by Archie M. Richards, Jr.
September 24, 2007

If you acquired a universal life policy in the early 90s or before, beware. It's likely to crash.

I'm talking about permanent life insurance, which remains in effect even at advanced ages. The original kind of permanent life insurance, called "whole life," was inflexible, because the values were calculated by hand. The premiums had to remain fixed.

But the introduction of computers in the 1970s enabled policy values to be determined even when the premiums fluctuated. The insurance company presents the policyholder with a premium range. If the payments are too low, the death benefit can't be sustained. If the premium payments are too high, the IRS says the policy no longer qualifies as life insurance and taxes some of the earnings. Within the given range, the client can choose how much to pay, changing the amount later if desired.

Short-term interest rates in the 1970s were way high. (Inflation was rampant, causing interest rates to be high as well.) Insurance companies took advantage by investing their new universal policies in short-term loans, lending their money out for short periods.

As long as short-term interest rates stayed up, the death benefits remained supportable despite the low premiums. Universal life policies became very popular.

But a funny thing happened on the way to advanced ages: Government economic policies improved, and the rate of inflation fell from a high of 14 percent to only 2 percent. With inflation down, the interest rates on short-term loans plummeted.

Many insurance agents had told clients they'd be okay if they continued paying the premiums at the original amounts. For those who did, the chickens will come home to roost. If you acquired a universal life policy before the early-1990s, you're likely to receive a notice from the insurance company saying that without increasing your premiums substantially, the policy will soon have no value. Like an airplane out of fuel, the policy will crash and burn.

Here are suggestions:

• Determine whether you still need life insurance. After all, the kids are out on their own. Your mortgage balance is low or possibly paid off. You and your spouse will have pension income, and you've accumulated investments. Does your family have a demonstrable need for extra money immediately after you die? If not, drop the policy. You might even do so now, while the policy still has cash value. (To determine your need for insurance, it might be helpful read the 3/7/05 article entitled, "How Much Life Insurance is Needed?")

• Continue the insurance policy, but with the death benefit reduced to a level that the current premiums support.

• Discontinue the life insurance and acquire a policy that pays for long-term nursing-home care instead. (Read " Long-Term Care Insurance Isn't for You: It's for Your Family" from 6/27/05.)

• Divert your premium money into additions to your investments. Beefing up the investments could supply all the cash your family needs when you die. If life insurance is still called for while the investments are accumulating, buy inexpensive term life.

  (To add even more to your investments, obtain a reverse mortgage to turn your house into money without your moving out. Read my column, "Turn Your House into Money Without Moving Out" dated 12/18/06.)

No, the policies that are in danger are older universal life policies invested in short-term loans. The interest rates on those loans have fallen precipitously. At current levels, the premiums will no longer support the death benefits originally expected.

Many universal life policies acquired some time ago are headed for a crash. Be warned.