What is Universal-Variable Life Insurance and How Does it Work?

 Insurance Basics for Medical Professionals

By By Jeffrey H. Rattiner, CPA, CFP®, MBA

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After determining the need for insurance and the amount to purchase, the doctor-client and financial planner’s next task is to match those needs to the client’s objectives to determine what type of policy the client should purchase. The life insurance industry features more products today than ever before. One reason for this change is that, clearly, the insurance industry has expanded its product base to become more competitive. Another reason is that clients’ needs are constantly changing and the insurance companies must keep up with those needs or run the risk of having funds withdrawn from their companies. New and different types of life insurance products are here to stay. Since life insurance represents a significant part of a doctor-client’s risk-management program, planners have to be versed in the specifics of the varied product base.

Definition

Universal variable life insurance is a hybrid of universal life and variable life insurance. It lets policyholders adjust premiums and reconfigure the death benefit level. The cost of this increased flexibility depends on the equities that are invested.

Similarity to Variable Life Insurance

Similar to the variable life contract, the policyholder gets to choose the investment medium under this contract, with no guaranteed cash value levels or growth. Policyowners are given the choice of option A death benefits (face amount only) or option B death benefits (face amount plus cash value). Because of the daily changes in cash value, however, option B is often not available. Premiums and death benefits are flexible and not guaranteed.

Assessment

Universal variable life policies are most appropriate for people with changing financial needs or long-term needs and for those who are willing to give up all guarantees in exchange for policy and investment flexibility.

Conclusion

And so, your thoughts and comments on this ME-P are appreciated. What kind of life insurance do you have doctor, and is it enough? Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

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What is Universal Life Insurance and How Does it Work?

Insurance Basics for Medical Professionals

By Jeffrey H. Rattiner, CPA, CFP®, MBA

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After determining the need for insurance and the amount to purchase, the doctor-client and financial planner’s next task is to match those needs to the doctor-client’s objectives to determine what type of policy the client should purchase. The life insurance industry features more products today than ever before. One reason for this change is that, clearly, the insurance industry has expanded its product base to become more competitive. Another reason is that clients’ needs are constantly changing and the insurance companies must keep up with those needs or run the risk of having funds withdrawn from their companies. New and different types of life insurance products are here to stay. Since life insurance represents a significant part of a client’s risk-management program, planners have to be versed in the specifics of the varied product base.

Universal Life Insurance

Universal life is a flexible premium life insurance policy that permits the policyholder to change the death benefit periodically (with satisfactory evidence of insurability for increases) or change the amount or frequency of the premium level (decreasing the amount as long as a sufficient cash value exists that would be used to pay current premiums). A fixed percentage of the gross premium is allocated to the insurer’s operating expenses and to mortality charges for the insured’s classification that changes constantly on the basis of net amount at risk and age. The remainder is credited to the policy’s cash value. Each month, the reserve fund is credited with monthly interest in a manner similar to that for whole life products. Universal life policies guarantee a minimum rate equal to that of whole life products but will credit the fund if the current rate is higher than the guaranteed rate. The excess return is accrued to the policyholder like a dividend.

Policyholders earn a fixed rate for the first year only and then a variable rate on a monthly basis thereafter on investment earnings. Interest credited to the policy depends on the insurer’s investment results. It is not possible for the insurer to predict the exact amount of cash value the insured will have down the road. The risk is that if interest rates are lower than anticipated, the insured may be required to make additional payments into the policy. Also, the insured can withdraw money without terminating the contract or can borrow money (as opposed to withdrawing or surrendering) in order to avoid tax consequences. A good rule of thumb is never to borrow more than 95% of the cash surrender value, since the remaining 5% is used to pay mortality and operating costs for the policy in the future. In the first year, the charges are unusually high because the costs of underwriting, policy issuance, and agents’ commissions are high. If the insurance company has lower expenses and passes them on to its policyholders, however, policyholders will benefit from the lower charge.

  • Required Premiums

Universal life policies usually have a minimum required premium in the first year that all insureds must pay. After that, the insured can change the premium amount and run it as an expensive term policy (i.e., pay a smaller amount) by using the cash surrender value to pay premiums. This works as an artificially paid-up policy by paying more premiums in a shorter period of time. Federal law, however, limits the amounts the insured may pay into a policy. Amounts in excess of the maximum will turn the policy into a modified endowment contract (MEC).

