Flexible permanent life insurance

Variable life and variable universal life insurance are similar in all of the following ways EXCEPT

Both require fixed, set premiums. Both types of policies offer a death benefit and cash values that vary based on the performance of the investments in the subaccounts.

Variable universal life policies have the same two death benefit options as those in fixed interest universal life insurance policies. As a third death benefit option, what do some variable universal life polices offer?

a guaranteed minimum death benefit equal to the policy's level net amount at risk plus the sum of total premiums paid Under option 2, a variable universal life insurance policy offers a death benefit equal to the sum of the policy's specified amount plus the cash value.

universal life insurance

Not long after adjustable life was introduced, the insurance industry introduced a product featuring even greater flexibility: universal life insurance (UL). With UL the policyowner can, within certain limits, increase premiums, reduce premiums, or pay no premiums. Similarly, the policyowner can increase the death benefit (subject to evidence of insurability) or decrease it—either with or without any change in premium.

minimum interest guarantee

Universal life insurance policies guarantee that the monthly interest credited will not be less than a certain guaranteed minimum. This amount, typically 3 or 4 percent, is stated in the policy contract. At the same time, the insurer may also credit rates higher than the guaranteed minimum if market conditions warrant. More simply, a UL policy provides for both guaranteed and current rates. The current interest rate, which generally reflects prevailing rates, can change every year or more frequently. These rates may be (and often are) higher than in traditional life insurance products

Which of the following statements about indexed life insurance is NOT correct?

The insured bears all of the investment risk with an indexed life insurance policy. To offset the risks in having the interest credited to a policy's cash value tied to the stock market, most insurers offer a guaranteed minimum interest rate.

Unbundled policy componants

In a universal life insurance policy, the three components that are central to the policy's premium—mortality, interest, and expenses—are treated as separate policy elements. In other words, they are unbundled. This unbundling is the key to the flexibility enjoyed by UL. When the policyowner pays premiums for a universal life insurance policy, the premiums are credited to the policy's cash value. These values, in turn, are credited with a rate of interest. From the cash value the insurer deducts an amount to cover the mortality and operational expenses associated with the policy. As long as the policy's cash value is enough to cover the monthly deductions, the UL policy remains in force. However, if premiums are reduced or terminated, the cash value will become depleted and the policy will lapse

Adjustable life insurance

The first of the new generation of flexible permanent life products was the adjustable life insurance policy. Adjustable life gives the policyowner freedom to change the premiums, face amount, and even the basic type of insurance. The policy may effectively be changed to a term life, ordinary whole life, or limited-pay whole life policy. For example, if a policyowner increases the death benefit but does not increase the premium, the cash value growth slows or stops. This impact on the cash value can reduce the term of the coverage from the insured's whole life to only five years or so—effectively converting it into a term life policy. An increase in the premium will result in the death benefit increasing. The main advantage of adjustable life insurance is its flexibility. Insurance needs change over time, and adjustable life lets the policyowner change the policy to best suit those changing needs.

VUL monthly deductions

Administratively speaking, VUL premiums are handled by the insurer much as they are for UL policies. As with universal life insurance, VUL "unbundles" the three basic premium components (interest, mortality, and expenses) that are managed through a monthly adjustment to the policy. In addition, when a policyowner pays a premium for a VUL policy, the insurer normally deducts a premium charge. This deduction includes state and federal premium taxes. The VUL premium charge varies slightly from its UL equivalent by including an investment management fee to cover the cost of managing the separate account. It may also include a sales load, which is an additional charge imposed by the insurer to allow the company to recover its new business acquisition costs. (These costs include first-year commissions, field expenses, underwriting costs, etc.) Once the insurer deducts the premium charge, the net premium is then allocated to the policy's variable subaccounts that comprise the policy's cash value. (The subaccounts are selected by the policyowner.) Depending on the policy and the insurer, the policyowner may have 20 or more variable subaccounts from which to choose.

