Life Insurance Definitions

Guaranteed vs. Current Term Premium

A simplified Yearly Renewable Term (YRT) illustration for a 36 year old male non-smoker, buying $250,000 of term life insurance might look like this:

	Year	Current Premium	Guaranteed Current Premium	Re-entry Premium
	1	$225.00	$225.00	$225.00
	2	260.00	260.00	260.00
	3	295.00	295.00	295.00
	4	330.00	330.00	330.00
	5	357.50	357.50	357.00
	6	390.00	390.00	390.00
	7	422.50	422.50	422.50
	8	462.50	462.50	462.50
	9	497.50	497.50	497.50
	10	547.50	547.50	547.50
	11	637.50	1865.00	277.50
	12	740.00	2010.00	392.50

The hypothetical illustration above was run to illustrate two crucial points. First, notice that the current premium (which is based on current mortality) and the guaranteed premium are the same for the first two years. After that, the guaranteed premium is considerably higher than the current premium. In most YRT plans the insurance company reserves the right to charge up to the guaranteed premiums. However, guaranteed costs would generally be realized only if insurance company mortality experience worsened substantially (i.e., a plague hit the US). Some companies guarantee the current premium for only one year; others may guarantee the current premium for several years. Obviously, the longer the current rates are guaranteed, the better for the consumer. Since life insurance companies have stayed historically very close to their current premiums, guaranteed premiums are not a major factor in comparing YRT plans.

Re-entry Premiums

After you have a term insurance plan for a number of years, some insurance companies allow you to reduce your premium if you can prove that you are still in good health (this is called re-entry). Typically, the re-entry premium is the same as the current premium until the tenth year. After the 10th year, the re-entry premium is lower. Re-entry generally requires you prove good health by submitting statements of health, medical records, or by taking a physical exam.

Insurance companies have lower re-entry premiums which reflect the lower mortality expense of healthy new applicants. Lower mortality occurs because applicants who buy new policies, or successfully re-enter a policy, must be in good health to receive the best rate. Conversely, an insured who is in year seven of his policy may have developed a serious illness. Since the insurance company must renew the policy regardless of health (on most plans), a new healthy client represents a better risk than the ill client who bought the policy seven years ago. That is why the re-entry price is lower than the renewal premium. If you currently have term life insurance (and have had it for at least 2 to 3 years), check to see if your company offers re-entry. If you can qualify, re-entry may save you thousands of dollars. If your current plan does not allow re-entry, you may want to get a quote and re-qualify at lower rates with another company. Before finalizing that decision you need to read the section on replacement.

Preferred Underwriting

Many companies quote incredibly low term rates for preferred non-smokers, but rarely deliver that rate. To get these companies' best rates, you may need to be in better shape than Bruce Jenner. Our quote system assumes you will be issued as a preferred non-smoker. However, we have selected companies who more frequently deliver those preferred rates. This may put us at a bit of a disadvantage compared to our competitors who may quote low, but unattainable, rates. Remember, when buying term insurance, it is the rate at which your policy is ultimately issued that is important, not the lowest quote!

If you have known health problems, communicate with an agent before quoting. When talking with your agent you may want to discuss the following factors:

• Your height and weight, if you are overweight.

• Your cholesterol level, if you know it is over 220.

• Your driving record, if you have more than one moving violation in the last three years.

• Your blood pressure, if you have treated or untreated high blood pressure.

• Your smoking habits if you have quit smoking within the last 3 years.

Any of the above factors should indicate to your agent that the absolutely lowest priced policy is probably not available to you. However, if notified in advance, your agent may be able to find a premium within a few percentage points of the low priced policy. Communication in advance is essential.

For serious health problems, communication with the agent is more important still. Many agents can submit your health information to several insurance companies simultaneously, allowing you several offers to compare.

Universal Life and Universal Variable Life

When applying for a Universal (UL) or Universal Variable Life (VUL) contract you have to decide between death benefit option A and death benefit option B. With option A, the death benefit will remain level over the life of the contract. In the rare event that your cash value became larger than the face amount, the death benefit might be increased. If you died with option A, your cash value becomes part of the death benefit, and is not added to the death benefit. Option A should be considered if you have a level need for insurance.

