Industrial Average. They saw two benefits to the policies: reasonably priced insurance and tax-sheltered investment. When the markets melted down last fall, the investment value of their accumulation accounts fell by approximately 50%. At presstime, they have decided to apply for term insurance and plan to let their UL policies lapse to cut their losses.

That couple will have a lot of company – with some trying other solutions – if industry insider predictions crystallize this year. They contend that UL sales illustrations connected to equity-linked investments in UL accumulation accounts have become outdated in light of the market meltdown. “This is just going to get worse and worse and worse over the next period of time,” suggests Kim Shaheen, president of Regina-based Kim Shaheen Financial Inc. Shaheen points out that the implications of the potential problem go beyond disappointment over investment performance. “It has the possibility of becoming a significant issue for people’s estate planning goals.”

QUESTIONING EQUITY The meltdown has triggered a second round of questioning about equity-linked UL products, says Tony Bosch, president of Vancouver-based Complete Brokerage Services Inc., recalling that index-linked UL products appeared in the mid-1990s as a response to falling interest rate yields. The first round occurred during the market downturn that started in 2000 and continued until the beginning of 2003.

The UL accumulation accounts likely to take the largest hit are those sold on a yearly renewable term basis, referring to the calculation of the cost of insurance, especially those in the bonus product category, Bosch explains. A bonus product carries a higher management expense ratio on the investment component but provides for a “bonus” in one or more of three circumstances: a specific time period; extra payments by the client; or specific performance levels. “If you take a bonus product and a bad market and an illustration that was illustrated too high like at 8% or 10% … when you add all of those factors, then you’re really looking at a difficult situation.”

Clients facing disappointing statements about their UL investments have several options besides the one the unlucky couple chose. One option: pay additional cash to keep the insurance in force by paying an amount equal to the cost of insurance, explains Susan St. Amand, president of Ottawabased Sirius Group Inc. This will mean that the accumulation account (if equity-linked) will fluctuate with the market in the meantime but that the client has covered all of the insurance charges.

A CASE FOR CONVERSION The client can also increase the amount allocated to the guaranteed portion of the accumulation account, where it was previously set up, or even set up a new one. “Some of these contracts have minimum guarantees of 4%, which is pretty attractive in a tax shelter at this point in time,” she says.

In another option, the investor can convert all or part of the equity component to an interestlinked option. Ironically, the reverse might be suitable for some clients. In that case, a client who has their investments in an interest- linked account might opt to transfer the money to an equitylinked investment, in a universal life version of the “buying opportunity” concept, which teaches that the falling market presents buying opportunities.

“There will be people [who] have purchased contracts in the last while and put their money into daily interest or one-year GIC type [investments] and now feel that it’s an opportune time to click back into the equities,” she says, adding that this may involve a market value adjustment. The insurer bases that adjustment on what it considers as the value of releasing money from the guaranteed portion, a calculation that depends on factors such as current market rates, how long the money had been held in the guaranteed component and amount of time remaining in the guaranteed term, such as moving from a five-year GIC after one year.

THE WAITING GAME Depending on the amount of cash buildup inside the UL policy and the cost of insurance, it may be possible to adopt a wait-and-see stance for a year or more.

Some industry insiders say that policyholders may pursue a more drastic solution, perhaps encouraged by an aggressive class-action lawyer, and mount a class-action suit against insurers. Their case would be weakened by the fact that regulations call for illustrating an adverse scenario but few if any illustrations show a negative rate of return.

Al Emid, a Toronto-based financial journalist, covers insurance, investing and banking.