Ch. 5 - Permanent Life Insurance Products

overfeeding (variable universal life)

= adding extra sums to early premiums, is a potential hedge against that possibility

straight/ordinary life

= continuous-premium whole life contract for which the insured pays a level premium for his/her lifetime or to age 100 (or later on the newer versions) - either pays a face amount upon death of the insured or endows for the face amount at the endowment age, whichever occurs first

corridor of coverage

= difference between the purchase amount and the face amount - essential to the retention of the tax free death benefit, which remains in effect as long as the policy remains in force

general account

= what most U.S. life insurance companies invest whole life policy cash value holdings in, comprised largely of conservative holdings in U.S. Government bonds and highly rated corporate bonds, mortgages, and preferred stocks - these conservative fixed income investments earn the prevailing interest rate at the time they are purchased, and the preferred stocks can earn dividends

single premium life

Based on an insured's gender, age and health, a one-time premium will provide a pre-paid death benefit. Naturally, the larger the initial contribution, the greater the death benefit will be. Younger insureds, with more living years over which the company can profit, will get more for their money.

policy illustration scenarios (universal life)

Best case - using current interest rates (the higher) and current mortality charges (the lower). Worst case - using guaranteed interest rates (the lowest) and guaranteed mortality charges (the highest). Mid-point - using interest rates and mortality charges half-way in between, perhaps the most likely outcome.

taxation of cash values

The interest earned in fixed contracts and account of variable contracts along with dividends and capital gains earned from the variable life insurance contract's separate accounts are tax-deferred as long as the funds remain in the policy. Upon surrender, the amount that represents an excess over the "cost basis", typically the base policy premium less any dividends paid from participating policies, is considered taxable income. Policy loans, using the cash values of the life insurance policy for a loan from the insurance company with the life insurance policy as collateral, are income tax free. The exception is in situations where the outstanding loan is greater than the cost basis when the policy lapses, then the excess value over and above the cost basis is taxed as ordinary income

universal vs. whole life

Universal life insurance offers low risk tax deferred cash values. Unlike whole life's guaranteed cash value with its pre-determined interest rate calculated and displayed in the table of non-forfeiture values, which will not be adjusted higher or lower if future interest rates change, universal life insurance cash values can fluctuate based upon a number of factors.

investment sub-accounts (variable life)

can make changes in their investment choices without incurring any tax liability. Transfers among the investment account choices may incur an administrative fee, and there could be limits as to how many transfers can take place during a calendar year Nearly all companies allow multiple-choice allocations, subject to minimum dollar amounts or percentages actual investment managers may be from the insurance company's investment department or from a third party money manager, most likely from a name brand mutual fund organization

vanishing premium plans (variable life)

depended on the performance of the underlying investment funds. Tumbling stock prices during the past decade led to many irate customers whose dream of premium relief was the only thing that vanished.

cash values (variable life)

none guaranteed, except for any money that is invested in the fixed account

premiums (variable universal life)

- policyowner can "drop in" a lump sum, make regularly scheduled (planned) premiums on a monthly, quarterly, semi-annual or annual basis, or can vary the timing and amount of premiums as wanted or needed After the first year, and subject to company imposed minimums and maximums, premium payments can be increased or decreased. They can be made more or less frequently, skipped altogether, or discontinued for periods of time providing the policy's cash value is sufficient to cover continuing internal monthly policy charges

mortality charges (universal life)

- (higher) maximum guaranteed rate - (lower) current rate: reflects the current mortality experience for the company, number of death claims paid out compared to the projected number. The company may continue charging the policy based on a current scale. On the other hand, on a class basis, but not an individual basis, it may increase the current rate. Under no circumstance can the rate ever exceed the maximum guaranteed rates listed inside the policy.

cash accessibility (variable universal life)

- Loans at low net interest charge (some companies limit the amount of the policy loan to 90% of the cash values) - Partial withdrawals subject to stated minimums/maximums and a potential small withdrawal fee - Uncontested right to surrender the policy at any time, subject to an annually decreasing surrender charge

AIR - Assumed Investment/Interest Rate (variable life)

- a.k.a. hurdle rate The actual death benefit paid out in any one year will be the greater of the internal death benefit or the minimum guaranteed death benefit: - If the actual investment returns are greater than AIR, the internal death benefit will be larger than the previous year. - If the actual investment returns are the same as AIR, the internal death benefit will be the same as the previous year. - If the actual investment returns are less than AIR, the internal death benefit will be less than the previous year.

