UNIVERSAL LIFE PLANS

Universal Life- universal life insurance provides permanent lifetime coverage that is unbundled and flexible. The universal life product allows the policyowner to reduce the face amount (amount of life insurance applied for), or increase the coverage, subject to underwriting. Three death benefits are available:

1. Face amount (Option A)
2. Face amount + cash value (Option B)
3. Face amount + return of premiums (Option C)

Policyowners are also given the availability of changing between death benefit options (subject to policy provisions and underwriting). Additional flexibility is provided through the ability to stop, restart, or change premium amounts.

Universal life products are unique from whole life in their unbundled cost structure- listing mortality, expenses, and interest separately.

• Mortality charges: cover the cost for the life insurance coverage; a.k.a. cost of insurance charges or COI’s is generally expressed as a dollar amount per $1,000 of insurance.
• Expenses: charges that an insurance company imposes to cover costs it has incurred for administering a policy. Expenses may include:

1. Monthly policy fees- an monthly charge per policy that ranges from $4.00 - $15.00 per month (one product does not charge a policy fee at all).
2. Premium loads- a percentage of the premium that is deducted from each payment to cover expenses; current premium loads range from 3% to 50% (several carriers offer 0% load policies).
3. Per 1,000 charges- a charge that normally varies by age, sex, and issue class that is charged for every $1,000 of insurance applied for, hence the name; ranges from the first two years to all years of the policy (numerous carriers offer products with no per 1,000 charges).
4. % of fund charges- a charge that is deducted from the policy’s account value annually; ranges from 0.30% - 0.60% annually (most products do not have this charge).
5. Surrender charges- a stated charge that will be assessed against the account value of the policy if it is surrendered during the surrender charge period (range from 9 – 20 years with several products having no surrender charge at all).

• Interest: a minimum guaranteed interest rate is provided for, as well as a higher, current rate of interest which is not guaranteed. Interested is credited based on either portfolio or new money rates.

1. Portfolio based rates- based on insurance carrier’s investment portfolio; generally more conservative, but a better choice when interest rates are headed down because of the broad portfolio with varying maturities.
2. New money rates- based on the insurance carrier’s current investments; generally more attractive, and a better choice when rates are going up; less predictable and subject to change.

Universal life can be used as an efficient means of cash value accumulation through it’s ability to accept regular and unscheduled premium payments. In fact, it is frequently used as a vehicle for retirement income and education funding when overfunded.

Note that due to the unbundled nature of universal life, and the ability to generate cash values, regulation has been imposed to prevent the policies from becoming an investment product. The Tax Equity & Fiscal Responsibility Act (TEFRA) of 1982 was the first legislation to stipulate the required difference between a policy’s face amount and the cash value (TEFRA corridor) in it’s definition of life insurance contracts. In 1988, the Internal Revenue Code was amended to stipulate that if a policy was over-funded (whether at issue or at a later date), it would be classified as a Modified Endowment Contract (MEC). This would adversely affect the policy be requiring that any distribution representing a gain from the policy would be taxed. The seven-pay test was established to place limits on the amount of premiums that can be paid within a sevenyear period for MEC testing. Furthermore, “material changes” in inforce policies, such as a reduction in face amount or change in death benefit option, are cause for re-testing of MEC. If a policy is a MEC, distribution are taxed on a last-in first-out (LIFO) basis to the extent of a gain, subject to a 10% penalty, unless the distribution is made after age 59 ½ or if death, disability or annuitization occurs. Distributions include policy loans, withdrawals, cash surrenders, and dividend distributions. Once a policy is a MEC, it is always considered a MEC even if it is exchanged into a new policy through a 1035 exchange. All parties are urged to consult their own tax advisor regarding tax consequences of any distributions on life insurance, as this course should not be relied on for tax or legal advice nor for any recommendation to which financial product, design, crediting method or insurer is superior or inferior.

Policyowner/insureds also have the ability to stop paying premiums on a universal life policy if cash values are sufficient. However, the policies should be continually monitored in the event that interest rates do not perform, due to their interest-sensitive nature. A popular benefit on universal life products lately is extended no-lapse guarantees, or ENLGs. These riders or embedded benefits give the policyholder the capability of guaranteeing the death benefit, regardless of how interest rates perform, as long as the policy is funded at a certain premium level. Although the cost is usually higher than a current assumption universal life scenario, the cost is certainly less costly than the guarantees associated with most whole life plans.

Universal life policies, like whole life, provide the option for cash flow via loans. Loans are usually made available at a fixed loan rate. Preferred loans may also be available after the policy has been inforce for a specified number of years. These loans provide for a net interest rate of zero because the interest rate charged on the loan is the same as that credited to the policy. Some loans are available with a variable interest rate which is based on Moody’s Corporate Bond Yield Average. The rates on these loans are determined once the loan is initiated and cannot change until the loan is paid off and a new loan is initiated. An advantage of variable rate loans is that the interest being credited to the policy may be higher than that being charged against the loan. However, the opposite can also be said, and one can become up-side-down on their loan if credited rates do not perform.

Alternatively, policyowners have the option of taking a partial withdrawal of their cash value. Partial withdrawals not only reduce the cash value of the policy, but also reduce the death benefit. A partial withdrawal normally has an administrative fee that the home office charges for processing the transaction (usually around $25). It is important to note that a partial withdrawal cannot reduce the death benefit below the policy’s minimum face amount.