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On the “Selling Points” for Whole-Life and Universal-Life Insurance

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De-Bunking Conventional Sale Wisdom

By Rick Kahler MS CFP® ChFC CCIM http://www.KahlerFinancial.com

Rick Kahler CFP“You need to protect yourself and your family with life insurance that you won’t outlive.”

This is one of the common selling points for whole life or universal life rather than term life insurance. At first glance, it seems to make a lot of sense. Of course you don’t want to outlive your life insurance. Having it pay benefits upon your death is the reason you buy it.

This statement, however, misses one essential fact. Many people don’t need to worry about outliving their life insurance, because they outlive their need for life insurance.

Outliving the Need

We don’t all need life insurance throughout our entire lives, any more than we do auto or homeowners’ insurance. If you no longer drive a car, you don’t need auto insurance. If you no longer own a home, you don’t need homeowners’ insurance.

For example, in circumstances like the following, you may no longer need life insurance:

  • First;  when you and your spouse have accumulated enough assets and income streams to independently care for yourselves.
  • Second;  when your children are self-sufficient adults.
  • Third;  when your estate is too small to owe estate taxes or liquid enough to pay the estate taxes.

Primary Purpose

The primary purpose of life insurance is to replace the future income of a primary breadwinner. Two groups most likely to need it are middle-aged couples saving for retirement and parents of minor children. Ideally, most young families should have over $-1 million in life insurance to provide for the children if either parent should die prematurely.

Yet many of them are unable to afford the higher premiums for this much “permanent” insurance. Their choices are to underfund their needs with a smaller permanent policy or purchase an affordable 30-year term policy.

As we age, the probability of dying becomes greater. Therefore, a $1 million life policy costs much less for a 25-year-old than a 75-year-old. It doesn’t matter if the policy is cash value, whole life, universal life, or level term, the cost of providing the life insurance component increases every year.

Psychological Aversions

Yet most human brains have a psychological aversion to price increases. In order to please their customers with life insurance premiums that didn’t increase every year, insurance companies came out with level term policies. Essentially, the premiums are averaged out by overcharging in the early years of the policy and undercharging in the later years.

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Higher  Premiums

Whole life and universal life insurance policies don’t have that same averaging. To be “permanent,” the premiums must be much higher in order to fund a savings account that grows over time and is often used to offset a significant portion of the death benefit in the later years of the insured’s life. Usually, if the insured cancels the policy, a portion of the premiums will be refunded.

Cash Value

A cash value policy may occasionally be a good estate planning tool, generally for those with substantial wealth. It might be used to fund an irrevocable life insurance trust upon the second spouse’s death, perhaps to pay taxes on an illiquid estate like a family farm or other property. It also can be used for those wanting to leave the bulk of an estate to charity and still provide income to their children. These strategies rarely apply to those whose primary goal is basic income replacement for their families.

Assessment

One of the ironies of insurance in general is that we all know it’s essential and we all hope never to need it. For most people, life insurance is not really an exception to this. Its primary purpose is not to provide us with investment income, but to provide our families with income if we aren’t there.

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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.

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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.

Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™8

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.

Comprehensive Financial Planning Strategies for Doctors and Advisors: Best Practices from Leading Consultants and Certified Medical Planners™

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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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

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