CFP Class 1, Module 6 - Life Insurance & Annuities

Common Life Insurance Needs Rules of Thumb - 4

1. Income Replacement Approach or Human Life Value, 2. percentage of income method, 3. personalized needs approach, or 4. multiple of salary approach.

Education Funding Example: Five-year old, four years college. Current year of college expenses totals $25,000, inflation 6%, and earn 7% on their investments. Using three-step approach, how much life insurance is needed? Death tomorrow.

13, N; 6, I/YR; 25000, +/-, PV; and solve for FV, which equals $53,323, represents cost of first yr. BEG, 4, N; 1.07/1.06 = 1.094 - 1 = 0.009434 x 100 = 0.9434, I/YR; 53,323, +/-, PMT, solve for PV = $210,321 sum needed at beginning of first year needed to cover four years of costs. 13, N; 7, I/YR; 210,321, FV, solve for PV = $87,276.

Common Life Insurance Needs Rules of Thumb - Personalized Needs Approach - Final Step

Add up Four LIFE Category totals = life insurance needed or death benefit needed minus any existing life insurance. Leave out savings /investments/other assets unless client insists will be used to reduce life insurance need. Must be done for each spouse individually.

Capital Retention vs. Capital Utilization Model

Additional premium of capital retention over capital utilization model relatively small despite larger death benefit. If beneficiary lives beyond life expectancy principal continues generating income & principal can be passed on to heirs.

Life Insurance Needs Analysis - Client Profile

Age, income, health, marital status, savings/investment level, goals/objectives, survivor's needs, estate liquidity needed, risk tolerance, existing Insurance all important.

Agree on Economic Assumptions when Determining Life Insurance Needs

Agree on inflation rate estimate, after tax return. Be conservative and get client buy in. Always assume client will die tomorrow when estimating need.

Universal Life Flexible Premium Amounts

Allow owner to decide when & how much. Only limitation is that cash value must be enough to allow policy reserve to cover cost of next month's charges.

Interest Sensitive Life Insurance - Universal Life

Also called flexible premium adjustable life. Pimary difference between Whole & Universal Life is products unbundled in latter. Can see risk elements like mortality, cost of insurance, expense charges, admin fees & credited interest. U for unbundled but real advantage is flexibility.

Whole Life Limited Pay Policies

Also known as Limited Pay Life Policies, have shortened premium paying period. Death benefit continues for life of insured or until age 120 when policy endows, but premiums stop earlier.

Equity Indexed Universal Life Downside Protection

Assume S&P 500 dropped 10% over a given index interval. Account value would remain unchanged from its starting point for that interval. Didn't earn any interest but didn't lose any money. Participate in market gains while avoiding its losses.

Capital Utilization Example: 45 year old wants to replace 50k, of 80k income. Salary increase 3% per year, and plans to live to 90 at 6% interest.

BEG, 45N, 1.03 INPUT 1.06 Shift % Change = 2.9126 I/YR, 50k PMT, solve for PV = 1,281,305 invested at 6% annually will generate 50k annually starting tomorrow until capital depleted at 90.

Universal Life Costs

Based on net amount at risk plus expense charges which may consist of fixed dollar amounts, level percentage of premiums, policy origination fees, and/or first year load. As all unique, some UL policies cost more than traditional policies.

Variable Universal Life (VUL) Insurance

Built on Universal Life platform. Also known as flexible premium variable life. VUL marries flexibility of Universal with investment selection of Variable, but VUL only guarantees mortality rate & right to keep policy in force by paying premiums required should cash value decline.

Variable Life (VL) insurance

Built on Whole Life model. Owner chooses sub-accounts. Premiums are fixed but face amount & cash values vary by sub-account's earnings. Usually guarantees death benefit will never be less than initial face amount.

Monitor Life Insurance Needs Over Time

Calculations are made as of today as assume client could die tomorrow, so monitor/update at set intervals.

Universal Life Adjustable Benefits

Can adjust face amount of the policy as needs change. Kids grow up so need less life insurance, so adjust existing policy down rather than having to buy new one.

Adjustable Whole Life Waiver of Premium Rider

Can choose a disability waiver of premium rider that waives scheduled premium or one that will waive the Whole Life equivalent premium. Second option pricier but may increase policy value.

