Your new client purchased a life insurance policy several years ago. He 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 he 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 he was required to pay for the insurance death benefit. Life insurance finally seemed attractive, so many financial advisors told their clients to consider "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 the variable life insurance policies.

Then a significant prolonged stock market decline occurred; one that caused 401(k) accounts to shrink dramatically. However, your client did not notice the impact on his variable life insurance. He thought he just needed to keep paying the premium provided by his former financial advisor and the insurance would be fine. The stock market recovered over time and so did his 401(k) and the cash value of the life insurance policy seemed to bounce back. Your client did not carefully review the insurance company's statements to notice that his insurance policy's cash value did not recover nearly as much as his 401(k).

Years passed and the stock market went into another prolonged decline, with substantial negative returns, followed by a period of significant volatility. Your client's retirement funds and his retirement seemed extremely vulnerable. One day the life insurance company sent a letter that captured your client's attention -- his policy may lapse unless he pays substantial additional premiums.

His former financial advisor has retired and he contacts you. You confirm the grim facts: He must pay substantially greater premiums for the rest of his life, or he may have no life insurance. Your new client cannot afford the huge premium increase, as he is trying to save enough in his last working years to retire; or maybe he has already retired, and the required premiums are impossible. You advise your client that he could decrease the face value of the life insurance policy and continue to pay the same premium or just let the policy "lapse" if he cannot afford additional premium payments.

How could this happen to your client's life insurance? When he purchased the policy years ago, his financial advisor showed him 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 client's financial advisor gave him 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 new client's variable life insurance was never guaranteed to last and to provide the death benefits he counted on for his family. He 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 his 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 clients' variable life policies, you should help them review the status of those policies and their financial and legal choices now. Remind your clients who are considering life insurance products (paraphrasing Aristotle), "the less attractive probability is preferable to the attractive impossibility."