The life insurance industry has become increasingly complex. New and multiple policy types deliver both choice (a good thing) and complexity (not such a good thing) to your client’s decision-making. Policy names (Adjustable, Flexible and in my opinion, sometimes Combustible) are not helpful either. If I have a difficult time keeping up, I can’t imagine the challenge for advisors who are not in the life insurance industry and for the consumer, who has little chance to understand and select the option best suited for their circumstances.
Below is a simplified explanation of a subset of products. This is not an all-inclusive list nor is this a full description. Also, I take the position that there are no inherently good or bad products…there are however suitable and unsuitable products given the insured’s planning goals, premium tolerance and appetite for risk, certainty and guarantees.
Here we go…
Temporary Life Insurance
Term – A “death benefit” only policy providing pure protection for a specified, selected period of time. Beneficiaries receive death benefit proceeds should the insured die within the selected “term” period (10, 15, 20 or 30 years) and receive nothing if the insured lives beyond the term period selected. Term insurance accumulates no equity or cash value. It is inexpensive (at younger ages) because it is designed and priced to be outlived by the insured. As little as 2% of all term policies end in a death claim. The other 98% lapses. A good choice when the length of needed coverage is known.
Permanent Life Insurance
Universal Life – The scheduled premiums, cash value, and duration of the death benefit are determined largely by a projected interest/policy crediting rate and assumed amount of expenses. Actual cash value and duration of the death benefit are determined through a declared interest rate by the carrier and actual expenses extracted from the contract. Unfavorable differences between the assumed and actual policy performance can result in an increased premium or policy lapse. Flexible premiums, including skipped premiums, are allowed but require careful review and management as this will negatively impact policy performance and duration thus accelerating a potential lapse.
Whole Life Insurance – Generally the highest outlay of premium for a desired level of death benefit. Cash value is credited based on an annually declared dividend. The least flexible permanent policy, often referred to as a “forced savings plan.” Dividends can be applied against the premium to reduce the out of pocket costs. Dividends are projected and not guaranteed. Because dividends are a function of carrier profitability, a declared dividend can also be thought of as a “return” of premium overcharge. Whole Life has often been promoted with a “vanishing premium.” Don’t believe it. Premiums don’t vanish. They can be offset by the dividend and this is where a client can be misled. Be careful.
Variable Life Insurance – A co-mingling of life insurance and securities. The insured can couple their need for insurance with their desire to invest. This coupling comes with a higher fee schedule and may create greater likelihood of a policy lapse as the fees create a higher “hurdle” to achieve the policies assumptions. An infusion of additional, unexpected premiums may be necessary in order to make up for missed projections and the costlier pricing/ fee schedule. Returns can legally be projected up to 12%, compounded annually, which can lead to disappointment.
Indexed Universal Life – Designed as a hybrid between Universal Life and Variable Life. Indexed Life credits cash value based on an index performance (typically the S&P though most carriers offer others indices to select) and establishes an earnings / policy crediting “cap” and “floor” (which cannot go negative) to reduce volatility. A percentage of the index’s performance (referred to as Participation Rate) is then credited to the contract which is determined and can be adjusted by the carrier on an annual basis.
An example will best illustrate:
|Policy Cash Value Credited at||9%|
|Subject to an Earning Cap||10%|
The spread between the Indexed Return of 12% and the Policy Crediting Rate of 9%, is forfeited in exchange for the earnings floor that cannot go negative. How a particular carrier establishes these variables must be understood in order to maximize the contract.
Indexed Life requires review of its several features and matched against the client’s planning objectives. Often promoted as a “cash accumulation” policy.
No Lapse Guaranteed (NLG) Universal Life – Sometimes referred to a “term for life,” NLG is a low out of pocket premium policy that will remain in force regardless of interest rate, dividend and/or stock market performance as long as the scheduled premium is paid in full and on time. By design, NLG accrues little, if any cash value, and is an appropriate solution for those who favor term insurance though desire coverage to be in force indefinitely.