Death Benefit Options

There are two death benefit options under a universal life policy: option A and option B. Option A pays the face amount of the policy. Option B pays the face amount plus the cash surrender value of the policy. For example, let’s say a nonsmoking 30-year-old male wants to purchase a $200,000 universal life policy. For this, he pays an annual premium of $1,200. If the cash value at age 35 is $3,000, under option A the beneficiary would receive $200,000. Under option B, however, the beneficiary would receive a combined $203,000, which represents the death benefit plus the cash value. There is a higher cost for option B, which reflects the higher mortality charge based on the higher death benefit. Further, as in all cash value policies, if a policy loan is outstanding at the time of the insured’s death, that amount is ultimately subtracted from the death benefit.

No Flexibility

The insurance company retains the right to change the charges that it makes for mortality, and also for expenses (a maximum mortality chart will be found in the policy). This right makes it possible to know the changes being made for mortality at various ages. The insured has the ability to change the face amount or premium level. The insured has to pay only the charges for expenses and mortality to keep the policy in force. There is no flexibility within the investment, however, because universal life policies are invested in short- to medium-term money markets. The safety of cash value is high and the potential rate of return is moderate to high.

Advantages and Dis-Advantages

Advantages of universal life include policy flexibility, higher stated rate of return, and full disclosure of fees, loads, and proportion of premium invested. Disadvantages include the lack of a forced savings element if run as an expensive term policy, a potential drop in the rate of return, and lack of the most competitive investment vehicle.

  • Assessment

Historically, because the universal life product had not been tested for an entire business cycle, an adverse selection of insureds could affect the profitability of the product and, subsequently, the amount received by the policyholder. Therefore, actuaries couldn’t predict with reasonable certainty whether their mortality predictions were realistic. Also, the policy was introduced at the top of the interest rate cycle. Therefore, insureds are now learning the effects of lower current and future interest rates in this decade. Policyholders may find that the earnings in their accounts are not sufficient to cover the mortality and expense charges incurred in their policies, in some cases. If the cash value goes too low, policyholders will receive a call on their account, similar to a margin call on a leveraged stock portfolio. If a universal life policy is underfunded, there is little in the way of investment characteristics. The key to analyzing universal life policies is to have the monthly breakdown of (a) state premium taxes, (b) expenses, (c) amount at risk, (d) mortality charges, (e) account values, (f) interest earnings, and (g) surrender values. This policy is most appropriate for people who want choice and flexibility.

Conclusion

And so, your thoughts and comments on this ME-P are appreciated. What kind of life insurance do you have doctor; and is it enough? Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com and http://www.springerpub.com/Search/marcinko

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What is Variable Life Insurance and How Does it Work?

Insurance Basics for Medical Professionals

By Jeffrey H. Rattiner, CPA, CFP®, MBA

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After determining the need for insurance and the amount to purchase, the doctor-client and financial planner’s next task is to match those needs to the doctor-client’s objectives to determine what type of policy the client should purchase. The life insurance industry features more products today than ever before. One reason for this change is that, clearly, the insurance industry has expanded its product base to become more competitive. Another reason is that clients’ needs are constantly changing and the insurance companies must keep up with those needs or run the risk of having funds withdrawn from their companies. New and different types of life insurance products are here to stay. Since life insurance represents a significant part of a client’s risk-management program, planners have to be versed in the specifics of the varied product base.

Variable Life Insurance

A variable life insurance policy is similar to a whole life policy. It was designed as a solution to the problem of the decline in purchasing power that accompanies inflation. The premium is fixed, and the face amount of the policy varies with the type of investment. For example, the cash value within a variable life policy may increase substantially due to the types of investment selected for that policy. Further, because IRC regulations require that the cash value not exceed a specified percentage of the death benefit, an increase in cash value may also increase the face amount of the policy so that it is in compliance.

Cash Value Not Guaranteed

The cash value of the policy is not guaranteed. The death benefit never goes below the original face amount. In other words, there is a built-in guaranteed death benefit. Variable life policy funds are in a separate account of the company. If the company should go into receivership, insureds who have their policies in a separate account are unaffected by what happens to the general account of the insurance company. When the insured takes out a loan, the equity from the account becomes collateralized. The insurance company then transfers an amount equal to the loan to the general account. The collateralized equity stays in the general account until the loan is paid off.