corridor requirment

In 1984, Congress created a legal definition of life insurance that requires all life insurance contracts to maintain a minimum level of pure insurance protection (net amount at risk) to be considered life insurance. A contract that fails this requirement loses the favorable income tax treatment enjoyed by life insurance. Congress wanted to prevent life insurance policies from being used mainly for tax-advantaged investment purposes. The corridor requirement is designed to prevent policyowners from overfunding the contract. As shown in the chart, even with the level death benefit (Option 1), if the cash value increases too rapidly (from paying too high a premium), the death benefit will increase to maintain the minimum corridor of protection. The required corridor amount is expressed as a ratio between the UL policy's death benefit and cash value. For policies issued since 2009, the required minimum percentage declines to age 120, at which point there is no further requirement and the cash value may equal the death benefit.

UL death benefits

While the death benefit in most life insurance policies is referred to as the policy's face amount, with UL it is called the specified amount. The distinction is important. Face amount implies a benefit amount that is contractually guaranteed. With its flexible policy terms, the UL contract cannot guarantee a face amount. Instead, with UL it is the amount specified by the applicant as the target death benefit. Only if the policy is properly funded will the death benefit equal (if not exceed) the specified amount. Universal life policies typically offer two standard death benefit options: Option 1 (or Option A): level death benefit Option 2 (or Option B): increasing death benefit In keeping with its flexible character, universal life insurance lets policyowners switch death benefit options with few if any restrictions.

Bob bought a $100,000 universal life insurance policy and chose an increasing death benefit. At his death ten years later, the policy's cash value had increased to $50,000. What will his beneficiary receive?

$150,000 If Bob chose a level death benefit instead, his beneficiary would receive $100,000 at his death.

VUL cash value access

The policyowner can access his or her VUL cash value through policy loans, withdrawals, or a complete surrender. In many cases, withdrawals are not available from a VUL policy until after the first policy year. Amounts taken from the cash value reduce the death benefit. Surrender charges may be assessed to withdrawals in the policy's early years.

variable universal life

A popular product today is variable universal life insurance (VUL), which combines features of variable life and universal life. Like variable life, VUL policies invest their premiums in separate (nonguaranteed) investment accounts. That means the growth of the contract's cash value is based on the performance of the underlying investment. Also like variable life insurance, VUL is considered both a life insurance and securities product. To sell VUL policies, a producer must hold both a state life insurance license and a FINRA securities registration. Like universal life, VUL policies feature premium flexibility. Policyowners can increase or decrease the premium payments they make and even stop payments. As long as the policy's cash value covers the monthly deductions for the cost of insurance and expenses, the policy stays in force. If the cash value is not sufficient to cover the monthly deductions, the policy lapses.

VUL cash values

A VUL's cash value is the sum of the values of the subaccounts into which funds are allocated plus any funds allocated to the fixed interest account. Premiums allocated to the fixed account (invested in the insurer's general account) are guaranteed both as to principal and interest and receive interest at the insurer's current rate. However, premiums allocated to the variable subaccounts are not guaranteed. Instead, subaccount values move up or down depending on the investment performance of the underlying subaccount portfolio. A policyowner can transfer funds from one variable subaccount to another within the policy as his or her objectives and/or risk tolerance change. This can be done without any income tax consequences.

UL surrender charges

Adding new business is expensive for a life insurance company. The costs of gaining new business can be 150 percent or more of the first-year premium. Included in these costs are first-year commissions, field expenses, and underwriting costs. The insurer eventually recovers these business acquisition costs as part of the expense charge. However, if a UL policy is surrendered early the insurer does not have the opportunity to recoup its acquisition costs. For that reason, UL policies impose a surrender charge if they are surrendered within a specified period of time after issue. Insurers may assess either a front-end load or a surrender charge for purposes of recouping acquisition costs. Because they directly reduce the amount that is added to the cash value, front-end loads are less appealing to consumers than surrender charges (which are not assessed if the policy is not surrendered). Hence, universal life insurance policies are usually back-end loaded. In a back-end loaded policy, surrender charges are added for withdrawals of cash value from the policy. Surrender charges are also added for full surrenders if the insurer has not recovered all of its business acquisition costs. Policy surrender charges are clearly spelled out in the contract and decline over time. For example, the charge may be 10 percent during the first policy year, 9 percent the second year, and so on. There are no legal limits to the length of time a policy may impose a surrender charge. While 10 years is common, they may extend for the first 15 policy years or longer.

