What is Vanishing Premium Policy
A vanishing premium policy is a form of permanent life insurance in which a consumer can use the dividends from such a policy to pay the premium. Over time, the cash value of the policy increases to the point where dividends earned by the policyholder equal the premium payment. At this point, the premium is said to disappear, or vanish.
Understanding Vanishing Premium Policy
Vanishing premium policies may be appropriate for consumers worried about longer-term fluctuations in income, such as the self-employed, people who wish to start a business or individuals who wish to retire early.
Some come with a high annual premium in the early years, at which time the policy offers modest benefits; the premium may subsequently drop, and the benefits then increase. Other policies may have a fairly steady premium and a set level of benefits until the vanishing point. In each case, cash value generally increases over time.
A vanishing premium policy may be suitable for some consumers who plan to use the policy benefits as supplemental income upon retirement. In the interim, the policy offers these policyholders tax-deferred advantages while cash value accumulates. In some instances, a person uses a vanishing premium policy in conjunction with estate planning.
- Dividend payments, based on current interest rates, from the cash value of life insurance are supposed to cover for premium payments after some time in vanishing premium policies.
- Such policies generally charge high premiums with few benefits in their early years.
- There was a boom in vanishing premium policies during 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 who had sold these products in the past faced accusations that they misled consumers regarding the number of years for which they would have to pay premiums before the policy could support itself. This situation was a result of circumstances in which vanishing premium policies came into existence. (See below).
Consumers may also want to be careful not to rely mainly on the maximum benefit relative to minimum premiums, as the amount earned could fall below this scenario.
Lastly, it is important for prospective buyers to understand that the amount credited to cash value is lower when interest rates are lower than the expectation described in the policy; if this happens, policyholders may end up paying premiums for more years than they first thought. This also is why buying a vanishing premium policy during a period of historically high interest rates might be a bad idea.
A Brief History of the Vanishing Premium Policy
Vanishing premium policies got their start in the late 1970's and early 1980's, a period of very high nominal interest rates in the U.S. Many were sold as a form of whole life insurance. When dividend rates eventually declined, this increased the number of years many whole-life policyholders had to pay their premiums until the fees finally went away. Several policyholders sued multinational life insurance companies in the 1990s, when rates declined, claiming that they were misled by them.
For example, Canadian life insurance company Crown Life Insurance made an out of court settlement amounting to almost $50 million with a plaintiff and the insurance broker. New York Life Insurance company settled with plaintiff attorneys and policyholders, with the former netting as much as $22 million from the case. An August 1995 cover story in Money magazine listed vanishing premium life insurance policies as one of the "eight biggest rip-offs in America" as Congress held hearings to discuss "Deceptive Practices in the Sale of Life Insurance."
Research indicates that the insurance companies did not breach the contract they signed with policyholders. These contracts do not guarantee future interest rates and provided for insurance companies to change them "in light of economic events." Additionally, state laws also provide customers with a "free look" period during which they can back out of an insurance contract.
Examples of Vanishing Premium Insurance Policy
Interest rates on one-year treasury bills rose to as high as twelve-percent in the mid-1980s but they fell to three percent in the early 1990s. Insurance companies witnessed peak sales of their vanishing premium insurance policies during the 1980s but, when the interest rate tide turned in the 1990s, they faced lawsuits from customers.
In one case, Mark Markarian sued Connecticut Mutual Life Insurance. When he bought a life insurance policy in 1987, Markarian's broker told him that he would have to only have to pay $1255 for the next seven years and $244 in the eighth year as premiums. But Markarian received a notice from Connecticut Mutual in 1995, claiming that he still owed them premium payments.
Other cases during the same time period had similar complaints. For example, the plaintiff - a broker - in one case cross-filed a claim against the insurance company after his clients filed one against him. They asserted that their premiums were not supposed to exceed $91,520 but, in actual fact, totaled more than $800,000.