Life Insurance Needs Analysis - Risk Tolerance

Can refer to cash value fluctuations of policy if any. Low to moderate tolerance than Whole or Universal Life could be appropriate. Moderate to high consider Variable Life or Variable Universal Life, which provide returns based on underlying market sub-accounts.

Common Life Insurance Needs Rules of Thumb - Personalized needs Approach - Income Replacement

Can use human life value approach which uses capital utilization /depletion here or could use capital retention where principal used to generate income remains intact or depleted very gradually.

Modified Endowment Contract (MEC)

Cash value policy that builds cash value faster than a 7 Pay Whole Life Contract and therefore loses life insurance tax advantages. Failed 7 step test, which is owner deposited more than total net annual premium payments at any given time in first 7 years. All single premium life policies MECs.

Universal Life Policy Features - Admin Expenses - Banded

Charges may vary according to face amount. Banding identifies range of face amount (10-99k) death benefits. In lower band may have one charge while death benefits in higher band may have lower charge.

Benefits of Keeping Existing Life Insurance Policies

Client has already paid acquisition costs, time periods for incontestability & suicide clauses may have already expired, older policies may have higher dividends, client already qualified.

Life Insurance Needs Analysis 7 Aspects

Client profile, goals & objectives, survivor's needs, estate liquidity, risk tolerance, existing insurance, amount of insurance needed.

MEC Example

Created by TAMRA. Policy's annual premium 2k, max deposits in first 3 years can't exceed 6k. If deposit 1k first 3 years, can still deposit 4k & avoid MEC classification. Once a MEC, always a MEC. Can still become a MEC after first 7 years i, which starts another 7-year premium pay period.

Universal Life Policy Features - Admin Expenses - Current

Current charges against the cash fund for each premium paid.

Universal Life Policy Features - Mortality Charges - Current

Current year's charge against the contract usually lower than the guaranteed rate. Based on company's actual experience vs. the mortality schedule.

Universal Life Option 2 or B

Death benefit equal to initial face amount plus cash value. Effectively a level term policy with an increasing cash value, as term insurance gets increasingly expensive with age, larger amount of premium goes to term vs cash value.

Endowment instead of Insurance

Death benefits & cash surrender value same at a specific date, like 20 years from issue. Used to be popular but Congress Changed laws with Technical & Miscellaneous Revenue Act (TAMRA) of 1988. Now less popular.

Selection Facts In Life Insurance Selection

Define the client's specific circumstances. These are then taken into account in selecting an appropriate type and amount of life insurance.

Equity Indexed Universal Life Participation Rate

Dictates percentage of index gain credited to the policy. Assume Equity Indexed Universal Life uses S&P 500 which gains 10%. If have a 70% participation rate, 7% credited to the policy.

Life Insurance Needs Analysis - Client Profile - Health

Direct impact on cost. Underwriters decide if client preferred, standard, or a substandard risk based in part on health. A client who is "rated" or substandard by one insurer may not be rated or charged extra by another.

Capital Retention Example: 45 year old wants to replace 50k, of 80k income adjusted for inflation. Salary increase 3% per year, 6% interest.

Divide 50k by inflation adjusted rate of return 1.03 INPUT 1.06 Shift % Change = 2.9126 I/YR = 1,716,667, have to add percent sign after 2.9126, needed to generate 50k for first year and an increasing amount thereafter without reducing the principal.

Universal Life Policy Features - Credited Interest - Interest Credited on Loaned Amounts

Dollar equivalent of a loan on the contract. May receive the current credited interest rate or some other, lower rate as defined in contract.

Common Life Insurance Needs Rules of Thumb - Personalized Needs Approach - Education Funding

E in LIFE model. Use 3-step college funding calculation where college cost inflated, PV of annuity due serial payment calculated, then discounted to PV, or can take college cost today & multiply by 4 years kid will be in school as death is assumed to be tomorrow.

Life Insurance Needs Analysis - General Survivor's Needs

Examples include education fund, income, retirement fund, postmortem emergency fund, adjustment fund allowing spouse to travel, stop working etc., to adjust to death & estate liquidity.

Common Life Insurance Needs Rules of Thumb - Personalized Needs Approach - Final Expenses

F in LIFE Model. Final expenses include funeral arrangements, 6 month emergency fund, final medical costs, adjustment fund, sum for charity. Know your area's funeral costs. Medical costs estimate done by taking health insurance's max out of pocket limit as a guide.