Option A

- advantage: over time there will be a lower net amount at risk than the insurance company faces → less of an impact on the cash value account when it comes time for the monthly mortality charge deduction for the actual life insurance coverage → larger cash value accumulation - would appeal to those whose main goal is to accrue the most cash value over the life of the policy and for the least premium outlay - builds up the cash value sooner in order to discontinue premium payments and let the internal policy costs be deducted monthly from the accumulation (will decrease the cash value over time, but it will not affect the death benefit, which was set from the start anyway) corridor of insurance narrows as the cash value increases through premium payments, interest credits, or both. The net amount for which the insurance company is actually at risk is the difference between cash value and face amount. Since that corridor represents the pure insurance, the company's "amount at risk" decreases as the cash value increases. As that ratio progresses, a smaller percent of the premium is devoted to mortality charges. All things being equal over time (interest rates, administrative charges, etc.), this is why it would result in a higher cash buildup in Option A than in Option B.

taxation of death benefits

- death benefits paid to named beneficiaries received in a lump-sum are generally income tax free - interest generated by leaving the death benefit with the insurance company in favor of income distributions would be subject to income taxation

partial withdrawal (variable universal life)

- may be subject to minimum amounts such as $500 and administrative fees such as $25 - once taken can never be repaid like policy loans

whole life policy riders

- term riders: can be purchased on the primary insured, spouse, or children to cover the outstanding mortgage balance, to assure that college tuition would be taken care of, or to protect future insurability - accidental death (a.k.a. double-indemnity): pays an additional amount that is specified or equal to the face amount of the coverage issued and pays out only if death is a result of an accident independent of all other causes - waiver of premium: suspends scheduled premium payments in the event of the insured's or policyowner's disability, which has lasted at least six months. Under this waiver, all policy benefits, including cash build-up, continue to accrue

1035 exchanges

= allows for the exchange of existing insurance policies from one into another without incurring any tax liability on the interest and investment gains in the current contract - useful if another insurance policy has features and benefits that are preferred or are superior to those found in an existing contract, such as a larger or more adjustable death benefit for the same or less premium outlay, better underwriting classifications, different interest crediting rates, a wider selection of investment choices, unique and valuable riders, or more favorable settlement options - surrender charges might still apply on the existing contract, and a new surrender charge period will likely commence after the exchange on the newly acquired policy allowed: - life insurance to life insurance - life insurance to an annuity - annuity to an annuity - life insurance or annuity to long-term care prohibited: annuity to life insurance

no lapse feature (variable universal life)

= as long as the minimum required monthly premiums are paid, regardless of investment performance, the policy remains in force with the death benefit guaranteed up to a certain time period, such as the first 5 - 10 years from policy issuance or to a specified age (e.g. 70), at which time additional premium may be required - additional premiums paid in may actually extend the period of time the no-lapse protection is in place - policy withdrawals will decrease the duration of this protection may also be acquired by a separate rider issued by the insurance company for an additional premium charge. Note that some no-lapse protection benefits can place restrictions on investments into certain investment funds or place a limit, on a percentage basis, as to amounts that can be placed into those funds. Typically, its aim is to keep the policy from being overly aggressive in the investment selections which would pose additional risks to the insurer. Some companies even have a defined portfolio(s) which must be used when electing this feature or rider

defined-benefit strategy (variable universal life)

= establish a desired result and then work backwards to determine what needs to be done in order to achieve it - contribution amount will vary depending on the existing balance, current interest, and investment returns

taxation of settlement options

Annuity-type distributions, lifetime payouts, are taxed under the cost recovery rules of IRS Code section 72, which provides for the policyowner's investment in the contract to be recovered over the expected payout period. For example, $40,000 in premiums grows to $65,000 in cash values which are used to create a lifetime income payment, perhaps at retirement. A percentage of the monthly payout for life is taxed based on the payee's life expectancy, with the balance received income tax free as a recovery of the cost basis. After the cost basis is recovered and while payments continue, they become fully taxed since the source of the funds must be coming from earnings only

adjustable death benefit

If there is a need for more coverage, the policyowner and the insured, if two different persons, can complete an application to the insurer. If approved, the face amount of the policy will be adjusted accordingly. The policyowner can also request a reduction in the amount of the death benefit should the protection needs diminish or if premium funding becomes an issue. This adjustable death benefit feature allows for the policy to potentially meet the changing insurance protection needs of the policyowner without having to buy another policy or replace the existing plan. Depending on factors such as how long the policy has been in force, age of the insured, amount of coverage and cash values, a reduction in death benefit may trigger a violation of the MEC rules.

