A vanishing premium policy is a form of permanent life insurance in which dividends from the policy are used to pay its premiums. Over time, the cash value of the policy increases to the point where dividends earned by the policy cover the premium payment. At this point, the premium is said to disappear, or vanish.
Understanding Vanishing Premium Policy
Vanishing premium policies are ideal for consumers facing long-term income volatility such as the self-employed, those looking to start a business, or people aiming for early retirement. Some policies feature high annual premiums in the initial years, providing modest benefits that increase later. Other policies maintain steady premiums and benefits until the vanishing point, with cash value generally increasing over time.
This policy is suitable for those planning to use the benefits as supplemental income upon retirement. It also offers policyholders tax-deferred advantages while the cash value accumulates. In some instances, a vanishing premium policy is used in estate planning.
Key Takeaways
- Dividend payments, based on current interest rates, from the cash value of life insurance are supposed to cover premium payments after some time in vanishing premium policies.
- Such policies generally have high premiums with fewer benefits in their early years.
- There was a boom in vanishing premium policies during the late 1970s and 1980s, a period of high interest rates.
- Vanishing premium policies make sense during periods of high interest rates.
One criticism of vanishing premium policies is that some insurance representatives misled consumers about the number of years for which they would have to pay premiums before the policy could support itself. The amount credited to cash value decreases when interest rates are lower than expected, potentially resulting in policyholders paying premiums for more years than initially thought.
A Brief History of the Vanishing Premium Policy
Vanishing premium policies gained popularity in the late 1970s and early 1980s when nominal interest rates were high in the United States. Although marketed as a form of whole life insurance, many policyholders found themselves continuing to pay premiums for longer than expected as dividend rates fell with interest rates.
Litigations ensued against various major insurers, including New York Life, Prudential, Metropolitan, Transamerica, John Hancock, Great-West, Jackson National, and Crown Life Insurance, mostly resulting in substantial settlements. The negative publicity and legal scrutiny surrounding these policies ultimately pivoted Money Magazine to label them as one of the “eight biggest rip-offs in America” in August 1995.
Despite these disputes, legal scholars suggest the insurance companies adhered to their contracts since they explicitly noted that future interest rates credits were not guaranteed, leaving room for customer reassessment within the “free look” period allowed by state laws.
Examples of Vanishing Premium Insurance Policy
Interest rates on one-year Treasury Bills rose as high as 16% in the early 1980s but dropped to 3% by the early 1990s. During the 1980s, insurance companies enjoyed peak sales of vanishing premium insurance policies. However, as interest rates fell in the 1990s, insurers faced multiple lawsuits from dissatisfied customers.
For instance, Mark Markarian sued Connecticut Mutual Life Insurance after buying a life insurance policy in 1987, based on his broker’s advise that premiums amounted to $1,255 for seven years and only $244 in the eighth year. However, in 1995, Markarian was notified that he owed additional premium payments.
Similar complaints led to significant disputes. An insurance broker eventually filed a cross-claim against Crown Life Insurance Company after estimating inaccurate premium projections that led to customers owing much more than anticipated.
Understanding the intricacies of a vanishing premium policy, including historical context and potential pitfalls, can be crucial in making a knowledgeable decision regarding your financial future.
Related Terms: permanent life insurance, dividends, cash value, premium, life insurance, tax-deferred, estate planning, whole life insurance, interest rates, policyholder.
References
- Daniel R. Fischel, Robert S. Stillman. “The Law and Economics of Vanishing Premium Insurance”, Pages 1-3. Delaware Journal of Corporate Law, 1997.
- Macrotrends. “1 Year Treasury Rate - 54 Year Historical Chart”.
- United States District Court, District of Massachusetts. “Markarian v. Connecticut Mutual Life Insurance Company”.
- Supreme Court of Texas. “Crown Life Insurance Company v. Casteel”.