death benefit option 1

Death benefit Option 1 (shown in the figure) resembles the death benefit of a traditional whole life policy. It generally remains level, and the policy's cash value is paid as a part of the policy's specified amount. As with traditional whole life insurance, increases in the cash value reduce the net amount at risk to the company but do not increase the death benefit paid at the insured's death.

death benefit option 2

Death benefit Option 2 features a generally increasing death benefit. This benefit equals the policy's specified amount plus its cash value. The policy has a level net amount at risk that is always equal to the specified amount, and as the cash value increases, the death benefit increases by the same amount. If the cash value decreases, the death benefit decreases by the same amount. However, the death benefit payable never decreases to less than the specified amount stated in the policy. Because the net amount at risk (i.e., the pure insurance protection) remains level, the cost of insurance deductions under Option 2 are normally higher than in an otherwise identical universal life insurance policy with an Option 1 death benefit.

indexed life insurance

Indexed life insurance is a fairly recent product innovation. It is a form of permanent insurance in which the interest credited to the contract's cash value is tied to an equity index instead of a rate declared by the insurer. The product name distinguishes it from other methods of crediting interest on the policy's cash value. The actual index used in these policies is usually a stock market index like the S&P 500. (A few product designs are tied to a bond index instead of an equity or stock index.) The index can also be an interest index. Indexed life can take the form of universal life, where the premium payments are flexible or whole life, where the premium payments are fixed. With either approach, the interest credited to the contract's values is based on the change in the associated index. The index change during the index period is converted to a percentage. (The index period is often one year but can be longer or shorter.) This percentage determines the actual interest credited to the policy's cash value. For example, assume a policy is tied to the S&P 500. At the beginning of the contract's term, the S&P is at 1200. At the end of the term, the S&P is at 1300. The change in the index between these two points (8.3 percent) becomes the basis for the amount of interest that will be credited to the policy. The advantage of an indexed policy to consumers is the potential for higher rates of return than those associated with traditional policy interest-crediting. To offset the risks in the stock market, most insurers offer a guaranteed minimum interest rate. Other features are consistent with the underlying life insurance policy.

premium flexability

Premium flexibility is one of the main features of universal life insurance. Traditional life insurance policies lapse if the policyowner fails to pay a premium when due. In contrast, a UL policyowner can decrease or even skip premium payments. As long as a UL policy's cash value covers the monthly deductions, the policy remains in force. However, the amount or frequency of premium payments must be such that the cash value is funded enough to support the monthly deductions. If the cash value is not enough to cover the costs of the policy, the plan will terminate. To make these changes to the premium payment, no formal agreement is required. Rather, the policyowner simply makes the premium payment that he or she chooses. This differs from adjustable life insurance, where a formal agreement is required. While UL policyowners have considerable leeway in deciding the premium they will pay, insurers provide guidance to help them make sure they do not underfund or overfund the policy. In most cases, insurers list three different premium levels—a low-end, high-end, and "just right" amount: The minimum premium is the least amount estimated to cover the cost of pure UL insurance and the policy expenses. Funding a UL policy at its minimum level risks the policy's long-term integrity. The target premium is the premium level at which insurers typically pay full first-year commissions to their producers. This is the only relevance of the target premium, though it represents a sound middle ground for policyowners to follow. The maximum premium, also called the guideline premium, is the highest amount that can be paid for that level of death benefit and still permit the policy to meet the guideline premium test. The guideline premium test is one of the tests a policy must meet to qualify as life insurance and thus receive the favorable tax status of life insurance. The test is applied to determine whether the policy has been "overfunded." This term refers to the case in which a policy's cash value accumulation is too great relative to the policy's death benefit; that is, it exceeds the IRS corridor requirement.