death benefit options

Option A = traditional level death benefit option where the policy pays the face amount as a death benefit regardless of the cash accumulation in the policy Option B = payout of the face amount of the policy plus an amount equal to the cash accumulation within the policy

taxation of dividends

The IRS views this as a return of premium dollars; therefore, it is not subject to income taxation. Dividends come from an overcharge in the premiums paid on participating life insurance policies issued by mutual insurance companies. The insurance company's board of directors must declare a dividend if it is going to be paid. Dividends are not guaranteed because it is dependent upon the insurance company's performance. If declared, each policy will be entitled to receive its share of the divisible surplus. The policyowner can elect to have the dividends pay current and future premiums, purchase paid-up additions, purchase one year term insurance, remain with the insurance company on deposit at interest, or paid out to them in cash. Dividends typically begin to accrue after one to two years.

guaranteed minimum & current interest rate (universal life)

The cash value is deposited into a fixed account with two stated interest rates, a current rate and a minimum guaranteed rate. The current rate is generally higher than the guarantee. In a very low interest rate economy, that may not be the case; it may actually be the same. depends upon interest rates in the marketplace that's affected by inflation, the Federal Reserve Board's actions, the Federal government's tax and fiscal policy, and supply and demand for fixed income investments. It also depends upon how well the insurance company's general account has performed and how much interest the company can afford to credit to the policy while at the same time remaining competitive in the marketplace.

cash values (universal life)

Universal life offers the policyholder the opportunity to earn more than what might be guaranteed from a traditional whole life insurance plan. If the internal charges remain constant, increases in premium payment are deposited into the cash value accumulation account which can benefit from interest credits that exceed the guaranteed minimum rate. cash buildup accumulates free from current taxation. It is technically tax deferred and taxed at withdrawal on the favorable first-in, first-out (FIFO) basis, taxable only after withdrawals exceed cumulative deposits. In other words, withdrawals to basis are not taxed, only the funds representing the excess are taxed. Cash values can be accessed one of three ways: surrendering the policy, taking policy loans, or taking partial withdrawals, also referred to as partial surrenders.

premiums (universal life)

generally lower than traditional whole life insurance policies for the same face amount, age, sex, and underwriting class, because unlike traditional permanent life insurance plans, where the cash value is guaranteed based on a pre-determined interest rate calculation, the universal life insurance policyowner assumes some of the interest rate risk amount can be more or less than contractually scheduled. By adjusting the amount of premium paid, the policyowner can lengthen or shorten the premium-paying period as well. As long as there is sufficient cash values in the policy to cover the monthly mortality charges and other expenses, premium payments can actually be skipped. may pay in any amount, subject to any company imposed minimums, or simply keep the policy in force, and a maximum, which the insurer will notify the policyowner to avoid loss of tax benefits should the policy become classified as a modified endowment contract (MEC), and payment can be made on any time schedule. Assuming sufficient cash value is in the policy to cover the monthly deduction for the insurance coverage charges, premiums can be skipped altogether. flexibility allows someone whose income fluctuates to fund a policy with maximum convenience. That feature enables the policyowner to increase the premium amount when interest rates are high to take advantage of the opportunity to earn high rates on a tax deferred basis and decrease or skip premiums when his/her budget requires or when interest credits are not as attractive. It may also be the case that if the policy is properly funded, then there may not be the incentive to add more money when interest rates are at its lowest. policyholders who contribute the bare minimum while interest rates are relatively high may be required to make mandatory contributions when rates fall in order to continue the policy

waiver of monthly deduction rider (universal life)

in the case of the policyowner's disability, as defined in the rider, the insurance company will waive its right to collect the monthly deduction from the cash values and the policy's death benefit will remain in force. It is likely that the cash values of the policy will continue to grow but with no additional premium payments, it would be based solely on the interest credited to the policy's cash accumulation account.

right to exchange for fixed benefit (traditional whole life) policy (variable life)

only available if the investment fund changes its investment adviser or if there is a material change in the investment policies or objectives of the investment fund. From insurer notification, the policyowner has 60 days to make the exchange. The new policy will be issued on the same insured, with the same policy date, issue age, and at least as much as the initial guaranteed minimum death benefit

flexibility of variable universal life

policyowner may: - switch part or all of the cash values into different investment accounts in response to changing market conditions and financial objectives - switch death benefit options to either bolster cash value accumulation or increase the death benefit - decrease or postpone premium payments if the cash flow is sufficient - increase premium payments (within IRS limits) to enhance cash value accumulation or to increase the death benefit

death benefit (variable universal life)

provided by drawing enough money out of the investment account each month to pay for what is essentially one-year renewable term life insurance coverage in an amount equal to the difference between the investment account balance and the policy's face amount, the net amount at risk. Conceivably, if the invested balance falls below an amount sufficient to cover the insurance cost, additional funding would be required to keep the policy in force

annual reports (universal life)

required to be available and sent to policyowners to show the status of the policy. This shows how much premium and when it was paid, as well as any expense deductions that may have been taken out before the net premium went into the cash accumulation account. From there, it shows how much was deducted for mortality and other charges after which interest is credited to the values in the cash accumulation account. Insurance company home offices and some company's field or agency offices require in force illustrations to show the status of the policy at a point in time.

