Life Insurance Horror Story: The Risk of Leveraging

January 3rd, 2012 | Author: Mitch Reynolds

A Life Insurance Horror Story That Could Put You off Buying Insurance

Advice to invest in life insurance gone terribly wrong

life-insurance-horror-story-leveraging-your-home I’m really not trying to open up the New Year by scaring you with a life insurance horror story. This article is one that I have wanted to write for a while but never felt it was the right time. Now with the promise of a new year ahead, and 2011 behind us, I decided to write my cautionary tale just to keep some perspective.

Just to be clear, this is a second hand story. It was told to me by an industry representative who works with many life insurance brokers. I can’t verify if the information in this story is true, nor do I wish to point out the wrongs of any specific life insurance company or disparage a specific agent.

This story might be true, but it’s still a cautionary tale to all those who are approached to invest heavily into life insurance by an agent or broker who is also getting paid to lend them money to fund the investment. Here is my tale.

Leveraging your home to invest into universal life insurance

We will call our fictitious couple Vitaliy and Alexandra. They moved to Canada from eastern Europe over ten years ago and had done everything right as new immigrants. The both became fluent in English, they got good jobs, bought a house early, and have aggressively paid down their mortgage. Even though they were not rich by any means, things were going well.

They were approached by a life insurance agent with a strategy to help them bolster their retirement savings by using the equity in their home to invest into universal life insurance.

It was 2006, and the housing boom in Calgary was at its peak. Vitaliy and Alexandra had done very well on their house, with over $250,000 of equity built up in it at current real estate values.

The Strategy

The strategy this insurance agent presented to Vitaliy and Alexandra was to take out a second mortgage on their home and dump all that money into a new universal life insurance policy. Because they were both making good money they could afford the extra monthly mortgage payment and the loan (leverage against their house) would come to them tax free and could be invested into the tax sheltered investment account inside the universal life insurance policy.

So, Vitaliy and Alexandra took out $175,000 of equity from their home and invested it into a Joint First-to-Die universal life insurance policy in late 2006. Because of the rapid growth in the stock markets and everyone was making a killing on the TSX and Wall Street, they decided to invest heavily into equities with their $175,000 venture into their universal life insurance.

How it went horribly wrong

As we all know now, the economic system was being propped up on toxic loans in the US housing market, and the whole thing started to unravel in 2008 with the collapse of Bear Stearns and Lehman Brothers.

In Calgary, AB, the economy hit a serious rough patch as the price of oil declined to under $40 a barrel and all the new investment projects in the province were halted or shelved. The housing market began to tank as more people left Calgary and Alberta than moved into the province for jobs, and many people were being laid off.

For Vitaliy and Alexandra they did not escape the economic fallout. Vitaliy lost his job and they were finding it hard to make the ongoing payments on their now two mortgages. Their home was now underwater (they owed more money on it than they could sell it for) and their investment portfolio inside their universal life insurance policy had lost over 40% of its value.

Vitaliy and Alexandra had to make some serious financial decisions and they decide to take their losses and get out of the universal life insurance investment plan, reduce their mortgage payments and use some of the money they had left from the insurance investment to see them through the economic turmoil.

Now to add salt into the wound

Little did Vitaliy and Alexandra know that their universal life insurance policy had a cancellation fee for early surrender within the first 10 years. This cancellation fee rises in the early years of the policy and then slowly declines as you approach the ten year mark. After 10 years, no universal life insurance policy in Canada has a cancellation fee, so it is easy to cash out at that point.

But for Vitaliy and Alexandra, they had just started the 3^rd year of their policy, and in 2009 they found out that the cancellation fee was higher than the remaining equity in the policy. From the original $175,000 they had invested, they had about $100,000 remaining in cash value inside the policy. The cancellation fee to redeem their life insurance policy was over $130,000. This would have left them with $0 from their initial investment of $175,000 and the huge new debt on their house.

Whatever happened to Vitaliy and Alexandra?

Well, this is where the story ended for me. I don’t know what ever happened to this couple I was told about second hand. They might have engaged legal action against the life insurance agent or company who sold them the plan. They might have lost their house. Vitaliy could have found another job and they are still struggling and holding things together. I just don’t know the end of this story, but it probably isn’t a happy ending.

Avoid your own life insurance horror story

I have some tips for you to avoid getting into a similar situation. Life insurance is a very good financial planning product, both for immediate risk protection and long term cash accumulation, so long as you do not put yourself at risk to buy the product. Remember, insurance should be a risk protection tool, not a risky investment. Here are some tips:

NEVER leverage against your home, the place you live, to invest in uncertain markets. You might lose your home.
If you are leveraging (borrowing money to invest into any product) be sure you can afford the repayment plan and never over-extend yourself.
Plan your life insurance needs with risk management first – use low cost term life insurance for short term risk needs.
For long-term estate planning, look at fully guaranteed whole life insurance as an alternative to the more volatile universal life insurance if you are risk averse.
Be sure not to take on too much investment risk within your universal life insurance policy fund – your investments should be more conservative in order to protect the life insurance death benefit you are buying.
Understand the cancellation fees of any life insurance or investment product you buy and be prepared to pay them if you need to get out of the plan early.

Life Guard Insurance can help with your existing universal life insurance

If you would like a second opinion on your current universal life insurance policy, especially if it was sold as more of an investment plan than a risk management tool, we would be happy to examine it and give you our unbiased opinion. Sometimes a second pair of eyes on your policy will help you understand the policy better and keep you on track with a good investment or find the quickest escape for a poor investment. Contact us today for a no obligation consultation on your existing universal life insurance policy.

The article was written by +Mitch Reynolds. If you found this article interesting or it made you think, please feel free to share your comments below. Liking us on Facebook, giving us a +1 on Google or Tweeting this article about a life insurance horror story would also be very much appreciated.