Advantages of Direction

The ability to direct the account value to the investment of the policyholder’s choice is the key advantage of variable life insurance policies. The sale of one fund and the purchase of another within the contract is not a taxable event. The premium can never be raised, no matter how poor the investment is. The policy must be registered under the Securities Act of 1933 as a security and sold with a prospectus. The agent selling the policy must be licensed under the Securities Exchange Act of 1934 and in most states must pass the National Association of Securities Dealers (NASD-FINRA) series 6 and 63 examination. Because of the uncertain nature of the investments in variable life policies, policyholders sometimes are given a limited option to return to a fixed life type of policy (called the 6E-2 Rule). A disadvantage to variable life policies is the limited number of fund choices available to the policyholder.

Assessment

Variable life insurance is most appropriate for younger individuals, people with moderate-to-high risk tolerance, people who want to control their investment account over the long term, and people who do not necessarily have to rely on their account balance.

Conclusion

And so, your thoughts and comments on this ME-P are appreciated. What kind of life insurance do you have doctor, and is it enough? Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com and http://www.springerpub.com/Search/marcinko

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What is Whole Life Insurance and How Does it Work?

Insurance Basics for Medical Professionals

By Jeffrey H. Rattiner, CPA, CFP®, MBA via iMBA, Inc.

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After determining the need for insurance and the amount to purchase, the doctor-client and financial planner’s next task is to match those needs to the client’s objectives to determine what type of policy the client should purchase. The life insurance industry features more products today than ever before. One reason for this change is that, clearly, the insurance industry has expanded its product base to become more competitive. Another reason is that clients’ needs are constantly changing and the insurance companies must keep up with those needs or run the risk of having funds withdrawn from their companies. New and different types of life insurance products are here to stay. Since life insurance represents a significant part of a client’s risk-management program, planners have to be versed in the specifics of the varied product base.

Term Insurance Alternative

Whole life insurance was introduced as an alternative to term insurance. Whole life is often called cash value insurance or permanent insurance to distinguish it from term insurance. The cash value in whole life insurance arises because of the level premium system and the need to account for prepaid premiums. Whole life insurance offers permanent protection at a level premium for the entire lifetime of the insured. Premiums remain fixed and are paid throughout the insured’s entire lifetime. The premium level can remain constant throughout the life of the policy because premiums are higher during the early years. The excess charge in the early years makes it possible to build up a reserve, which will be needed, together with interest earned, to keep premiums level throughout the life of the policy. Older clients then pay the same premium in later years as they did when they were younger.

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Cash Value

The cash value of a whole life policy serves a variety of purposes:

• It can be used for collateral for an insurance company loan.

• If the insured decides to terminate the policy, he or she can elect to receive the policy’s cash value at that time.

• The cash value balance can be remitted to the insurance company to purchase a reduced paid-up insurance policy. This will provide coverage until the funds are insufficient to pay the premiums. This cancellation feature is also referred to as a non-forfeiture value.

• If the policy is not canceled, the accumulated cash value becomes part of the death benefit paid upon the insured’s death (which makes this type of policy similar to a decreasing term policy). It can reduce cash flow by taking some of the investment results out of the contract either through dividends or through policy loans.

General Accounts

With a whole life policy, the insured does not control the investment vehicle. Policies are invested in the insurance company’s general account through the purchase of long-term bonds and mortgages. As a result, during a period of decreasing interest rates, whole life products can be expected to produce superior results since rates can be locked in when interest rates in general are higher. In contrast, rates in an increasing environment are locked in to their portfolios until maturity. There is no flexibility within a whole life policy. Premium payments, type of investment vehicle, and change in death benefit are all fixed. The safety of cash value is high, but the potential rate of return is low to moderate. If interest rates are rising, the price of the policy is declining, and you may want to suggest replacing the policy. (See Planning Issue 10.)

If the premiums paid to the insurance company turn out to be more than the company needs because expenses are lower than expected, the company’s portfolio investment return will be larger than the company expected. As a result, the company will then return some of the excess premium to the policyholder as a dividend or excess interest. Life insurance dividends are not taxable as income because they represent an excess of premium.

Premium Payments

The premium consists of mortality charge, policy expense, and a cash value. When the insured reaches 100 years of age, the policy endows with the face amount of the policy collectible by the insured. Since mortality tables end at age 100, the insurer considers the client dead and pays the face amount of the policy.

Whole life policies are packaged in a variety of ways. One policy, a limited-pay whole life policy, is a whole life policy with a death benefit continuing through age 100. The only difference between this and the traditional whole life policy is that premiums are paid only for a specified period, for example, seven years. In other words, the policyholder prepays the policy. A policy is considered to be fully paid up when the cash value of the basic contract plus the value of the dividend additions or deposits equals the net single premium for the policy in question at the insured’s attained age. The premium-paying period influences the cash value buildup in the policy. This is accomplished by using part of the investment return or dividends from long-term bonds and mortgages to pay the mortality and the expense charges on the policy for the rest of the policyholder’s life.