Personal Financial Information Needed to Determine Life Insurance Needs

Family demographics, including ages, attitudes, goals, health status, and personal resources. Other information includes the amount of total debt, current and expected costs for college, anticipated inflation rates, and long-term rates of return.

Variable Universal Life Investment Account Charges

Few policies offer volume discounts since VUL subject to contingent deferred sales charges (CDSCs).

Adjustable Life Advantages/Disadvantages

Flexible, know how long benefits guaranteed unlike Universal Life. Can end up being pricey term policy if pay only minimum premium & dividends inadequate to continue policy at initial premium rate similar to Universal Life. Easy lapse. More expensive than regular Whole Life.

Universal Life Policy Features - Other Charges - State Premium Tax & Withdrawal Charges

Generally 2-3% of any premium paid. Some companies charge same amount in all states so low tax states subsidize high tax states. Withdrawal charges are fees for money taken out of the contract

UL Policy Features - Mortality Charges

Guaranteed schedule of mortality rates included with contract giving max charge at each age.

Universal Life Policy Features - Admin Expenses

Guaranteed, contract states max dollar or percentage amount to be withdrawn. May be flat or percentage of premium, or cost per thousand of face amount or net amount at risk.

Variable Life Premiums & Risk

Higher premiums than for an equal amount of Whole Life. Give up guaranteed cash value for possibility of greater cash value/death benefit. Investment risk on policy owner.

Group Life Insurance

If all they have is group insurance may want to consider an individual policy. If need to maintain coverage post employment may be forced into an expensive conversion to an individual policy.

Universal Life Policy Features - Other Charges - Surrender

If contract terminated before death, charge may be made against contract's cash value. Typically ranges from 5-15 year sliding scales (10% charge for year one down to 0% for year 5). Annual statement often shows both surrender value & accumulation value.

Universal Life Flexible Premium Payments Disadvantages

If owner does not pay enough, cash account will be depleted & minimum & increasing payments will have to be made at that point to rebuild cash value. If cash value stays low, premiums will keep increasing just like term insurance.

Life Insurance Conversion Privileges

If rated client eventually wants to change to permanent insurance from term, it's much easier to convert within the same company due to conversion privileges, so keep permanent products in mind as well when selecting term company.

Variable Universal Life Policy Loan Effect

If take a loan insurer normally moves collateral cash value into the policy's guaranteed return account until loan paid off. Guaranteed return accounts very conservative & work against general purpose of using variable products.

Whole Life Endowed Policy

Insured reaches age of mortality 120. Reserves equal death benefit & policy has endowed. Accumulation paid out but amount received exceeding owner's basis or premiums paid taxable as ordinary income. New option company keeps funds to avoid taxes owner takes out loans instead.

Universal Life Policy Features - Credited Interest - Current Rate

Interest rate credited on deposit/premium. Usually guaranteed for one year. Frequently indexed to money market type rate.

Universal Life Policy Features - Credited Interest - Blended Rate

Last year's premium may receive a different rate than current premiums. Take older rates & blend them with current rate. No consistent method of calculating this.

Capital Utilization LIFE Example

Liabilities: $420,000. Income replacement: $848,970 Keystrokes: SHIFT, BEG; 56, N; 1.07/1.03 = 1.0388 - 1 = 0.03883 x 100 = 3.8835, I/YR; 36,000, PMT and solve for PV. Final expenses: $25,000 Education Total via three step: $113,443. Total need: $1,407,413 Minus current insurance: $50,000. Life insurance needed: $1,357,413.

Capital Retention LIFE Example

Liabilities: $420,000; Income replacement: $926,999, take-home pay of $36,000/0.038835 as the inflation-adjusted rate of return. Final expenses: $25,000. Education Funding: $120,000. Total Need: $1,491,999. Less current insurance: $50,000. Additional life insurance needed: $1,441,999

Life Insurance vs. Annuities

Life insurance pays beneficiaries when insured dies. Annuities pay when annuitant alive.

Equity Indexed Universal Life Rate Cap

Limits interest Equity Indexed Universal Life can earn by capping credited rate. For example, policy linked to S&P 500 with a 12% rate cap. Can't go over that even if S&P increases by much more.

Identifying Goals Helps Determine Amount of Life Insurance Needed - Examples

Liquidity at death for estate, dependent income fund, education fund, final expenses such as funeral and medical, emergency fund, all examples of goals.

