Lapse Probability Risk – Greater Than You May Think
FSLM products employ a unique actuarial chassis that makes it very different from VUL. One of the FSLM’s advantages is that it reduces risk for the client in many areas and eliminates the risk of lapse completely.
Many advisors and their clients assume that a heavily funded, especially a guideline single premium, VUL has little or no risk of lapse (or explode). There is a very large range of potential reduction in policy value between initial projections and lapse. Lapse means the policyowner would not only have less account value than “projected” performance, but would actually end up with nothing.
One recent study showed a large range of VUL lapse probability, and none of the case studies resulted in zero probability. These studies were based solely on market fluctuations versus constant returns using a Monte Carlo analysis and policies were funded to levels that projected that policies would continue to age 100 with assumed zero policy loans. This study of lapse probability does not include the possibility of the carrier increasing COIs or other policy charges during the life of the policy, a factor that would increase the lapse probability to a much larger percentage.
The Study Results
The high VUL lapse probability of maximum funded VULs projected to be perfectly safe is astounding! One case study guideline of single premium VUL’s lapse probability before age 95 was over 20% and none of the case studies had an insignificant chance of lapsing. Another case study of a VUL funded to age 100 showed a lapse probability prior to expected mortality over 40% if the expected return was only 1% less than illustrated, and an incredible 70% lapse probability prior to age 100. The study used no load VUL policies with low, transparent pricing from 2 insurance companies who cater to the RIA channel. Higher loaded policies would have shown even greater lapse probabilities. Click Here to Read the full Article (“Risk of Variable Universal Life Lapses Due to Market Fluctuations”)
Even if a computer illustration appears to guarantee against lapse, there is often subtle contract language that limits the carrier’s liability and if not, one must worry if the policy’s pricing assumptions can be supported by the carrier 30 or 40 years into the future. The FSLM has a 0% percent chance of lapse, also assuming zero policy loans. A VUL (even a max funded VUL) cannot be substituted for a FSLM and accomplish the same results. It is simply impossible to structure a VUL to emulate an FSLM because the FSLM is a totally different and unique actuarial design.
With the FSLM, there is no reason for a client to take on the added risk of a VUL, especially when FSLM features eliminate the explosion risk and enhance management and performance flexibility not found in a VUL chassis. Placing clients in VUL policies perceived to have little or no risk without disclosure of the true risks is certainly grounds for litigation and for an RIA a violation of their fiduciary responsibility, especially when there is now a known alternative, FSLM.