Techy Thursday -- Adjustable Life Products
Adjustable life is a flexible-premium adjustable death-benefit type of permanent cash value insurance. It is essentially a hybrid combination of universal life and ordinary level-premium participating life insurance. Adjustable Life combines the guarantees available in whole life policies with the flexibility of Universal Life. Policy-owners are able to adjust their premiums and face amounts but are not provided with guarantees in association with any change.
Definition Of Adjustable Life Insurance
Adjustable Life insurance is often referred to as the same as Universal Life. However, despite its similarities to Universal Life insurance, Adjustable Life insurance should not be confused with a Universal Life policy. Adjustable Life insurance is not a “direct-recognition current-assumption” type of policy. Direct-recognition current-assumption policies, such as Universal Life insurance “unbundle” policy elements, explicitly showing mortality and expense charges and interest credits.
This type of permanent insurance allows a policy-owner, after the initial payment, to pay premiums at any time, in virtually any amount, subject to certain minimums and maximums. The policy-owner can also reduce or increase the amount of the death benefit more easily than under a traditional whole life policy. To increase the death benefit, the policy-owner will usually be required to furnish the insurance company with satisfactory evidence of continued good health.
Features & Benefits of Adjustable Life Insurance
The insurance industry has evolved over the years, becoming more flexible to meet the complex, ever-changing needs of today's more sophisticated consumers. To meet these needs, products like Adjustable Life insurance was brought into the mix of life insurance products. Adjustable Life insurance is a level-premium, level-death-benefit policy that provides protection for as little as five years or for life.
The premium amount and the payment period are flexible too, which means the policy can change to fit individual needs--one policy for life. Adjustable Life has most of the options of other contracts with one important advantage--the cost of living provision. The cost of living provision is automatically added to every standard policy issued by The Principal. It allows an individual to increase the face amount of the policy to help keep pace with inflation. It's offered every three years if accepted. The amount of increase available is specified in the contract.
Cost of Living Agreement Feature
Included at no charge on most Adjustable Life policies, this feature allows the policy-owner to increase the face amount of your policy without providing evidence of insurability at the end of any three-year period in which premiums have been paid and the amount of protection has not changed.
Lengthen or Shorten the Protection Period
Similar to traditional participating policies, the pure protection and the savings components are not segregated. For a given premium payment plan, the cash value schedule is set, and withdrawals are not generally permitted without a complete or partial surrender of the policy. Many participating policies in the market today and most Adjustable Life insurance policies are indirect-recognition interest-sensitive or indirect-recognition current-assumption policies.
Waiver of Premium
There are two waiver of premium options that make sure the insurance program stays intact. If a policy-owner becomes disabled, his or her premiums are paid by the insurance company.
A Minimum Interest Guarantee.
A Reinstatement Period.
A Policy Loan Provision.
Settlement Options.
Face Amount Increase or Decrease Agreement.
This option allows a policy-owner to increase the face amount of his or her policy -- without evidence of insurability -- on seven option dates between ages 22 and 40 in addition to the Cost-of-Living increases. Increases in the face amount usually require evidence of insurability. Also, an increase in premiums that requires an increase in the face amount to stay within the definition-of-life-insurance guidelines.
Non-Repeating Premiums
Adjustable Life’s design allows a policy-owner to make “unscheduled” payments directly to the cash value. Such payments will lengthen the term of coverage or shorten the premium-paying period depending on whether the current plan of insurance is in a term mode or a whole life mode. A large enough payment might change a plan from term to age 50 to term to age 65, or from a life paid-up at age 75 to a life paid-up at age 65, or from a life paid-up at 75 to a life paid-up at age 65. Some insurance companies may restrict the availability of this feature in the first few policy years.
Policy Flexibility
Adjustable life lets the policy-owner decide how to use it, where to use it, and when to use it. He or she can also decide: How much insurance do I need? How much premium can I afford? Do I need protection to a certain age or for a lifetime?
Guaranteed Insurance Coverage
Depending on the cash flow, protection needs, and personal and business goals and philosophy, Adjustable Life insurance changes as needs change. So, with this flexibility, Adjustable Life insurance is well-suited for anyone from young married couples to professionals and business owners.
A limited protection plan can be set up for five years with low premiums to meet his needs. Between each adjustment periods, the policy is a level-premium, level-death-benefit policy. Depending on the particular premium and death benefit levels that a policy-owner may choose, the policy can assume the form of almost any traditional term or whole life policy from low-premium term through ordinary whole life to high-premium limited-pay whole life.
