Life insurance can provide stability when markets get rough, especially when a policy includes guarantees or indexed crediting protections. But those protections don’t eliminate every volatility impact.
In an indexed universal life policy, for example, a 0% floor can prevent negative index credits during a downturn. But that doesn’t stop policy charges from reducing cash value.
At the same time, index caps can limit the interest credited to a policy when the market rebounds. The policy may avoid taking the full loss, but capture less than the index’s full gain. Over time, that can create a gap between actual performance and the original assumptions.
Add loan risk and inflation to the mix, and suddenly a policy could lapse. The issue isn’t necessarily one bad market year. It’s how a life insurance policy holds up when weaker returns, borrowing, and ongoing costs interact.
Downside Scenarios
Like stocks and bonds, the cash value of a universal life insurance policy is subject to market forces — inflation, recession fears, and other economic factors. Indexed universal life and variable universal life policies are impacted the most because their cash value growth is usually tied to the stock market.
Periods of low returns can leave less policy growth available to offset ongoing costs. Cost-of-insurance charges, administrative fees, and other deductions continue even when credit returns are low or zero. If policy performance stays below the original assumptions, a policy may need higher premiums or other changes to stay in force.
Policy loans can add to the pressure. Negative arbitrage happens when the interest charged on a loan is higher than the interest earned or credited on the cash value. This creates a net financial loss or negative spread.
For example, if a loan rate is 6% while the collateralized cash value earns 3%, that difference creates an additional performance drag. The loan itself isn’t the problem. It’s the spread between what the policyholder is paying to borrow and what the policy is earning.
Over time, the unpaid net interest cost can drain your remaining cash balance. If the cash value drops to zero due to heavy borrowing and negative spreads, a policy can lapse.
Stress Testing Properly
A policy should be stress-tested against weaker market conditions, not just the assumptions used in the original illustration. Conservative modeling can show what happens when returns stay low for several years, while adding buffers gives a policy more room to absorb higher costs, loan interest, or weaker-than-expected growth.
Not sure where your policy stands? You can’t control market high and lows, but you can stay ahead with an unbiased life insurance policy assessment. A review can flag weak assumptions, uncover hidden costs, and show whether your current strategy still works.
Remember, market volatility doesn’t necessarily break life insurance. The bigger risk is relying on your original projections as a guarantee.
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