Equity Indexed Universal Life Ratchet or Point to Point Method

Locks in the gain credited to the account each policy year. Index value at end of one policy year becomes starting value for next policy year.

Single Premium Whole Life Policies

Make a lump sum payment & no further premiums paid. If surrendered within first few years, big charges. Special tax rules apply as classified as a Modified Endowment Contract or MEC. Best used when someone has lump sum for specific bequest.

Universal Life Policy Features - Credited Interest

Minimum guaranteed rate to be credited to the cash value. Cash value feature what distinguishes UL from term insurance.

Universal Life Policy Features - Premiums

Minimum premium large enough to cover expenses/mortality. Target premium based on interest rate. Expected to be relatively stable over contract's life. Max amount of money contract can accept without becoming a MEC.

Universal Life Option B Level Death Benefit Option

Mortality cost increases with age. Amount of term protection decreases as cash value increases each year.

Whole Life (WL) Insurance

Most common type of permanent insurance. Has fixed premium, guaranteed cash value & death benefit & minimum guaranteed interest rate. Premiums initially higher than term, but stay level.

Amount of Life Insurance Needed

Most important question is how much, not what type. How much frequently determines type. Large amounts probably require term, as permanent too expensive. Term for temp needs, permanent for permanent needs. Can use a combo of both when calculating amount needed.

Death Benefits of Term Insurance

Most term insurance policies are either allowed to lapse prior to death so no death benefit, or are converted to cash value policies.

Common Life Insurance Needs Rules of Thumb - Multiple of Salary Method

Multiply wage earner's salary times a number that works for client. Most use 6 to 10. Younger client's need larger multiples, but not all client's need income replacement.

Participating Whole Life Policies

Mutual insurance companies sometimes pay dividends. Considered excess premium. Policy reserves based on conservative interest rate. But earn more than this so return a portion of excess as dividends. Until cumulative dividends exceed cumulative premiums paid, dividends tax free.

Selection Facts in Life Insurance Selection Process Subjective

No single factor can be considered in isolation; all facts must be weighed together. Any weighing process is somewhat subjective.

Equity Indexed Universal Life Percentage Change Method

One method for measuring change in underlying index only looks at index's starting & ending points at a set interval. Fluctuations in between disregarded. If during that period index declines, no gain credited to account.

Universal Life Option 1 or A - Risk Premium

Or "term premium" is the cost of providing insurance to cover net risk. Generally net amount at risk is the difference between cash value & death benefit. UL policies operating like this called Option 1 or A policies. Owner buying a tax deferred cash value fund & decreasing amount of term insurance.

Equity Indexed Universal Life (EIUL)

Or Indexed Universal Life, another form of fixed, permanent life insurance. Has a minimum fixed interest rate but also allows owner to potentially earn better rates through market indexed returns.

Universal Life Unbundled Structure & Full Disclosure

Owner knows exactly where premium dollars going. Full disclosure of where money is going. Expenses & charges vary widely so policies should be studied.

Universal Life Policy Features - Other Charges - Policy & Premium Fees

Policy fees may be for first year only or annually. Premium fees either a percentage of premiums or a fixed dollar amount per premium payment.

Adjustable Life Cost of Living (COL) Rider

Policy owner can increase policy once every 3 years by same percentage as Consumer Price Index. Additional premium for this based on insured's current age, but if decline to accept increase in any given year, all future increases forfeited. May need evidence of insurability to increase.

Modified Whole Life Policy

Preceded by a period of term insurance. Low, term-like premiums initially that automatically increase to Whole Life levels. Can also sell policy on children's lives or add as a children's level term rider ensuring they are insured for life.

Life Insurance Needs Analysis - Survivor's Needs & Estate Liquidity

Preferred method is permanent insurance, as term may not be renewable for long enough to be used for this purpose. Might need liquidity at death to cover debt, estate & inheritance taxes.

Decreasing Term Life Insurance

Premium remains level but death benefit decreases. Generally sold to cover home mortgages but rarely sold today.

Universal Life Flexibility

Premiums flexible and can be varied. Money not used to pay expenses & mortality charges can accumulate in product's cash value account. As long as more premiums & interest going in than expenses /mortality charges going out, cash value grows.

Interest Sensitive Life Insurance - Whole Life

Premiums vary to reflect the insurer's changing assumptions with regard to death investment and expense factors.

