What is Indexed Universal Life? To understand indexed universal life insurance you must first understand universal life insurance. Universal life is distinguished from whole life by a number of factors. From the consumer’s perspective, the most notable difference is premium flexibility. Unlike whole life, universal life does not require a fixed schedule of unchanging premium payments; they are completely flexible. The only time a fixed level of premiums is required is during the first one or two policy years (effectively setting up the “prefunding” needed to initiate the policy); after that, the timing and amount of premium payments is up to the police owner. This is made possible by the seemingly simple concept on which universal life relies. Universal life separates the two components of a whole life policy’s benefit—the pure insurance net amount at risk and the cash values—and administers them separately. Unlike whole life’s guaranteed level death benefit, a universal life policy makes no attempt to maintain a guaranteed death benefit or contractually scheduled cash value accumulation. It permits the pure insurance component to be funded independently of the cash value component. How a Universal Life Policy Works A UL policy’s operation can be described in simple terms. Here’s how a UL policy works. 1. The policy owner selects an initial insurance amount and the type of death benefit option. This option can be either: a level death benefit, or a death benefit that rises in relation to the policy’s cash value. After a certain period of time from policy issue, the amount of insurance or death benefit option can be changed. 2. Based on the insurance amount and the death benefit option selected, a premium amount and payment schedule is established. A “minimum” premium is required only for the first year or two. Though the insurer recommends a “target” premium level after the initial period, the amount and timing of premium payments are completely flexible. The premium is directed into the policy’s cash value or accumulation account. 3. Each month, the insurer credits the funds in the accumulation account with interest. The amount of interest so credited is the “current declared rate” determined by the insurer. This amount fluctuates, based on the current investment and economic environment. In this way, it more closely reflects market rates. Current UL interest rates will vary from crediting period to crediting period, but will never be lower than a minimum guaranteed rate (typically 3 percent to 4 percent). 4. Each month, a charge for the cost of the pure insurance (term) cash accumulation account. To the extent the cash value is sufficient to support these monthly deductions, the insurance remains in force. Consequently, the policy’s funding is directly dependent not on the payment of premiums but on the amount in the cash value account. In turn, the amount in the cash value account is dependent on the level and frequency of premium payments and interest crediting. Cash value amounts in excess of the insurance costs and expense deductions continue to earn interest at the rate declared by the with whole life insurance; accumulated funds in a whole life policy can be accessed only through a loan (with interest) or through complete surrender of the policy. With UL, money can be withdrawn from the cash value without incurring interest and with no obligation to repay the amount. 6. Within specified limits, policy owners can pay more than the target premium. On a regular basis, the policy owner receives a statement from the insurer outlining the status of his or her policy: premiums paid, expenses charged, interest credited, insurance costs deducted and cash values accumulated. This full disclosure is unique to universal life and should play a role in the on-going determination of product suitability. The practitioner should take the time to review these statements periodically With policy owners and explain how they illustrate whether the policy continues to provide the benefits and values intended when the product was first purchased. The flexibility of UL offers consumers options that are not available with traditional whole life insurance. The policy owner can adjust the death benefit or premium payments to fit his or her situation. As financial priorities come and go and as different situations present themselves, the flexibility of a universal life policy allows the coverage and cost components to adapt to the owner’s needs. This flexibility is one of UL’s chief benefits. However, with this flexibility come fewer guarantees. This, in turn, requires the UL buyer to assume a level of risk absent from traditional whole life. Consequently, when evaluating the suitability of a UL policy, it is important to consider a client’s understanding of the product’s operation and his or her ability to manage the product. Specifically, the practitioner should make sure that the client understand the policy’s target premium. Target Premium A UL’s target premium amount is based, in part, on the insurer’s mortality costs and expenses. It also includes an assumption of future investment returns. The higher the return the insurer earns, the greater the amount it will be able to credit to its UL policies. If the actual investment return credited to the policy is in line with what was assumed in determining the target premium and if the target premium is paid consistently, the policy will perform as anticipated. On the other hand, if the actual investment return credited to the policy falls short of what was assumed in determining the target premium, the cash value may not be sufficiently funded to carry the policy, even if targeted premiums are paid. In this case, additional premiums—above and beyond the targeted amount—would be required to keep the insurance in force. This aspect of universal life is very often misunderstood or its significance overlooked. Suitability standards require that the practitioner makes clear to the customer the effect that changing market conditions may have on a UL policy’s premiums. Overall, most insurers take a conservative path when establishing target premiums for their UL policies and the majority represent levels that are sufficient to keep these policies in force for life. ILL. 4.1 ■ Universal Life Insurance (Option I) Adjustable Benefit Universal life also offers flexibility with regard to the death benefit. First, the owner selects one of two options at purchase: a benefit that remains level throughout the policy’s term (Option I), or one that increases gradually over time in relation to the cash value growth (Option II). Second, after policy issue, that benefit can be increased or decreased at the owner’s discretion, with very few limitations. The decision to increase or decrease the benefit amount does not require issuance of a new policy; the insurer simply modifies the existing policy. Third, in most cases, a policy owner can switch from one death benefit option to the other. Consequently, a single UL policy can accommodate changing protection needs without requiring the owner to purchase additional policies. (It should be noted that almost all insurers require the insured to submit evidence of insurability if an increase in the death benefit is requested.) To differentiate between the two options, consider the following example. Suppose an individual purchases a universal life policy with a face amount of $200,000. Under Option I, the death benefit payable will remain at (or close