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Can a Policy Run Out of Funds?

Why can permanent life insurance policies become underfunded?

Permanent life insurance policies, particularly universal life and variable universal life, can become "underfunded." This happens because of a combination of factors over time:

  • Investment performance below expectations: Many policies sold in the 1980s and 1990s were based on optimistic projections of interest rates and stock market performance. However, events such as the 2001 technology bubble and the 2008–2009 financial crisis negatively affected these returns, which have generally been lower than projected.
  • The natural increase in insurance costs with age: The risk of insuring someone increases as they grow older, along with the cost the insurance company charges for coverage.
  • Using cash value to cover expenses: If the income generated by investments within the policy is not enough to cover the rising cost of insurance and other charges, the insurer will begin deducting funds from the policy's accumulated cash value.
  • Paying minimum premiums: Policyholders were often advised to pay only the minimum required premium. Over time, if returns are low and costs rise, this minimum premium may prove insufficient to keep the policy adequately funded over the long term.

Consequences of an Underfunded Policy:

When a permanent life policy lacks sufficient funds, the consequences for the owner can be serious:

  • Policy lapse: In the worst case, if the cash value is completely exhausted and no action is taken, the policy may be canceled or lapse. This means the insurance coverage disappears and beneficiaries will not receive the death benefit. The owner will have lost the money invested in premiums over the years.
  • A drastic increase in premiums: To prevent the policy from lapsing, the insurance company may require a substantial lump-sum payment or significantly increase future premiums. The goal is to cover the existing shortfall and projected insurance costs. This amount can be very large, especially at older ages.
  • Loss of cash value: Even if the policy does not lapse, the cash value that had accumulated may have been significantly reduced or depleted to cover costs. This eliminates a potential resource that could have been used for loans, withdrawals, or retirement planning.
  • A financial dilemma: The owner faces a difficult choice: make a significant payment to maintain coverage or let the policy lapse and lose the investment already made.

Owners of permanent life insurance policies, especially those purchased several decades ago—universal life and variable universal life—must periodically review their policies' status and future projections. Detecting underfunding early allows timely corrective action, such as increasing premiums or adjusting the death benefit. Consulting an independent financial advisor who operates under a fiduciary duty—an independent RIA—is an excellent way to obtain an impartial assessment and guidance on available options.