Factors to Consider
When Designing Your Life Insurance Policy(ies)
Whole Life Certified specialists trained are experts at designing whole life insurance policies according to the Rockefeller Method.
This worksheet will also help you design your polic(ies).
This includes the following considerations:
Risk Does Not Equal Return
Indexed and variable universal life policies are likely to have larger numbers on the illustrations, giving a sense of a higher return. But as we dig deeper, we find some areas of concern.
First, due to the nature of the required disclosures, complexity, and risk, they have at least 4X more pages to describe the policy. This risk transfer benefits the insurance company at the policyholder's expense. These extra pages demonstrate levers placing the risk on the policyholder.
Yes, they can illustrate higher, but what is the likelihood of this performance? Close to zero. It is imperative to look at the guaranteed cost side of the ledger and understand what could happen (usually go to zero).
There are cap rates that limit your upside, and even the limited downside doesn’t always account for the cost of insurance.
To help resolve these concerns, universal life policies add guarantee riders. However, these riders can be negated with missed payments, which removes the touted flexibility these policies should provide.
The policies are credited through an options strategy. The cap rates can change depending on the competition and, therefore, the options budget.
My suggestion is that if you want to invest in the market, don’t jeopardize it with a cash value policy that has too many moving pieces.
One of those pieces is the cost of insurance (M&E).
What are M&E Charges?
Mortality and Expense (M&E) charges are fees that insurers levy to cover the anticipated costs of paying out death benefits (mortality risk) and administrative expenses (expense risk) associated with managing the policy. These charges help insurers mitigate the financial risks they undertake by providing the insurance coverage.
How Do M&E Charges Work?
Calculation and Deduction:
Mortality Risk: This part of the charge is based on the insured person's age, health, and life expectancy. Insurers use actuarial tables to estimate the cost of providing the death benefit, adjusting the fee as the insured ages.
Expense Risk: This covers the insurer's administrative costs, including policy maintenance, customer service, and other overheads. M&E charges are typically deducted from the policy's cash value on a monthly basis. These deductions reduce the cash value of the policy, which can impact the amount available for investment or loans.
Variable Nature:
Age and Health: As the insured person ages, the mortality portion of the M&E charge generally increases because the likelihood of the insurer needing to pay out the death benefit rises.
Policy Terms: The specifics of how M&E charges are calculated can vary between policies and insurers. Some policies might have guaranteed maximum M&E charges, while others might adjust these charges based on changing actuarial assumptions.
What Do M&E Charges Mean for the Policyholder?
Cost of Insurance: M&E charges are a primary cost component in universal life insurance policies. Higher M&E charges can significantly reduce the policy's cash value and affect the overall cost of maintaining the policy.
Impact on Cash Value: Since M&E charges are deducted from the cash value, they directly impact the growth of the policy's investment component. High M&E charges can erode cash value, especially if the policy's investment performance is not strong.
Transparency and Understanding: Policyholders need to understand these charges as they can affect the long-term value and sustainability of the policy. Some policies may not be sustainable in the long term if M&E charges increase significantly or if the cash value is insufficient to cover these charges.
Risk Management: For policyholders, understanding M&E charges is crucial for managing the financial risk associated with their insurance policy. If M&E charges increase, policyholders might need to make additional premium payments to maintain the desired level of insurance coverage or avoid policy lapse.
Policy Lapse and Taxable Gains
How Lapses Occur:
Insufficient Cash Value: IUL policies require sufficient cash value to cover the cost of insurance and other fees. If the policy’s cash value depletes due to high charges, poor index performance, or excessive loans/withdrawals, the policy can lapse.
Non-payment of Premiums: If the policyholder fails to pay premiums or if the premiums paid are insufficient to cover the policy costs, the cash value can erode, leading to a lapse.
Tax Implications:
Taxable Income: When an IUL policy lapses, the IRS considers the event a taxable distribution. The policyholder must pay income tax on any gains in the policy. Gains are calculated as the difference between the total premiums paid and the cash value (or the amount received upon lapse).
Phantom Income: The policyholder may face a significant tax bill without receiving a corresponding cash payment, leading to a "phantom income" scenario. This can be financially burdensome, especially if the policyholder is unprepared for the tax liability.
Policy Loans and Lapse
Impact of Loans:
Loan Balances: IUL policies allow policyholders to take loans against the cash value. These loans accrue interest and can significantly reduce the cash value if not managed properly.
Loan-induced Lapse: If the loan balance plus accrued interest approaches or exceeds the cash value, the policy can lapse, triggering the same tax consequences as above.
Tax Issues:
Loan Taxation: When a policy with an outstanding loan lapses, the loan balance is treated as a distribution, which is taxable to the extent it exceeds the premiums paid into the policy.
Costs and Fees
High Costs:
Mortality and Expense Charges: IUL policies often have high mortality and expense charges, which can increase with age and reduce the cash value.
Administrative Fees: Additional administrative and rider fees can also erode the cash value, heightening the risk of lapse.
Market Performance and Cash Value
Dependence on Index Performance:
Variable Returns: The cash value growth in IUL policies is tied to market indices, which can be volatile. Poor market performance can result in lower-than-expected cash value accumulation, increasing lapse risk.
Misunderstanding Policy Mechanics
Complexity:
Policy Complexity: IUL policies are complex, and policyholders may not fully understand the mechanics, risks, and required management. Mismanagement can lead to unintended lapses.
Overly Optimistic Projections:Policy illustrations often use optimistic growth projections. Real-world performance can differ, leading to cash value shortfalls and lapse risks.
Mitigation Strategies
Regular Monitoring: Policyholders should regularly review their IUL policy statements and monitor cash value, fees, and performance.
Loan Management: Carefully manage policy loans to avoid excessive borrowing and potential lapses.
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