With option B, the death benefit is added to the cash value. If you had a $100,000 option B policy and cash value of $10,000, the policy would pay $110,000 at death. The death benefit is equal to face amount, plus the cash value. While many consumers feel they should buy option B, doing so will require considerably more long term premium. For this reason, option B should only be considered if you have an increasing need for insurance.

Many UL and VUL policies allow partial withdrawals. After several years, these policies may allow the policy owner to withdraw up to the amount of total premiums paid (the basis) into the contract. Taking a withdrawal up to basis can usually be done without recognizing the taxable gain which would exist if the cash surrender value exceeds total premiums paid.

Many UL and VUL policies offer preferred loans to make it more attractive for you to borrow against your cash value. With a preferred loan, you are charged interest to borrow money from your policy. However, the insurance company may credit most of the interest you pay, back to your own account! The result of this may be a loan with a very low net cost of borrowing (sometimes less than 1%). This low net cost of borrowing is important because preferred loans and partial withdrawals are a way of accessing money inside your life insurance policy, without recognizing a potentially considerable taxable gain. If you ever borrow far in excess of your basis, be careful to keep that policy in force, or you might have to recognize a huge taxable gain.

UL and VUL contracts have an accumulated value and a surrender value. The difference between the two amounts is the surrender charge. The cash surrender value is the amount your contract is worth if you actually surrender the policy. Surrender charges can last 10, 15, or 20 years.. Some UL and VUL contracts do not differentiate between an accumulated value and a surrender value. On these types of contracts, the values that you are quoted are the surrender values.

Retaining Tax Benefits of Life Insurance

You can lose some of the tax advantages of a life insurance plan by paying too much premium too quickly. On every UL and VUL contract, there is a certain premium that you should not exceed, referred to as the MEC (Modified Endowment Contract) premium. The MEC premium is based on the age of the customer and the amount of insurance being purchased. If this premium is exceeded, the life insurance contract will lose its tax free loan and withdrawal status. Furthermore, money taken prior to age 59 1/2 will be subject to IRS penalty.

When buying life insurance to supplement retirement plans, make sure that you stay below the MEC premiums. It is easy to design a program that stays under MEC premiums. Your insurance agent, or the insurance company, will guide you in this area.

In some instances it makes sense to exceed MEC premiums. Some clients may want to put a substantial amount of money into a UL or VUL today and pay no premiums in the future. If the client is confident they will not need to withdraw money from the policy and the policy will be kept until death, an over funded (MEC) life insurance contract may be acceptable.

Graded Premium Whole Life

Many insurance companies call their most competitive term policies Graded Premium Whole Life (GPWL). These policies have characteristics of YRT and Cash Value life insurance. These policies usually resemble a YRT since they have very low premiums in the early years. They resemble cash value life insurance because they eventually build up cash values (usually after a very long time period like 20 years). Our consultants refer to these types of policies as a YRT even though they are technically not YRT policies. It should be noted that while these types of policies are often quite attractive, after about three or four years, the insured should be considering replacement.

Problems with Under funding a Universal Life Contract

In a universal life contract (UL) you begin by paying a planned premium. In subsequent years, UL allows the flexibility of paying very small, or very large premiums. However, if you pay too small a premium for an extended period, your contract might run low (or out) on cash value. If you have low cash value in later policy years, considerably higher premiums will be required at that time to keep the life insurance in force.

UL consumers are often misled by the fact they have built large cash values in their policies. Sometimes, customers feel completely secure when they see that the interest generated within their UL policy is higher than the cost of insurance inside the contract. This security is not always warranted, because the cost of insurance will increase as you age. If, at some point, the cost of insurance becomes sufficiently high, the contract could run out of cash value.

UL can represent an excellent life insurance purchase. However, existing UL contracts should be reprojected every five years at minimum. If interest rates have been falling, the level of premium might need to be increased. If a UL contract is under funded (as above), the sooner the consumer moves to correct this situation, the better.

Net Interest/Net Rate of Return

The net interest rate on a UL policy is the interest rate which the insurance company is paying on cash values. Keep in mind, an insurance company will typically make a 1.5% - 2% higher rate of return on their investments than they credit to your policy. On a variable universal life (VUL) contract, the net investment rate of return is the rate of return after subtracting the asset management fees. Be careful when comparing UL with VUL. UL is usually quoted with a net rate of return, while VUL is quoted with a gross rate of return. If a consumer fails to adjust for this, any comparison is meaningless.