Universal Life Policy Features - Mortality Charges - Projected

Projection of company's mortality experience rather than current rates.

Whole Life Cash Value Account - Non-forfeiture Rates

Provide a benefit payable to policy holder if they quit paying premiums before death of insured.

Universal Life Policy Features - Credited Interest - Dividends

Rare for UL policies. Even mutual company policies rarely pay them.

Common Life Insurance Needs Rules of Thumb - Human Life Value Method

Rather than simply replacing lost income this approach accounts for changes in wages over a lifetime & discounts this amount to present value with final expenses. Capital utilization used, or capital depleted not retained.

Annually Renewable Term Insurance

Renews every year with premiums due. Risk period one year at a time so premiums initially low but increase with age. Most have max premium & only let you keep it until 70. Some states require higher reserve requirements for term policies that guarantee premiums for more than 5 years.

Primary Function of Life Insurance for Most Families

Replace earning power of family income earner & assure estate liquidity to meet family's cash needs.

Identify Resources to Pay for Life Insurance

Review financial position statement and cash flow to see what resources can be re-positioned to pay for life insurance.

Adjustable Whole Life Policy

Same as Whole Life but policy owner can adjust death benefit with corresponding premium adjustments as life circumstances change. Encompasses aspects of Whole Life, Term & Universal Life. Mostly obsolete.

Whole Life Limited Pay Policy Payment Options

Some have insured paying until a specific age such as 65 when payments cease. Others have 10 to 30 year pay policies when out of pocket payments cease. Shorter the pay period higher the premium.

Cash Value Life Insurance

Sometimes called permanent life insurance as designed to last a lifetime.

Non-Participating Whole Life Policy

Stock insurance companies capitalized by common stock are owned by shareholders and trade on markets. Don't normally pay dividends to policy holders. Whole Life policies they offer are called non-participating.

Equity Indexed Universal Life Spread Method

Subtracts a fixed amount such as 2 to 3% from the index's percentage gain in a given interval. If the index grew by 30% over a 3 year interval & insurer uses a 2% spread, account would be credited with a 28% increase in value.

Common Life Insurance Needs Rules of Thumb - Personalized needs Approach & LIFE Discussion

Takes into account all client needs/wants, specifically LIFE: Liabilities determine if want to have enough to pay off all debts using financial position statement, Income Replacement, Final Expenses, Education Funding

Buy Term Insurance and Invest the Rest?

Tax treatment better than that of buying term & investing difference, as internal grown of cash value generally tax free. Waiver of premium provisions lets you stop paying premiums if needed, but human nature to pay a bill, no to invest. Client's frequently spend the difference.

Two Categories of Life Insurance

Term & Cash Value. Term generally considered useful for short term needs & cash value normally used for longer term needs

Term vs. Permanent Life Insurance Products

Term cheaper initially, but permanent product premiums guaranteed to remain level, Whole Life, or can be designed to be likely to remain level, Universal Life. Lock in low cash value premiums while young & no more out of pocket premiums possible. Can convert term to permanent.

Term vs Cash Value Life Insurance

Term's lower premiums may be only way for client to cover entire life insurance need, but valid reasons for considering cash value products, which should not be rejected out of hand.

Universal Life Disadvantages

UL owner might end up with neither the most competitive insurance coverage nor the most competitive savings vehicle. With flexible premiums, compulsory savings of traditional Whole Life policies lost. Only those committed to paying should consider Universal Life.

Universal Life Disadvantages - Interest Rates

Uncertain future yield potential based on changes in interest rate. Most provide return based on short-term int rates, which react faster than Whole Life to falling/rising interest rates. Low interest rates have reduced UL's popularity but still make up up to 25% of all insurance.

Adjustable Whole Life Structure

Upon issue select face amount & premium with a death benefit guarantee period. Can change premium within a range. Limitations to shorten/lengthen guarantee period. Policy dividends can also be used to extend period & increase cash value. Can adjust face amount, premiums & coverage length.

Graded Premium Whole Life

Variation of a traditional whole life contract providing for lower than normal premium rates during the first few policy years, with premiums increasing gradually each year. After the preliminary period, premiums level off and remain constant.

Whole Life Non-Forfeiture/Cash Surrender Value

With most policies beginning in about the 10th year non-forfeiture value is equal to policy reserves.