How defined-benefit life insurance puts the risk on consumers' shoulders

One expert explains how perceived underperformance stems from a lack of understanding

How defined-benefit life insurance puts the risk on consumers' shoulders

The majority of pensioners probably understand how a shift toward defined-contribution plans works to their disadvantage. They put in a certain amount in contributions, and it grows depending on the pension fund’s performance; there’s no guarantee as to how much benefit they’ll get.

But far fewer people are likely to grasp how life insurance with defined-benefit contracts also increases the risk borne by consumers. And that lack of understanding, according to one financial expert, leads many to assume that plans are underperforming.

“If your car runs out of gas and stops along the side of the road, is it really underperforming?” wrote Bill Boersma, CLU, AEP, and LIC, in “Life insurance policies need gas, and if they don’t get it, they stop too.”

Boersma explained that prior to the late 1970s, practically all life insurance policies were fixed; buyers knew what was being contributed and what they had to expect. But since then, most insurance has shifted to a defined-benefit model. “Based on how they’re built and client expectations, even many whole life policies are defined benefit contracts,” he said.

What many life insurers have done, according to Boersma, is make the defined benefit only payable if the customer funds it appropriately. In the past, insurance carriers bore interest, mortality, and expense risk on their shoulders; today, insurance customers bear those risks — and many of them don’t understand that.

“[I]f they get it wrong and don’t fund the policy appropriately, the carrier doesn’t have to pay the benefit,” Boersma said.

The introduction of universal life policies in the late 1970s marked the shift to defined-benefit life insurance, he noted; variable life policies, blended and non-guaranteed short-pay whole-life insurance policies, and indexed policies also came as different versions of defined-benefit contracts.

“Only true guaranteed premium and guaranteed death benefit contracts, such as guaranteed universal life and non-blended whole life policies, are defined contribution contracts, as is term insurance,” he said.

The premiums of most defined-benefit policies, according to Boersma, are merely “point-in-time calculations” of how much might have to be paid to hit a goal given what has happened to date, what is currently happening, and what forecasts say might happen tomorrow. Had crediting rates rose or had contract expenses declined over the past number of years, premiums might have gone down.

“What actually happened, crediting rates fell for decades, and now some contract expenses are rising, so the requisite corrections need to be made,” he said. “I’m not saying policy premiums need to be tweaked with every single crediting or expense change but periodic review is essential or the policies may fail, as they have been for decades.”


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