variable life Vs. VUL

The features of variable life and variable universal life are easily confused. Both variable life (VLI) and VUL are securities products as well as insurance products. They both let the policyowner allocate funds to investment subaccounts offered by the insurer. Both also offer a death benefit and cash values that vary based on the performance of the investments in the subaccounts. However, they are distinct from each other in the following ways: Premiums—VLI policies have a fixed, set premium payable for the life of the policy. VUL policies generally require a minimum initial premium to cover first year costs. After that, VUL policyowners do not pay a set amount on a set schedule. Death benefit—Under a VLI policy, the policyowner's payment of the fixed premium guarantees the policy remains in force and provides the death benefit upon the insured's death, regardless of the performance of the separate account to which premiums and cash value are allocated. In contrast, under a VUL policy, the death benefit amount is not guaranteed. Cash value access—VLI policies allow policyowners to access cash values in much the same way as other whole life policies do. That is, they can get to it through cash value loans or through full policy surrenders. A VUL policy—like other universal life insurance policies—provides for cash value withdrawals.

UL morality charges

The monthly mortality charge deducted from a UL policy's cash value reflects the cost of insurance for that point in the insured's life. Consequently, over time, the mortality cost increases, which reflects the insured's increasing age. In addition, the deductions from the cash value may also increase. In many ways, UL is like a plan of term insurance with a cash value side fund. As the insured gets older, the per-thousand dollar cost of the insurance protection provided by the policy increases

UL cash values- monthly adjustments

To account for premium payments and to pay for the policy's insurance and expense costs, UL policies are adjusted on a monthly basis to credit to the cash value any premiums it received since the last monthly adjustment day; credit to the cash value the interest on the cash value for the previous month; and deduct from the policy cash value the cost of insurance (the mortality charge) and an expense charge.

accessing UL cash values

Traditional whole life policies provide access to cash values through only two means: policy loans a full surrender of a contract, in which all accumulated values are paid out to the owner and the policy terminates However, a UL policy offers a third option: partial withdrawals (also called partial surrenders) from the policy's cash value. With a partial withdrawal, the owner takes a portion of the cash value account in cash. A withdrawal reduces the UL policy's cash value as well as the current death benefit by the withdrawn amount. If the policy is under death benefit Option 1, the withdrawal may reduce the death benefit to an amount less than it was at policy issue. Under death benefit Option 2, the withdrawal reduces the current death benefit, but the specified amount (that is, the amount of the death benefit at policy issue) will never be less than it was at policy issue.

VUL death benefits

VUL policies offer the same Option 1 and Option 2 death benefits as in fixed universal life insurance policies. In addition, some VUL policies offer a third option. The three VUL death benefit options are: Option 1: The death benefit is equal to the policy's specified amount and includes a decreasing net amount at risk. Option 2: The death benefit is equal to the sum of the policy's specified amount plus the cash value and includes a level net amount at risk. Option 3: The death benefit is equal to the sum of the policy's specified amount plus the total premiums paid. Like Option 2, it includes a level net amount at risk. This appeals to consumers who are concerned that a drop in market values could mean the cash value is less than the sum of premiums paid. The policyowner can normally change death benefit options from Option 1 to Option 2, or from Option 2 to Option 1. Insurers normally do not allow policyowners to change to or from death benefit Option 3 after the policy is issued. In addition to the right to change death benefit options, within limits, the policyowner can also change the policy's specified amount. The specified amount can normally be increased with satisfactory evidence of the insured's insurability. The policyowner can, likewise, decrease the VUL policy's specified amount, but not so low that the policy's cash value exceeds the IRS corridor limit.