Frequently Asked Questions About Life Insurance.
(Much more interesting than the title would indicate!)
By Rudi Hoffman CFP®, CLU
Certified Financial Planner™ and Chartered Life Underwriter
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- What’s the difference between term and “whole life” or “Permanent” insurance?
- What is UNIVERSAL LIFE?
- I have an illustration for a Universal Life Policy. How the heck do I understand this? It is 17 pages long! Jeepers! And, what is the difference between the guaranteed and nonguaranteed rate?
- What is the Guarantee rider?
1. What’s the difference between term and “whole life” or “Permanent” insurance?
Response: Briefly, TERM is insurance for a “Term” or period of time. For instance, a policy may be a 20 year term, in which the premium (the amount you pay) and the face amount (what the policy pays upon “death”) both stay level for 20 years.
At the end of the 20 year period the term policy may be RENEWABLE (which means you can obtain another period of term insurance) but the premium will go up. In the later years, when people tend to die, the premium goes up astronomically.
The policy may also be “Upgradeable.” This means you can UPGRADE the policy to a PERMANENT policy without evidence of insurability.
There are several types of PERMANENT policies, but basically they are all the same in concept. A somewhat higher premium is charged by the insurance company over the cost of the “term” insurance. But this premium will never increase.
This allows you to have a CASH VALUE in your policy. In other words, the policy builds an amount of money that enables the policy to stay in place in the later years without the enormous premium increases that occur in term insurance in the later years. This “Cash Value” can also be used to pay the premium on the policy should the need arise.
2. What is UNIVERSAL LIFE?
Response: Universal Life is a form of permanent insurance in which the cash value builds at CURRENT or prevailing interest rates. It also allows more flexibility in adjusting premiums and face amounts than traditional permanent policies called “whole life policies.”
We can think of a Universal Life policy, often called a UL policy like this:
As you pay premiums into the policy, they go into a bucket of money or a savings type plan. This cash value is growing at a certain interest rate, called the CURRENT rate. This is the interest rate that is ACTUALLY being credited at this point in time. This interest rate is also called the nonguaranteed rate.
From this cash value, the insurance company pulls a relatively small amount to pay for the risk of your dying. This is the internal cost of insurance, which is sometimes abbreviated as the COI.
So, as you put money into the bucket, it is growing at the current rate of interest. There is also a COI being deducted from this account.
3. I have an illustration for a Universal Life Policy. How the heck do I understand this? It is 17 pages long! Jeepers! And, what is the difference between the guaranteed and nonguaranteed rate?
Response: Insurance companies selling Universal Life insurance want to credit a competitive rate of interest to you and your policy. This is not because they are altruistic, but because they want to earn your business. And in order to do this, the insurance companies must provide consumer oriented rates of interest on the cash value to the consumer.
Balanced against this fact, however, is the responsibility of the company to be able to pay the death benefit when it comes due, and also to remain financially stable over decades or even centuries of time.
To do both of these things, modern policies have and illustrate TWO assumptions in your illustration.
The ACTUAL interest rate being credited is showing in the right hand columns of your illustration. For instance, one insurance company is crediting a current rate of around 5%. Even in the low interest rate environment that currently exists, with bank CD rates at 2 to 4 %, this is the actual rate your cash value will receive.
There are also GUARANTEED columns. This projection shows what happens if the prevailing interest rates are so low that the company goes to the MINIMUM contractually guaranteed interest rates.
In other words, all modern policies have a schedule in the policy of renewal rates, the internal cost of insurance that is necessary to be deducted from your cash value. There are actually two schedules, one showing the actual rate, and a second schedule that has higher costs that the company COULD utilize. This fallback rate schedule is basically a safety net that would be utilized only if there were a huge pandemic or other catastrophe which caused a much higher mortality expense than expected. This schedule is also required by state insurance regulators, relating to the amount of money the company sets back for required RESERVES to guarantee the company can fulfill its obligations.
To this writer’s knowledge of 30 years experience in the insurance industry, no company has EVER gone to their “Guaranteed” rate schedule. Again, this is not because they are altruistic, but because to do so would mean that most healthy and insurable people would seek insurance elsewhere, leaving the company with a disproportionately high group of unhealthy folks.
So, the guaranteed side of the illustration show what happens at the MINIMUM contractually guaranteed interest rate, AND the MAXIMUM internal cost of insurance. Whew! Does that make sense?
4. What is the Guarantee rider?
Response: Some Universal Life policies include a policy provision which enables the death benefit to be GUARANTEED to age 110 or even age 120. This “Guaranteed death benefit” means that the policy will stay in force EVEN in the “double worst case” (maximum internal cost of insurance and minimum contractually guaranteed interest rates) scenarios discussed above.