Even though the plan of insurance can be changed, Adjustable Life insurance is basically a traditional fixed-premium, fixed benefit policy. Some of the items that are up for consideration are the policy loan provisions, the policy loan interest rate, and whether or not the company uses a direct-recognition method to determine the dividend paid policies with policy loans.
Other points to evaluate are the adjustment provisions and the commonly offered guaranteed insurability options. It is best to get the policies that have more liberal adjustment provisions. The policies that permit more frequent changes in the plan of insurance and that permit them sooner after the policy issue date are at the top of the list of considerations.
However, the more liberal the adjustments provisions are, the more involved they will be with higher expense charges. Another key feature is the quality of service of a particular insurance company. With the feature of adjustability to the needs that any one policy-owner may have, the quality-of-service rates are high. Changes require re-computation of the premium payment plan, cash value schedules, and projected dividend schedules and may involve a new underwriting evaluation in the event that insurability is required.
This service comes from a combination of the insurance company and of the agent. So, both of these entities should be considered and investigated. If either one of these entities takes several weeks or months to make the change that a policy-owner has requested, this can be much more than annoying to an individual who is anxious to make an adjustment.
Varieties of Adjustable Life Insurance
Charitable Adjustable Life
Charitable Adjustable Life (CAL) is a specially designed life insurance plan to help secure endowment funds for the future. It’s important that the future financial strength of these nonprofit organizations is secure. CAL is simple, effective and makes perfect sense for nonprofit organizations. After a nonprofit organization has secured a group of interested donors, the donors fill out a simple medical form, and an insurance representative provides a letter of intent to the organization. When the organization receives all premiums/donations, they simply send a check for the total amount to the insurance company
They face the dilemma of increased demand for services in the wake of reduced government support and overflowing operational costs. Charitable Adjustable Life can help ensure the well-being of individual nonprofit organizations by creating a pool of monies for future efforts. CAL is a simple permanent life insurance policy with competitive interest crediting. As the owner and beneficiary of the policy, individual nonprofit organizations have access to any cash values that accrue - a real plus if they need liquidity. CAL makes it possible to plan in the present for a bright future.
In the past, it was common to rely heavily on a handful of wealthy donors. Because CAL is affordable, those limited to making smaller donations may now be able to fund sizable gifts for tomorrow. CAL need not interfere with present solicitation efforts - it's meant to supplement, not replace, current donations. Donors to a nonprofit organization that participates will also find CAL attractive.
Variable Adjustable Life
Variable Adjustable Life (VAL) is a unique type of life insurance that provides a policy-owner with the opportunity for potentially greater wealth accumulation than is offered by traditional insurance policies, along with features that give control over a life insurance program. A full range of investment sub-accounts allows one to earn a potentially higher rate of return on your cash values than traditional policies and diversify dollars to suit risk and return objectives.
The cash value of a VAL policy will vary depending upon the performance of the underlying sub-accounts and may be worth more or less than the original amount invested in the policy.
Employees Adjustable Life Insurance
Various insurance companies in cooperation with thousands of employers across the country, offers a program that assists employees in providing protection and financial security for themselves and their families. This program allows employees of participating companies to purchase individual universal life insurance coverage through voluntary payroll deduction. Here are just a few of the important features offered:
This policy is available to employees of participating companies. Through payroll deduction, an insurance company is able to offer rates that are competitive. Employees can adapt their plan to accommodate their changing needs throughout the years. Premiums can be adjusted to satisfy an employee’s changing needs and/or new budget. The policy provides an increasing cash value, which may be used for emergencies, retirement, college education, or other financial needs. Employees also have the option to increase or decrease the policy death benefit or cash accumulation value without purchasing an additional policy.
Completion of a short, simple application is usually all that's needed. Physical exams are usually not necessary. Individual employees own their policy, so they can tailor it to meet their own needs. Should employees leave their present employer for any reason, they can continue their policy without any change in premiums or benefits.
Workings of Adjustable Life Insurance
Even though Adjustable Life is a flexible-premium type of permanent cash value insurance, and it can take on the form of almost any traditional term or whole life policy, it provides somewhat less flexibility to adjust premiums and death benefits than a Universal Life policy.
Generally, Universal Life policy-owners may vary their premiums at will or skip premium payments altogether if the policy has sufficient cash values to cover mortality and expense charges. Adjustable Life insurance policies cannot be set to zero without policy lapse or without invoking the automatic policy loan provision, unless the policy is in paid-up status. The minimum annual premium is typically equivalent to the premium for a 5-year term policy.
