1035 Tax-Free Exchange - Part 2

The intense competition within the life insurance industry to provide high-interest-rate returns in the 1980s gave way to the demand for higher-rated companies in the 1990s as consumers reacted to the tragic failures of too many insurance companies.

Also, during the 1990s interest rates decreased, and the actual dividends paid on whole life policies tended to be less than what was illustrated in the 1980s. Policy owners who had been sold policies based upon the promise that premiums would "vanish" in a certain number of years because the dividends would pay the premiums found out that the premiums did not vanish. Contrary to what was shown in the illustrations, the dividends were insufficient to cover the premiums. Not surprisingly, this led to a great deal of legal action and brought about a number of class-action suits in which many companies have been required to pay large sums to settle the claims of disgruntled policy owners.

Many policy owners used a minimum deposit strategy with whole life. Within a participating whole life policy, as soon as the combination of the cash-value increase (guaranteed within the contract) and the dividend was more than the whole life premium, they would use the dividend and also borrow against the cash value to cover the current premium due. Minimum deposit was the term used to describe the strategy of paying as little as possible into a policy.

You could access the asset base in the policy through loans offered at somewhere between 5 and 8 percent interest. Therefore, if you wanted to use the minimum deposit strategy, you would instruct the company to reduce the annual premium requirement by the amount of the current dividend and pay the balance of the premium due with a loan against the policy cash value. Implicit in all these methods of limiting the amount of money going into whole life policies was the idea that investment results from whole life policies were inferior, so it made sense to invest as little as possible.