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Advantages and DisAdvantages

Advantages of a whole life policy include lifetime coverage for the insured, a forced savings element, loan privileges, and a variety of premium payment plans. Over time, the cost is lower than term, the rate of return if the policy is kept until death is quite reasonable, and the policy will do a better job than universal life in keeping up with inflation. Disadvantages include a higher cost of death protection, a low rate of return, lack of flexibility, and incompatibility with inflation.

Assessment

Whole life policies are most appropriate for people who want or need a forced savings arrangement and for people who want lifetime coverage. As interest rates increased during the late 1970s, the returns received from insurance companies on long-term bonds and mortgage portfolios of whole life portfolios declined. As a result, in order to prevent policyholders from borrowing their cash reserves and investing these funds in other financial products, the insurance industry offered the following incentives:

• Existing policyholders were given the option to have their policies upgraded to reflect current market rates. Policies were upgraded through higher interest rates on cash values and higher future dividends and rates on policy loans.

• New types of policies were introduced—such as universal life, which tied cash value to short-term money market rates.

• Variable life insurance and universal variable life insurance were introduced, which segregated policy assets into a separate account.

Conclusion

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What is Term Life Insurance and How Does it Work?

Insurance Basics for Medical Professionals

By Jeffrey H. Rattiner, CPA, CFP®, MBA

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After determining the need for insurance and the amount to purchase, the doctor-client and financial planner’s next task is to match those needs to the client’s objectives to determine what type of policy the client should purchase. The life insurance industry features more products today than ever before. One reason for this change is that, clearly, the insurance industry has expanded its product base to become more competitive. Another reason is that clients’ needs are constantly changing and the insurance companies must keep up with those needs or run the risk of having funds withdrawn from their companies. New and different types of life insurance products are here to stay. Since life insurance represents a significant part of a client’s risk-management program, planners have to be versed in the specifics of the varied product base.

Term Insurance

Term insurance provides protection against financial loss resulting from death during a specified time. Term insurance is often characterized as providing “pure” protection because it pays only death benefits and does not contain any cash value features. Coverage stops at the end of the policy period. Term insurance comes in two forms: nonrenewable term and annual renewable term.

Nonrenewable Term Insurance

Nonrenewable term insurance offers the client the poorest quality because the insured has to requalify or prove evidence of insurability for coverage every year. As a result, its cost is the lowest since the insurance company annually re-underwrites the individual applying for coverage. This allows the insurance company to be selective and avoid adverse risks.

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Annual Renewable Term Insurance

Annual renewable term insurance is a quality term product. Under this type of term insurance, the policyholder may continue coverage on an annual basis. The rates are higher than nonrenewable term since the insurance company must continue to renew the policy at the insured’s option. The premiums generally increase as the policy matures, and the policy offers no flexibility. Coverage automatically stops if the premiums are not paid.

Conversion Provisions

Term insurance may offer a conversion provision that allows the insured to convert the term policy into a cash value policy without evidence of insurability, providing the insured with a guaranteed hedge against future un-insurability. The insured can convert the policy to a whole life policy at a later date. This can be done in one of two ways:

1. The insured can go back to the original policy date of issue and pay premiums on the basis of the younger age. All back premiums, including interest, must be paid to date.

2. The insured can pay premiums at the attained age (or at the age of the insured at the time of conversion).

Advantages of term insurance policies include a lower initial cost, allowing dollars to be invested elsewhere, and pure death protection. Disadvantages include the lack of permanence, the absence of a savings element, the expiration of the policy after a specified period, and a periodic increase in cost. The increasing premium structure of term insurance results from the decreased life expectancies of an individual’s later years.

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Assessment

Term insurance is most appropriate for young couples who have children or who otherwise may need a large amount of insurance. It is also appropriate for people who do not want to invest in a cash value insurance vehicle, who cannot afford the higher premiums of cash surrender policies, whose insurance needs will decrease over time, or who have temporary needs. Term insurance consists of mortality charges and policy expense. Because term insurance is quite expensive at the older ages, an alternative product was developed.

Conclusion

Your thoughts and comments on this ME-P are appreciated. Feel free to review our top-left column, and top-right sidebar materials, links, URLs and related websites, too. Then, subscribe to the ME-P. It is fast, free and secure.

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