charges/expenses (variable universal life)

typically deducted from the premium: - sales load - administrative expenses - premium taxes typically deducted from the separate accounts: - costs of insurance - mortality costs - investment management fees

universal life vs. variable life

universal life = policy with attached bank account at declared interest rates variable life = policy with attached investment account funded with mutual fund like portfolios that's subject to market fluctuation

cash values

- accessible by cashing in the policy, known as surrendering, or by borrowing against it - guaranteed amount is not taxed as it accrues in the policy, nor is it taxed upon surrender, unless and until it exceeds the total amount of premiums paid into the policy

fixed account (variable life)

- available in various holding periods - with its rate guarantees, is a better choice for the ultra-conservative investor - invested primarily in conservative, high-grade corporate and government bonds - may be several fixed accounts, offering various durations with different guaranteed rates - funds held inside the fixed accounts are backed by the insurance companies' general account and are, therefore, considered guaranteed - pay a certain fixed rate of interest which is guaranteed for a stated period of time (usually 1 year), after which the insurance company may reset the interest rate Some companies place restrictions on the ability to move funds out of this account. For example, no more than 25% of the account balance can be transferred out in any one year. The insurance companies do not want this to act like or be considered as a money market account for trading in and out of. Fixed accounts typically credit 3%-4% annual interest depending on the holding period The longer the time period in the fixed accounts, the higher the rate; the shorter the time period, the lower the rate. This mirrored the primary underlying investments made by the insurance company to support these accounts: U.S. Government and high-grade corporate notes and bonds

premium (variable life)

- fixed & required to be paid in full and on-time to keep the policy in force - no flexibility with regard to the payment of premiums - net premiums can be directed into one or more mutual fund like investment sub-accounts, which offer potentially high returns at varying degrees of risk

grace period (universal life)

- not based on the premium being paid by the actual premium due date; instead, it relies on the cash value account having sufficient funds to cover the upcoming monthly deduction for mortality charges and expenses - companies may require 2-3 months' worth of anticipated deduction amounts be sent in to avoid the policy from lapsing

policy loans (variable universal life)

- requires that the policyowner incur an interest charge - net loan interest rates are very competitive

overfunding

= pay more than the established premium of a universal life policy - can help to ensure that there will be a balance to prevent lapse - hedge against lowered interest rates as well as a method of building up accessible cash values for eventual living benefits down the road Going beyond certain maximums can cause a policy to become a MEC, thereby losing some significant tax advantages, upon taking cash from or against the policy. Recognizing that insurance companies will not become aware that premium amounts have exceeded the MEC limits until they have been already invested, the IRS provides a 60-day window for the insurance company to return the excess as if it had never been paid in. The company is responsible for making the calculation and providing the information to the policyowner.

death benefits (variable universal life)

Option A provides a level death benefit, with the cash value available for loan or withdrawal, but not added to the face amount at the insured's death. Option B, the cash values would be added to the death benefit. Depending upon the death benefit option chosen will determine the impact on the cash values long range. Typically, Option A generates more cash value measured at age 65 than will Option B due to the larger net amount at risk to the insurer and the increasing mortality cost as the insured ages. Option C, which would provide for a level death benefit plus an amount equal to the cumulative premiums paid - minimum face amount requirement of at least $50,000 or $100,00 - like with universal life, the policy's death benefit is adjustable - minimum and maximum amounts of any adjustments are also specified in the policy -cost for providing the death benefit is deducted from the cash value accumulation account which, if invested outside the fixed account option, is likely to experience both the ups and downs of the stock and bond markets - needs to be sufficient funds in the cash value accumulation account to keep the policy in force for some policies, the death benefit is: - Not guaranteed and can fluctuate daily with the investment performance of the underlying investment funds - Guaranteed for a limited period of time, such as 3 - 5 years, with a monthly cost associated with the guarantee (no lapse premium) - Guaranteed to be equal to a percentage of the cash value ranging from 100-250% (in order to comply with IRS tax regulations

no-lapse rider (universal life)

as long as a certain minimum designated premium payment is maintained, the policy is guaranteed to stay in force to a particular age such as 70, 80, or even age 120. However, that minimum premium paid to simply maintain a death benefit is rarely sufficient to build up significant cash values and almost sounds and can act like term life insurance Some policies build-in to the premium cost structure enough to guarantee against policy lapse for certain durations of time, for example, during the first five years from issuance, provided at least a minimum premium is paid on time and in full. Other policies offer this no-lapse benefit as a rider with a separate premium from the base life insurance policy. The cost of the rider will depend upon the length of the guarantee. Guarantees to age 90 will cost more than guarantees to age 70. Of course, along with the guarantee comes a minimum premium requirement.

