Fine print can trip up insurance policyholders
Universal life designed to offer premium holidays But some policies can be cancelled for non-payment

JAMES DAW

Many consumers may not know they could lose thousands of dollars if they cancel or skip one payment for their universal life insurance policy. 

The same would be true for other types of insurance. But universal life policies, which nearly 200,000 Canadians will buy this year, are assumed to have more flexibility. 

Sales of the complicated policies soared when the stock market was booming. They climbed from about 20 per cent of insurers' premium revenue in 1994 to about 60 per cent during each of the past three years. 

"The unfortunate thing is that the little guy, the one who has fallen on hard times, will be hurt most by the hidden surprise," says  Toronto insurance broker Bruce Cappon. 

This touchy issue is one that the companies with the most restrictive contracts were not even prepared to discuss when the Star attempted to collect data for a chart. 

Universal life, or UL, combines term insurance and a side fund with a wide range of investment options. The tax-sheltered fund is intended to permit relatively level premiums until late in life. 

In the early years of the policies, the fund value can be used in varying degrees to pay for premium vacations. But the degree of flexibility among policies is vast. 

A 40-year-old man who paid Empire Financial Group $1,810 each year for three years in order to have $250,000 of coverage could stop payments and coast for another 137 months. 

But, if the same man held an equivalent policy at Maritime Life Insurance Co. or Canada Life Financial Corp., he could only coast for four months on the fund values, which would be, respectively, $2,967 and $4,160. 

The man could potentially forfeit about $4,000 of fund value if he held the policies of two other companies. These companies would not answer the survey or confirm the figures. 

Cappon, of First Rate Insurance Inc., argues that the general descriptions in sales literature and the technical wording in policy contracts do not always highlight the restrictions of some policies explicitly enough. He would like to see provincial regulators investigate. 

A spokesperson for the Financial Services Commission of Ontario invites consumers to raise their concerns if they feel they have been dealt with unfairly. 

"If we have specific examples, we can act," Brian Donlevy says. "But consumers should always ask questions if they do not understand." 

Consumers know they will lose their coverage if they cannot pay their premiums for auto insurance, term life insurance or traditional whole life insurance (if they haven't already paid premiums for several years). 

But the public perception — which is justified in the case of many companies' policies — is that universal life offers more flexibility. 

Insurers promote the fact that policyholders can increase, decrease or skip payments, within limits. 

They can also increase or decrease the amount of coverage, add additional lives or switch lives insured by a policy and choose between a number of investment options. 

Consumers were captivated by policy illustrations, which assumed investment returns that have quickly proved unrealistic. 

They were persuaded that a universal life policy was the most economical way to provide an estate for their heirs. 

Most buyers did not contemplate having to skip premiums in the early years of the policy, or cancelling altogether. But the flexibility to do so would see them through an unexpected decline in income. 

When  Cappon's friends suffered a drop in business income, they asked for advice. He suggested they should arrange with their broker to temporarily skip payments on their policies. 

The husband and wife had built up thousands of dollars in fund value — money in excess of what was needed to cover the cost of insurance. 

So  Cappon and the broker who sold the policies to the friends thought they would be fine. 

It came as a shock to both insurance specialists when the couple got a notice that their policies were about to lapse. 

Their fund value was going to revert to AIG Life Insurance Co. of Canada, and the broker was going to have to repay $4,500 in sales commission. 

After they complained to AIG, the company agreed to allow their policies to remain in force if they paid their December premiums. 

AIG policies are far less flexible than others on the market. But the company was one of four that would not supply the Star with data for a comparison chart. 

The other non-participants were National Life Assurance Co. of Canada, its parent, Industrial-Alliance Life Insurance Co., and Equitable Life Insurance Co. of Canada. 

National Life, which is in the middle of the pack in terms of flexibility, objected on the grounds that it would not recommend that a client buy a policy under the simplified scenario set out by the Star. 

Cappon contacted other veteran brokers after his friends' experience. These brokers were similarly in the dark about the great discrepancy in flexibility among insurers.   

Sarnia broker Robert Haisman, a fan of universal life, says differences in flexibility on premium vacations are only the tip of the iceberg that brokers may be missing. 

"The life insurance companies send out a marketing guide and illustration CD, and expect sales to follow without consequences," he says. 

"Sales brochures and promotional literature do nothing to fully disclose the downside of UL. They only promote the upside. 

"The problem is that insurance companies are under absolutely no obligation to properly train the brokers selling their products, and UL is a very complicated product,"  Haisman says. 

James Bullock, a broker and the registrar of the Peel Institute of Applied Finance, says some insurers no longer even supply specimen contracts to agents. 

He says contracts are sent when a client is accepted for coverage. 

The client then has only 10 days to decide whether he or she will accept the contract or request a refund. 

When  Cappon raised his concerns on an Internet forum, http://www.foradvisorsonly.com , some writers said brokers should use company-supplied software to test how policies behave in unusual circumstances. 

Arthur Robson, a broker and managing general agent who owns Future Planning Insurance Agency Ltd., says the problem really lies with agents and brokers who don't understand the differences in UL contracts. 

"Most agents sell using computer illustrations with very little knowledge of how that particular company's product actually works," he says. 

Most companies deduct insurance charges from the cash surrender values, the money that a consumer could withdraw or borrow, Robson says. 

The cash surrender value will be substantially less than the fund value in the early years. 

Today, many policyholders will have negative cash surrender values because of poor performance on their investment in equity funds. 

"This creates a problem if they don't want to put more money into their contracts," Robson says. 

In our sample case, the 40-year-old man is a non-smoker. He buys $250,000 of coverage on his life and pays monthly premiums equivalent to $1,810 a year. 

The $1,810 in payments was chosen because that was the highest minimum premium required by any insurer, RBC Life Insurance Co. 

As high as this premium may seem for a modest amount of insurance, it is less than would be necessary to keep the policy in force to age 100 if, as we assumed, the man received a conservative 3 per cent rate of return. 

In the example, the cost of insurance is based on yearly renewable term rates. The cost of insurance would be as little as $224 at Empire in the first year, and more than $10,000 a year by the time the man reaches his 70s. 

Under these various assumptions, the earliest date that the man could skip a premium ranged from two months to 36 months for the companies that would confirm figures. 

Policies could lapse in the first three, four or more years, depending on the premiums paid. 

Robson points out that the results of the Star survey would be far different if we had not assumed a positive return. 

Some companies, such as Empire, Sun Life Financial Services Canada Inc., Transamerica Life  Canada and Manulife Financial, charge a much lower minimum premium than their rivals. Standard Life Assurance Co. reduces its minimum premium after the first year. 

So a policyholder would have more flexibility to maintain coverage if he or she ran short of money. 

Transamerica, the top seller of universal life, acknowledges that its current policies offer more flexible payment options than earlier policies. 

"With the current uncertain economic climate, clients and advisers are more risk-averse and have requested changes to the lapse provisions," says Joe  Kordovi, Transamerica's assistant vice-president. 

Cappon, Robson and  Haisman argue that universal life is a valid type of insurance but consumers must realize that contracts differ in more than price. 

Everyone should ask their broker or agent to supply extensive comparisons, and discuss the potential pitfalls of each policy, Cappon says. 

And don't assume that a broker knows everything about the policies he or she is selling.