In contrast with Universal Life insurance, and similar to ordinary level-premium policies, once a policy-owner has selected a given plan of insurance, premiums must be paid as scheduled unless the policy-owner notifies the insurer of his or her desire to change the plan of insurance. These advance requests for change in the premium payment plan or face amount or duration of coverage may be limited or restricted to specific dates or intervals.
Since Adjustable Life insurance earns dividends as opposed to interest, an individual should understand how dividends work. Adjustable life is a “bundled” product, which means expenses, mortality assumptions, and the company’s investment performance are lumped together when determining the rate at which dividends are credited. The advantage of dividends in the Adjustable Life insurance product is that policy-owners can receive dividends in a variety of ways. Dividends can be:
Applied to increase cash value. This option lengthens the protection period or increases face amount.
Used to shorten the payment period so the policy becomes paid-up sooner.
Accumulated with interest or taken in cash.
The dividend option can be changed at any time, depending on the customer's needs.
Adjustable Life insurance offers the conventional dividend options such as cash, premium reduction, accumulate at interest, and paid-up additions. Some of the polices also offer what is called a policy improvement dividend option. With the policy improvement option for the dividends become a part of the cash value and afterwards lose their separate identity.
Now, if the plan of insurance is an equivalent to some form of Whole Life Insurance, this option causes the face amount to increase without an increase in premiums or without changing the premium paying period.
Universal life is a prime example of an “unbundled” product. With unbundled products, the interest crediting rate, mortality assumptions, and expenses are stated, so the policy-owner knows exactly what interest rate is being credited. Changes in the interest rate, up or down, can affect face value, policy premium and policy values.
If a policy-owner decide, before five years are up, that he or she wants a lifetime protection policy, this is not a problem with adjustable life because the premiums can be increased and dividends used to lengthen the protection period. As he or she gets older and his income increases, he or she decides to increase the coverage to fit a new lifestyle.
Then, as retirement approaches, he or she may decide to discontinue premiums and have a paid-up policy. All these changes are possible with one Adjustable Life insurance policy. Even with this flexibility, a policy-owner generally is permitted to make changes at specified intervals and with advance notice to the insurer. Between adjustment periods, the policy is a level-premium, level-death-benefit policy.
Fees and Charges on an Adjustable Life Insurance Policy
With an Adjustable Life insurance policy, the costs of administration, record-keeping, and service are generally somewhat higher. It is possible for the insurance company to face greater risk of adverse selection also. The policy-owner has more latitude to exercise their rights to increase or decrease the face amounts and to reduce premium payments without reducing the face amount when the policy-owners health declines.
Considering all these aspects, expense charges and mortality charges tend to be somewhat higher in these policies than in otherwise compatible fixed premium, fixed-benefit policies. Life insurance companies are free to set their premiums according to their own marketing strategies. The premium includes a “loading” to cover such things as commissions to agents, premium taxes payable to the state government, operating expenses of the insurance company such as rent or mortgage payments and salaries, and any other applicable expenses.
Most of an insurance company’s expenses for a policy are incurred when the policy is issued. It may take the company five to nine years or longer to recover all its front-end costs. The state premium tax is an ongoing expense that averages about 2 ½% of each premium payment. Some insurance companies pay 55% first year commissions to the agents when the plan of insurance is similar to an ordinary whole life policy.
In the case that the insurance company offers a “no-load” or “low load” life insurance policy, there are still certain expenses that are unavoidable. Rather than pay either no sales commission or a very low sales commission, the cash value tends to buildup larger in the early years. Even though the commissions are lower, these companies typically must spend somewhat more money on alternative methods of marketing and may therefore incur generally higher expenses in this area than companies that pay commissions to agents. Many of the Adjustable Life insurance policies have no explicit surrender charges. However, some will pay a terminal dividend when the policy is surrendered.
The terminal dividend is typically higher the longer the policy has remained in force. Really this is a form of surrender charge since the company is holding back dividends it could otherwise pay currently and rewarding those policy-owners who maintain their policy longer with a greater terminal dividend.
Adjustable Life Insurance and Taxation
Generally, all policies are taxed in much the same manner as other types of life insurance policies. Death benefits do not usually have federal income tax consequences. Adjustable Life insurance policies are subject to the same income tax and estate, gift, and generation-skipping transfer taxation rules as all other types of life insurance policies. Living benefits from Adjustable Life insurance policies are also taxed in the same way as living benefits for other life insurance policies.