modified endowment contract (MEC)

money taken from a MEC in the form of policy loans or withdrawals, partial surrenders or even outside loans secured by the policy are subject to income tax and possible penalties Single premium life insurance policies, along with universal life and variable universal life, are susceptible to becoming labeled as a MEC rules look at the age of the insured, the life insurance policy's face amount of coverage, and the premium In general, the rules state that for the policy to be classified for tax purposes as a life insurance policy, there is no reason for the plan given an insured's age and the death benefit to have more cash inside it to end up with a policy with very little net amount at risk to the insurance company or the amount of premiums paid into it, on an on-going basis or cumulatively, to be more than is necessary to have it paid up for life material changes to universal life or variable universal life, which will trigger MEC classification: - increase in the premium payments - change in the plan of insurance to one that doesn't justify an extraordinarily high cash balance in relation to the policy's face amount - reduction in the death benefit, creating imbalance between the death benefit and the cash value 7-pay test = if too much is put in per year or cumulatively within the first seven years, the policy could violate the MEC rules way around the 10% penalty is similar to that of annuities and IRA distributions—withdrawals as a result of disability, or over substantially equal payments over one's life expectancy, or taken after 59½

Option B

potential for the most insurance protection without sacrificing cash buildup, but at a higher internal cost, since the net amount at risk will remain constant while the mortality charges increase. This will likely have a significant impact on the amount of cash values as well as on the total death benefit in later years. In certain interest rate environments, the insurance company may need to request the policyowner pay in more funds to keep the policy going. Assuming no withdrawals, the face amount is augmented by the cash value and the entire amount is received by beneficiaries free from federal income tax. Under long-prevailing law, this holds even if the policy had been overfunded into a MEC. The policy funding of Option B must be closely monitored since the net amount at risk (corridor) remains constant throughout the life of the policy. As the insured gets older and the internal charges increase the actual amount deducted from the policy, the account value will rise dramatically causing both the cash values and overall death benefit to decline.

universal vs. variable vs. variable universal

universal life: amounts and timing of premium payments can vary, but policyholders have no control over the investment portion of the net premiums. It's all deposited into a fixed, interest-bearing account with a guaranteed minimum interest credit or a current interest credit variable life: policyowners can select among a variety of investment options, but the premium amounts and due-dates are fixed variable universal life - policyowners pay whatever amount they want, subject to contractual and company minimums and maximums, whenever they want - flexible premium and adjustable life version of variable whole life insurance - incorporating the premium flexibility and death benefit adjustment features of universal life insurance while providing for policyowner-directed investment of the premium amount dedicated to cash accumulation as well as the existing cash values

waiver of planned premium rider (universal life)

waives an amount equivalent to the planned premium, whether it had been actually paid or not, in cases where the policyowner becomes disabled. This rider will not only keep the death benefit in place but will also fund the policy in such a way as to allow the cash values to grow. The cash values would also be accessible and can be used as needed by the policyowner.

mortality charge vs. current rate

while the mortality charge increases with the insured's age, a policyowner can keep pace by adding to the planned premium. The mortality charge has a maximum rate beyond which the company cannot charge, but most companies charge what is known as the current rate. Given that there are two interest rates, a guaranteed minimum and a current rate, and two mortality charges, a guaranteed maximum and a current rate, a universal life policy must be closely monitored to be certain that it is adequately funded. It is possible for either or both rates to change.

policy surrender (variable universal life)

Depending upon when a full surrender is requested will determine what percentage of the cash value that will be paid to the policyowner. Similar to universal life insurance, there is a surrender charge schedule which is applied to the account values during the first 10-15 years, depending on the company and policy, which decline over the years to zero. Surrender charges may decrease annually from the start or may hold steady for a while and then decrease

funding strategies (universal life)

