Life insurance products typically fall into two broad categories: Term insurance and Permanent insurance. Term insurance is almost always the best product to use for short term needs, and Permanent insurance is almost always the best product to use for long term needs.
Term Life Insurance
The best Term insurance products marketed today are “guaranteed premium” policies. Insurance companies will guarantee a fixed premium rate for 10, 15, 20, 25 or 30 years. Your cash flow or the length of time you need protection will determine which guarantee period is best for you. At the end of the guarantee period, premiums escalate rapidly and quickly become unaffordable. If one’s need for insurance continues beyond the guarantee period, the policyholder can take a new medical exam and re-qualify for a new policy, if they are still healthy, or they can convert their Term policy into a Permanent insurance policy without having to provide evidence of insurability. The conversion option within a Term policy protects policyholders in the event their health changes and they can no longer qualify for competitively priced insurance. Term premiums are a pure expense; they do not build equity/cash value.
Permanent Life Insurance
There are many forms of Permanent life insurance. The most popular types of Permanent insurance are: Whole Life, Current Assumption Universal Life, Guaranteed Universal Life, and Indexed Universal Life. There are also hybrid Permanent policies which offer the features and benefits of multiple forms of Permanent insurance. For example, many Indexed Life policies include a guaranteed death benefit feature similar to what is offered in Guaranteed Universal Life policies.
Whole Life Insurance
Whole Life is the old, traditional type of Permanent insurance. Whole Life policies are structured with a guaranteed premium, guaranteed cash values and a guaranteed death benefit. The guarantees are based upon a low interest rate/reserve assumption, so the premium rates are high and the guaranteed cash values are low in comparison to the premiums and cash values for most other types of Permanent life insurance. Companies credit participating Whole Life policies with dividends which can be used to reduce premiums or build additional equity/cash value. Over time, dividends reduce the cost of Whole Life policies, so they deliver competitive long-term value.
Current Assumption Universal Life
Current Assumption Universal Life policies were developed to offer more flexibility than Whole Life contracts. Premiums are flexible on a Universal Life contract. Payments can be scheduled comparable to a Whole Life premium, or they can be increased to pre-pay a policy over a limited number of years, or premiums can be scheduled well below the required premium for a Whole Life policy. Policyholders are not forced to base their payments on a low interest rate/reserve assumption as is required with Whole Life policies. Premiums can be calculated based upon a higher interest crediting rate, one more in line with the insurance company’s portfolio return. And, premium schedules can be changed during the lifetime of the policy. The death benefit on a Universal Life policy can also be adjusted during the lifetime of the policy, if the policyholder’s needs change. Current Assumption Universal Life policyholders must be cautious they don’t make unreasonably high interest rate assumptions and schedule unreasonably low premium payments, as the policies may become underfunded and not stay in effect for the lifetime of the insured. Current Assumption Universal Life policies build equity/cash value, which is directly related to the amount of premiums paid.
How Crediting Rates Impact Cost
The interest rate or investment return that is credited to a policy has a direct bearing on the ultimate cost of a policy. A higher crediting rate will support a lower premium payment and will reduce the cost of a policy; whereas, a lower crediting rate will require a higher premium payment and result in a higher cost policy. Interest rates have steadily declined over the past 30 years and are currently at historically low levels. Insurance companies’ investment portfolios are predominately bond-based portfolios. As higher yielding bonds mature in insurance companies’ investment portfolios, they have to reinvest that money at lower returns, which has caused company portfolio returns to gradually decline. That is why you may have experienced or heard of insurance companies having to reduce the dividend scale on their Whole Life policies or having to credit lower interest rates on their Universal Life policies. Lower dividend scales and interest crediting rates increase the cost of Whole Life and Current Assumption Universal Life policies. To give consumers access to higher crediting rates on their policies, insurance companies companies developed Guaranteed Universal Life policies and Indexed Universal Life policies.
Guaranteed Universal Life Insurance
With a Guaranteed Universal Life policy, the insurance company will guarantee the premium amount, the number of years premiums are required, the death benefit amount and the number of years the death benefit will stay in effect. You can structure a Guaranteed Universal Life policy with a low premium payable for life and guarantee the death benefit for life. You can also structure a Guaranteed Universal Life policy to have a higher premium payable for as few as one year which will guarantee the death benefit for any time period desired (to age 85, to age 95, to age 100, for life, etc.). In calculating the guaranteed rates for these policies, insurance companies project what their future earnings and mortality experience will be. Anticipating that interest rates will rise at some time in the future, the premium rates insurance companies have been willing to guarantee in recent years has been well below the current premiums for Whole Life policies and Current Assumption Universal Life policies. Although premiums are lower, a disadvantage of Guaranteed Universal Life policies is the policies have little or no equity/cash value. The insurance companies take what would otherwise have been credited to equity/cash value to support the cost of policy guarantees and to reduce the risk exposure of the insurance company. Guaranteed Universal Life policies are especially cost-effective at older ages, but they should always be considered as a baseline for comparison when evaluating what form of Permanent life insurance is best suited to meet a person’s long term insurance needs.
Indexed Universal Life
In response to ongoing low interest rates and stock market volatility, the insurance industry developed Indexed Universal Life to give policyholders access to higher returns with built-in safety features that eliminate downside market risk. The interest credited to premium deposits on Indexed policies is normally linked to one or more financial indexes, the most common of which is the S&P 500 Index without dividends. Policyholders are credited with the positive performance in the Index each year up to a Cap, which is currently 12% with most companies. Some companies also offer Indexed options with a crediting rate greater than 100% of the positive performance in the market. For example, one option credits policies with 150% of the positive performance in the Index up to a Cap which is currently 10%, so if the S&P 500 Index without dividends is up 6%, a policy would be credited with 9% interest that year. If the Index has negative performance, the product provides a 0% floor, so the policyowner’s money is never exposed to negative returns. The policy also contains an annual reset provision which captures and locks-in each year of positive return, so premium payments as well as the annual growth credited to premiums is protected from market losses. Indexed policyholders have the added flexibility of allocating all or any portion of their money to the insurance company’s Fixed account, which credits a yield comparable to what the insurance company credits on its Universal Life policies. Indexed policies build equity/cash values, directly related to the amount of premiums paid.
Survivorship or Second-to-Die
The types of policies discussed above are all single life policies. Another popular form of Permanent life insurance is called Survivorship or Second-to-Die insurance. That is a policy that insures two people, typically a husband and wife, where the death proceeds are payable when the second spouse dies. Survivorship policies are commonly used in estate planning, because our tax structure allows a married couple to defer estate taxes until the death of the second spouse. Premiums for a Survivorship or Second-to-die policy typically cost 60% of what an individual Permanent policy would cost on the insured male. Survivorship policies are offered on the Permanent insurance platforms discussed above; there is Survivorship Whole Life, Current Assumption Survivorship Universal Life, Guaranteed Survivorship Universal Life, and Indexed Survivorship Universal Life. The features and benefits of single policies mentioned above are the same for their Survivorship counterparts.