Except Annuity-type distributions, living benefits are generally taxed under the cost recovery rule.” The cost recovery rule is sometimes called the First-In-First-Out rule. This rule treats amounts received as non-taxable recovery of the policy-owner’s investment in the contract. After the policy-owner’s investment is full recovered, additional amounts which are received are treated as taxable interest or as gain in the policy.
Annuity-type distributions are taxed under the cost recovery rules of Code section 72 which states that the policy-owner’s investment in the contract is recovered over the expected payout period. The interest that may be paid or credited to living benefits and held by the insurer, is immediately taxable in full.
Adjustable Life Insurance and MEC
The flexibility in the Adjustable Life insurance policies raises the possibility that the policy could become a MEC. The distributions of a policy areis what will receive a MEC classification penalty. Under a MEC classification the distributions are taxed under the interest-first rule rather than the cost recovery rule. Now if the distributions occur before the policy-owner is 59 1/2, dies, or becomes disabled, there will be an additional 10% penalty.
A MEC classification results in both a faster taxation of investment gains and a possible penalty tax for early receipt of that growth. The non-annuity living benefits such as policy loans, loans secured by the policy, loans used to pay premiums, and dividends taken in cash, are the contract distributions referred to in the paragraph above. Not included in the contract distributions are dividends used to pay premiums, dividends used to purchase paid-up additions, dividends used to purchase one year term insurance, or the surrender of paid-up additions to pay premiums.
Adjustable Life Insurance and Business Insurance
Adjustable life also can be a great product for funding business plans. The flexibility of an Adjustable Life insurance policy makes it suitable for many business life insurance needs.
Adjustable Life insurance offers a conservative and guaranteed vehicle for all sorts of business applications where adjustments in death benefits and / or cash accumulations are frequently required, including split dollar plans, non-qualified deferred compensation plans, death benefit only plans, key person insurance, buy-sell agreements, retiree-benefits funding, and in qualified retirement plans which use insurance.
The salary increase rider can be attached to adjustable life to increase the face amount using a multiple of salary. For instance, if the face amount is two times the salary, each year as the executive’s salary increases, so would the face amount of the policy. The executive bonus plan allows the business owner to bonus the amount of premiums to the employee, thus treating it as compensation and receiving a current tax deduction.
Advantages & Disadvantages of Adjustable Life Insurance
As life changes, so do financial goals and the need for protection also change. Unfortunately, most life insurance policies cannot change to meet those new goals and emerging needs. Adjustable Life can save the policy-owner money because he or she does not have to pay costly policy fees every time coverage is added.
An individual’s financial life can be simplified by combining all changes within one single policy. This means the policy-owner has only one policy to deal with -- one premium notice, one set of cash values, one beneficiary designation.
Advantages
Gives control over an insurance program because it can change as the need for protection changes -- without adding a new policy or dropping an old one.
Eliminates the need to choose between whole life and term. With Adjustable Life insurance, the type of plan is determined by the need for protection and the amount of premium one chooses to pay. He and she can change from term to whole life -- and back again -- at any time.
Offers more certainty regarding cash value accumulations than other insurance policies.
Allows a policy-owner to take advantage of tax-deferred growth. At any time, he or she can accelerate cash value growth -- and build toward specific long-term financial goals -- by paying additional money to the policy beyond the regular premiums.
Gives a policy-owner a competitive return on cash value. Adjustable Life insurance invests cash value at market rates.
Free transfers between sub-accounts let the policy-owner adjust the investment strategy according to personal goals and priorities.
Access to cash values through policy loans and partial withdrawals. Loans and withdrawals may reduce the cash value and death benefit of the policy.
The requirement to pay scheduled premiums under the selected plan of insurance provides a “forced saving” feature.
Disadvantages
· Surrender of the policy within the first five to ten years may result in considerable loss since cash surrender values reflect the insurance company’s recovery of sales commissions and initial policy expenses.
It has somewhat less flexibility to adjust premiums and death benefits that over policies.
It has restrictive withdrawal rules.
The flexibility to change premium payments and death benefits may inadvertently cause the policy to become a modified endowment contract (MEC) with adverse tax consequences.
Lifetime distributions or withdrawals of cash values are subject to income tax to the extent attributable to gain in the policy.
It offers only the traditional level total death benefit
Interest paid on policy loans is generally nondeductible.