- minimum funding = paying just enough to cover expenses—not a viable choice in early years as it may have an impact on any policy guarantees and the policy would act similar to term life insurance - adequate funding = paying just enough to maintain the policy with minimum cash values - investment funding = over-funding to increase cash values for future use - maximum funding = paying the company's stated maximum to achieve all of the benefits the policy has to offer and provide the utmost flexibility in the years ahead

traditional whole life

- if policy is participating (issued by mutual insurance company), then may also receive dividends that can generally be withdrawn tax-free for any purpose - provide specific benefit for set premium with little flexibility - combo of decreasing term insurance (coverage that decreases periodically) + a growing cash value, in that the face amount is constant as the interior cash value builds up - allows the premium and investment percentage to remain constant. Mortality costs increase with age, but the cash buildup offsets that reality - guaranteed cash values with a pre-determined fixed interest rate credited to the cash values - well suited to needs that do not diminish over time, such as paying estate settlement costs, final expenses, and taxes - loans are received income tax free while the policy remains in force

cash values (variable universal life)

- market-condition and investment-choice sensitive cash value accumulation account builds up over time from the premium payments and the investment earnings from the separate accounts selected. The cash value can be used by a policyowner for non-insurance purposes during his/her lifetime. Variable universal life insurance does not provide a minimum guaranteed cash value. Instead, the cash value is dependent on the performance of the separate accounts selected. All of the risk from the individual account performance is assumed by the policyowner. The cash value account functions independently of the insurer's own investment portfolio After any upfront costs are deducted, the net premium is deposited into the cash value accumulation account where the internal cost of the death benefit is deducted with the remainder, along with the existing cash value, is invested. In the event that the monthly charges for mortality and expense risk, taxes, cost of insurance, and monthly administrative charge exceed the balance of the internal investment account, policyowners must be notified before a lapse is processed. Similar to universal life insurance, this time period is 61 days from notice Each asset classification carries its own unique benefits and risks; together, they provide the opportunity to create a tailored, diversified investment strategy. The return on those investments is credited to the contract. The policy value is determined by multiplying the number of accumulation units (similar to shares of a mutual fund) to the value of each unit as calculated at the end of each day the markets are open. Like mutual funds, any portfolio interest earned, dividends received, or capital gains realized are reinvested in additional full and fractional units of the investment fund. Note that investment funds can be closed to new deposits or replaced or substituted with other fund managers if costs get too high or performance is not in line with other similar investment objective funds. The fixed account typically does not impose an asset management fee like the other investment choices. Dollar cost averaging and portfolio rebalancing are available on variable universal life insurance policies. It is possible that insurers will not allow both features to be in effect at the same time. Automatic rebalancing may be required to keep certain riders in effect such as the no-lapse protection benefit.

policy exchange (variable universal life)

- may be exchanged for a non-variable life insurance policy at any time typically within twelve months after policy issuance - new policy will be issued with the same policy date, issue age, and initial death benefit of the variable universal life insurance policy

partial withdrawal (universal life)

- not a loan so no interest is charged; however, the remaining policy has a reduced death benefit and cash value - administrative fee and withdrawal minimums are likely - once taken can never be repaid like policy loans can - Option B death benefit: accumulation value would be reduced but not the initial specified death benefit amount

separate account (variable life)

- provide a range of investment options from which the policyowner can select: growth, value, index, balanced, overseas, money market funds, fixed accounts - performance of the underlying separate account portfolios is reflected in the death benefit and cash values

transfers (variable life)

- some companies restrict the number of internal account transfers that may be made during a year as well as investment minimums per transaction and per separate account - some companies may even charge for effecting changes from one separate account to another

policy loans (universal life)

= borrow against accumulated cash values - policy loans are not reported to any credit agency - generally limited to a percentage of the accumulation, 90% is common, and an interest rate is charged - as long as the policy has not become a MEC, loans are considered to be a non-taxable event - cash value of a universal life insurance policy is used as collateral for a policy loan (loans are based on cash value balances, but are actually extended from the insurance company, while a like amount is "frozen" in the policy as collateral) As such, it continues to earn at least the minimum guarantee, making the net interest rate paid on the outstanding loan that much less. A 6% loan interest rate offset by a 3.5% guaranteed minimum interest credit means the net loan cost is 2.5% generated from the insurance company directly using the cash accumulation account and death benefit as collateral. Interest is charged for the loan while it is outstanding. The loan can either be repaid, recaptured upon policy surrender or at the time a death claim is submitted. Repayment of the loan is not required like with an installment loan or mortgage, but if the interest is not paid, it is added to the outstanding loan balance, which removes an additional amount from the available cash value. If that remaining balance is not sufficient to cover the internal deductions and interest, the policy will lapse. Any outstanding loans will be deducted from the payout in the event of the insured's death or upon cash surrender. Loans will have a long-term effect on the policy, reducing the policy's reserves, lowering the cash value, requiring continuing interest payments and possibly resulting in a need for higher premium payments as remaining cash values may not be sufficient to cover higher mortality charges that increase with the age of the insured. As with nearly all personal loans except home mortgages (currently), the interest paid is not tax-deductible. Policies that lapse with an outstanding loan balance greater than the policy's cost basis will trigger a taxable event

policy loan (variable life)