to) $200,000, as long as target premiums are paid. If the individual chooses Option II, the death benefit will rise in relation to the cash value. If the cash value increases to $15,000, the death benefit will equal$215,000; if the cash value increases to $25,000, the death benefit will be $225,000; and so on. Under either option, the death benefit amount can be increased or decreased as the owner desires. If, for example, a temporary need expires, the policy can be adjusted downward to provide lower benefits. If there is a need for greater protection—after a home has been purchased, for example—the death benefit can be increased (usually after providing evidence of insurability) for as long as needed. An increase or decrease in protection will adjust the amount deducted from the cash value account, but again, as long as the account is sufficient to cover these costs, the insurance remains in force. Consequently, a temporary increase in coverage may not require additional premium payments; in fact , payments might even be suspended for a period of time even after coverage has been increased. Indexed Universal Life Insurance Indexed universal life insurance offers all of the benefits of a universal life insurance policy, while crediting a guaranteed minimum interest rate and linking the excess interest rate to the upward movement of a particular equity index, such as the Standard & Poor’s 500. Policy owners don’t know in advance what excess interest their policies will earn, but they do know that if the equity index increases in value, the excess interest credited to their policies will be a stated percentage of that increase. If the equity index decreases in value, their policies will be credited with the guaranteed minimum rate. The impact of negative index returns is limited by a growth floor (typically 0% to 2%), and the maximum interest crediting rate is limited by a growth cap. The cap varies among insurers from 7% to 12%. Each index is made up of different companies and measures a slightly different mix of industries. The policy owner should examine and select the index account that meets his overall objectives. The major advantage of an indexed universal life insurance policy is the option to participate indirectly in the upward movement of a stock index without assuming any of the risks involved in investing in the stock market. Variable u Advantages of Universal Life • The policy’s flexible provisions give owners considerable control over policy values. • As a permanent plan, coverage extends for the whole of the insured’s life. • Flexible premiums allow owners to adjust payments to fit changing needs and goals. • Due to flexible funding, policy owners have some control over the growth of cash values. • As cash values grow, policy owners can decrease or skip premiums as circumstances require. • Premiums in excess of the cost of insurance contribute fully to the cash value accumulation. • Cash values grow tax deferred and are easy to access. • Interest credited to UL cash values is reflective of current (conservative) market conditions. • A minimum rate of return is guaranteed with most policies. • Coverage can be adjusted—up or down—as needs change. The death benefit option can be changed to accommodate the desire for greater cash accumulation or an increased death benefit. • The premium for the policy’s protection element is generally lower than whole life. • Tax-advantaged withdrawals can be taken without interest or the requirement to repay them. • The ability to take partial withdrawals provides for more flexible liquidity than whole life. • Policy statements provide full disclosure of costs, coverage and accumulated values. • An indexed universal life insurance policy offers the option to participate indirectly in the upward movement of a stock index without assuming any of the risks involved in investing in the stock market. Disadvantages of Universal Life • Premiums are more costly than term, at least initially. • Since premiums are payable at the policy owner’s discretion, the amount of the death benefit cannot be guaranteed for the life of the policy. • Additional premiums may be required to maintain the coverage if current interest rates fall below initial assumptions. • Nonguaranteed values mean that the policy might not meet protection needs; some of the risk of policy performance is assumed by the policy owner. • Increases in coverage amounts generally require the insured to submit evidence of insurability. • The policy’s flexibility—and the responsibility the consumer must assume in funding the benefits—may seem complex and hard to understand. ILL. 4.2 ■ Universal Life Insurance (Option II) When is Universal Life Suitable? Flexible, interest-sensitive, adjustable, permanent—the features of universal life make it seem as if it would be a suitable option for just about anyone who needs a permanent plan of life insurance protection. For many, it is. It represents a viable alternative for the “buy term and invest the rest” client or one who is reluctant to commit to the relative rigidity of a traditional whole life policy. The following describe prospects for whom a UL product may be suitable: • a client who needs permanent life insurance protection but can’t afford the cost of whole life; • a young family whose insurance needs are likely to grow and change; • a new business owner who anticipates changing stages of growth and development; • a client who is attracted to the flexibility of unstructured premiums; • a client who prefers to earn current short-term rates rather than the longer term rates associated with whole life; • a client who wants a policy that can adapt to changing circumstances; • a client who is attracted to the concept that a single, versatile policy can serve insurance needs over a lifetime; • a client who likes the idea of being able to prefund policy values.ual Funds Whole life universal life Variable Annuities Equity-Indexed Annuities Mutual Funds L You Must Understand . . . The client should understand the following with regard to a universal life policy: • The primary purpose of the policy is long-term protection. • Though premiums are flexible, the policy requires the buyer’s long-term commitment. • The target premium amounts could be affected by adverse market conditions. • Additional premium payments above the targeted schedule might be necessary to keep the insurance in force—that is, if not paid, the policy would lapse. • The primary purpose of the policy’s cash value is to fund the cost of the insurance protection. • The guaranteed minimum rate and the current declared rate are not the same. • If current interest rates decline, the rate at which the cash value grows may be less than expected. • Partial withdrawals would affect the policy’s death benefit, mortality cost and the amount in the cash value available to earn interest. • An increase in the policy’s benefit will likely require the insured to submit evidence of insurability. • The policy’s annual statement must be reviewed carefully to determine how the product is performing and whether some adjustment might be required. • Early surrender of the policy may be subject to surrender charges. Universal life is suitable when the client needs adjustable coverage, desires a policy that can grow, is capable of understanding the policy, seeks flexible funding and is willing to forego some guarantees to obtain this flexibility.
Posted on: Fri, 27 Sep 2013 07:34:39 +0000
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