TERMS - Universal Life Insurance

Universal Life (UL) Insurance

• Combines life insurance with tax-advantaged investing

• Policyholders do not pay premiums, they make deposits to the policy.

• Permits withdrawals

Cost of Insurance (COI)

1. Mortality costs (of life insured)

2. Administrative expenses

3. Investment income

Mortality Costs

• The cost of covering the risk of death.

Modal Factor Formula

1 / number of payment per year

Face Amount

• The amount of insurance taken out.

Death Benefit

• The amount received by the beneficiary when the life insured dies.

Minimum Premium Pays

• Pays the life insured’s mortality costs, the policyholder’s administrative expenses and premium tax and is designed to keep the policy force until age 100.

• Not enough to build up the investment account within the policy.

Maximum Premium

• Respects the deposit limit in order to keep the policy tax exempt.

Erosion of Policy’s Cash Value

• When increased face amount leads to increased COI.

• This will lead to a smaller amount of premium deposits being available for investment after the COI has been deducted from the investment account.

Net Amount At Risk (NAAR)

• Dollar amount that an insurance company stands to lose if you pass away.

• The difference between the death benefit and the cash surrender value (CSV).

  • Death Benefit - Value of the Investment Account

Morality Cost Formula

NAAR x COI / 1000

Yearly Renewable Term

• A one-year insurance that renews at the end of every year.

• Cost of UL insurance under this increases each year because risk of death increases with age.

• Good choice is the policyholder would qualify for low term rates and he wants more of his deposit to be invested in the early years of the policy.

Level Death Benefit Plus Account Value

• The death benefit is the original face amount of the policy plus the value of the investment account.

• Grows slower than UL policies with a level death benefit.

Level Death Benefit

• The insurance company usually only pays out the original face amount, although some policies pay out the value of the investment account that exceeds the policy’s face amount.

• Offered in two forms:

  • Death benefit equal to the face amount

  • Death benefit is equal to the policy’s account value when the account is worth more than the face amount.

• Least expensive option

Level Death Benefit Plus Cumulative Premiums

• The policy pays out the original face amount, plus the sum of all the premiums, regardless of the value of the investment account. Any excess that may remain in the investment account is retained by the insurance company.

• The beneficiary receives the original face amount plus the sum of all premiums paid.

• Most expensive death benefit option (for UL policies)

• NAAR = original face amount + the cumulative premiums - the account value

  • Reduces the NAAR quickly

Indexed Death Benefit

• The policy pays out the original face amount, indexed according to the rate specified in the policy, regardless of the value of the investment account. Any excess is retained by the insurance company.

• The face amount indexed for inflation.

• This option is most suitable for individuals desiring to protect an end-of-life risk that is expected to increase over time.

Net Premium

• The money that remains after the premium tax, the mortality cost, and policy expenses are deducted from the gross premium.

• Formula:

  • Gross premium - premium tax - mortality charge - expense deductions = net premiums

Gross Premium

• The total amount of deposit, or premium paid, by the policyholder.

Daily Interest Accounts (DIA)

• Accounts that offer a usually low interest rate based on the yield of a specified benchmark.

• Returns may only be a flat or a positive, but never negative.

Guaranteed Investment Accounts (GIAs)

• Provide a fixed rate for a term.

  • Terms begin at one year and last up to 20 years.

• Offer a guaranteed minimum interest rate based on a specified benchmark.

• A market value adjustment or penalty may apply if the policyholder redeems this prior to its maturity.

• Returns may be flat or positive, but never negative.

Index Fund Investment

• Earns interest based on the returns from a chosen index.

• Indexes are available based on location, equities, bonds (or a combination of both), size of market capitalization, or objective (growth or income).

• Management fees may be charged against the value of the investment.

• Returns may be flat, positive, or negative.

Mutual Fund Investments

• Earns interest based on mutual fund returns.

• Available based on equities, binds (or a combination of both), size of market capitalization, management style or focused on a specified geographic region.

• Management fees may be charged against the value of the investment.

• Returns may be flat, positive or negative.

Leveraging

• A variation of a third-party loan where a loan can be obtained using the cash surrender value and the death benefit as collateral.

• The proceeds of the loan are invested according to the policyholder’s financial objectives.

• Principal and interest payments are not required. The loan plus accumulated accrued interest would be repaid upon the death of the life insured by the death benefit with the residual death benefit going to the beneficiary.

• If the loan is invested to produce property income, the interest rate that accrues against the loan is tax deductible by the policyholder.

• Using the CSV as collateral avoids any tax liability that might occur if the policyholder took a policy loan or made a withdrawal from the policy.

• Vital to the success off this strategy is that investment returns must be greater than the cost of borrowing

• The policyholder may have to surrender the insurance policy if personal funds are not available to make the repayment. The forced surrender of the policy may result in a potential tax liability.