= borrow against the cash values of the policy at pre-determined fixed interest cost Any outstanding loan and loan interest will reduce any values upon surrender of the policy and payment of any death benefit may be an enhanced policy loan feature that lets the policyowner borrow from his/her cash value at or near a zero net interest cost when specific cash value amounts are achieved or when the policy has been in force for a certain number of years. This is achieved by the insurance company extending the loan from its own accounts at 4%, for example, and holding, or "freezing," an equal amount in the borrower's policy as collateral and crediting 3.5% to that amount, making the net cost of the loan one-half of one percent. Essentially, the policyowner is moving money out of the separate account equal to the amount of the loan, and it is placed into a fixed account supported by the insurance company's general account

variable universal life

= combines the features of universal life and variable whole life into one policy - provides dual control: when premiums are invested and what investment funding vehicle the investment is made in - plain variable whole life has taken a back seat to variable universal life primarily because of the premium flexibility - tax regulations that must be adhered to when cash withdrawals are made so that no negative income tax consequences occur - grace period is the same as with universal life insurance - developed in response to the inflation and high interest rates of the 1970s and early 80s, which made the rates of return on traditional whole life policies uncompetitive - most complex financial product in insurance market

universal life

= form of permanent life insurance that combines flexible premiums, adjustable death benefits, and cash values that can earn interest credits based on current money market rates - technical name for universal life is flexible premium adjustable life insurance - combination of one year renewable term insurance and a "savings" component within the policy Universal life also offers cash value with a current fluctuating annually declared interest rate with a guaranteed minimum amount stated in the contract. The death benefit can be level or increasing, and can be reduced from the initial amount applied for or increased with proof of insurability The client best suited for this understands that interest rates fluctuate over time, and they are willing to review the progress or lack thereof in the cash values and take any necessary and appropriate action to keep the policy in force. They are also looking for premium flexibility in case their financial situation changes for better or worse, along with the ability to make changes in the face amount, and would rather work with one policy, one producer, and one life insurance company to address their changing life insurance needs. These individuals have a need for insurance and also favor a conservative savings plan. While there is no actual investment choice, as in variable life insurance plans, the cash values are not subject to market risk, and do have a guaranteed minimum interest rate. Universal life is unique in many respects.

prospectus (variable life)

= most important and complete source of information about a variable contract's inner workings, including fees, expenses and charges, goals, government requirements, and investment options - w/o it, any variable contract sale would be prohibited contains: - various subaccounts' investment objectives and policies - management fees and other expenses charged - risks and volatility of the accounts

death benefit

= net amount at risk (the difference between face amount of coverage & policy's cash value) for insurance company + cash surrender value of policy - net amount at risk to the insurer decreases over time as the cash values build

front load

= not crediting any cash values for the first few years to offset the costs of issuing a policy, which include sales commissions, underwriting, medical exams, etc.

limited-pay life

= premium is higher than under straight life policy issued at same age, which allows the policy to be paid-up prior to the endowment age - also pays a face amount at death or maturity and charges a level premium - can be issued to be paid-up in one year (single premium life), 20 years (20-pay life) or by age 65 (life paid-up at 65) - due to higher premium, usually accumulate a greater cash value in a shorter period of time than a straight life policy - provide for policies to be considered paid-up when certain milestones are reached (e.g. after a period of time or at a particular age like 65) - in a nod toward increased longevity, most companies now can hold the money at interest as an eventual death benefit, which may have tax advantages to the policyowner and to the beneficiary

interest rate risk

= rates may go down to and never rise above the guaranteed minimum stated in the policy. This interest rate risk will have a significant impact on the performance of the policy and the premiums required in order to maintain the policy

defined contribution(variable universal life)

= selecting and maintaining an amount of premium and living with whatever result it creates - more common approach of variable universal life insurance buyers - to offset poor investment performance, the policyholder may have to pay additional lump sum premiums or pay higher than planned premiums

variable whole life

= type of permanent life insurance with a fixed premium = whole life insurance policy that allows the policyowner to direct a portion of the premium into a separate account (such as stock, bond, & money market funds) which serves as the basis for policy benefits = protection features of whole life insurance + growth potential of various investment options found in the insurance company's separate account - minimum guaranteed death benefit - any investment income, realized capital gains, or interest is automatically reinvested - considered a security and can only be sold by prospectus from securities registered representatives Variable life is a form of life insurance that transfers risk to the policyowner. For those who are willing to take on investment risk with their life insurance policy in order to potentially achieve a greater cash value accumulation and greater overall total death benefit Other than the death benefit and the fixed account, the insurance company assumes no risk. Because the policyowner assumes all of the investment risk, there is no similar "floor" below which cash values may fall.

surrender charges (universal life)

For a period of time, the cash or accumulation value available will be less than the cash value accumulation. The gap between the two is due to the surrender charge that will be imposed for withdrawals during the first 10-15 years. The surrender charge is a declining charge based on a percentage of premium paid or on the entire cash value. The charge eventually disappears, and the cash value is then fully accessible. The surrender charge table will resemble ones used with annuities. The year-by-year declining withdrawal or surrender charges are represented by the difference between a policy's accumulation account balance and its current cash surrender value. The cash surrender value is the amount accessible by loan, through withdrawal, or at surrender. Surrender charges, assessed in the early years of a policy, can be based on a decreasing percentage of the cash value or premiums paid. Charges may decrease annually from the start or may hold steady for a while and then decrease The total amount received at surrender is taxable only to the extent that it exceeds the cumulative paid-in premiums. If the policy is a MEC, the total earnings may be taxable and possibly surtaxed as well if withdrawn prior to age 59½. Conversely, if the amount received is less than the cumulative premiums, the difference is not a tax-loss deduction as an outside investment loss might be. Surrendering the policy means giving up the death benefit protection originally intended for the named beneficiaries. Also, like annuities, some companies may allow up to 10% of the cash to be withdrawn without incurring a surrender charge. Some companies will "carry over" that privilege; if no withdrawals in a particular year, up to 20% will be charge-free the following year. Both of these limits relate mostly to single pay universal life because cash buildup is slower to develop in conventional universal life insurance policies. The MEC rules tend to discourage withdrawals from any single pay policies prior to age 59½ due to the imposition of a 10% tax penalty on top of the taxable event it creates.

death benefit (variable life)

Most variable policies include a guaranteed minimum death benefit, assuring the policyowner that the death benefit will not fall below the initial face amount selected even if the investment accounts fare poorly. This is contingent upon the scheduled premium being paid. The guarantee is based on the claims paying ability of the insurance company. The actual death benefit could be higher than the face amount of the policy depending upon the performance of the selected investment options. This is not only a side-effect of high-earning investment funds, it also keeps the corridor of coverage—the gap between the cash value and death benefit at any given age—at a level that preserves the policy's tax treatment as insurance rather than as an investment, like an annuity. Those advantages include tax-deferred growth, tax favorable withdrawals and tax-free death benefits. Because of the reliance on market conditions, the cash value fluctuates. There is absolutely no guarantee to the amount of the cash value invested outside of the fixed account. If the underlying subaccount investments do not perform well, any previous increases above and beyond the guaranteed minimum death benefit may be recaptured. Going forward, any "losses" would first have to be made up before the total death benefit could ever again exceed the guaranteed minimum.

cash value accumulation account

policy's costs are being deducted from the cash values while the balance is credited with interest Premiums paid, after any up-front charges, are deposited into the cash value accumulation account, where the policy's costs are being deducted from the cash values while the balance is credited with interest. In a significant departure from traditional plans, however, universal life provides for the automatic monthly payment of the mortality costs from the accumulated cash value even if the planned premium is not paid. As long as there is enough cash value in the account, the policy does not lapse Rather than pre-determined cash value as in traditional whole life, universal life's cash value is based on the timing and amount of the premium deposits, expense deductions, and an interest credit (which can vary) all taking place within the cash value accumulation account. After the net premiums are deposited into the account, deductions are taken for the mortality charge and company expenses. The monthly mortality charge is based upon the age, gender, and rating of the insured at the time of policy issue. The balance is credited with a current interest rate, set by the company, and is subject to adjustments based on the company's underlying earnings. All universal life contracts specify a guaranteed minimum rate ranging typically from 3-4%.

option switching

some insurers allow a limited amount of switching between the two while the policy is in effect. Such changes may require a greater or smaller premium commitment, based on the company's increased or decreased risk, but it affords the policyowner a certain measure of control. Someone with a limited life expectancy, for example, could shelter funds from eventual taxation by dumping them into an Option B Universal Life Insurance policy. Some companies may impose a minimal charge to make the switch, and moving from A to B may require providing proof of insurability.