A Permanent Life Insurance Policy is different from term coverage-something that is important to understand for the cost of permanent life insurance. It provides insurance for a client’s entire life, and, as long as a client pays premiums, will always have a death benefit. Additionally, permanent polices will accrue cash value as they proceed over time. Over time, this will grow into an asset as value increases. A client can even surrender a late-stage permanent policy for retirement funding.
Some permanent life insurance policies, specifically guaranteed universal life (GUL) and Whole Life (WL), have required premiums. However, dividends, paid-up addition cash values or policy loans can reduce Whole Life policy cost. But the actual cost of the policy is not the premium, and finding the underlying costs on the policies is a challenge.
Premium Payments
For many life insurance policies, there is no required premium. These policies – flexible premium universal life – will suggest a target premium, but the policyholder can pay as much or as little as they want. The cost of the policy is entirely different, but a client can find the cost on the expense pages of a policy illustration (that typically must be requested), or on the annual reports issued by the insurance company.
The costs include the cost of insurance (COI), the pure mortality charges, as well as policy loads, administrative charges, rider charges, surrender charges, and loan interest (if applicable). In a variable universal life policy, insurers will also take investment fees and mortality and expense charges from the policy.
Over the life of a policy, the cost of insurance is by far the most significant expense in the policy. However, in the early years other charges may be higher to recoup the cost of underwriting the policy.
There are two challenges for a TOLI trustee regarding the cost of permanent life insurance.
Underlying Costs
- First, high underlying costs can be “hidden” by a high rate of return assumed in the as sold policy illustration. This is especially apparent in flexible premium products where a client can choose the rate of return assumption. A variable universal life or equity index universal life policy may have higher costs than a current assumption product for the same insured. Yet the CAUL product may assume a 4% return while an agent can illustrate up to a 12% return in a VUL policy and up to 7% rate in an EIUL policy. We once had a replacement policy that looked prudent only because the rate of return assumed in the sales illustration was so high. That high return hid costs in the new policy that were 4 times that of the existing policy. Was the new policy “better” than the existing policy? Absolutely not. But the agent made it appear to be by illustrating a rate of return that most likely would not have been met. A trustee must control costs. Don’t be hoodwinked by the illustration game.
Cost of Insurance
- The cost of insurance within a policy increases on a cost per thousand dollars of coverage each year. In the policy’s later years the increase is dramatic, as seen in the chart below from the TOLI Handbook. Cost of insurance is not charged on the total death benefit of the policy but on the net amount at risk, which is the difference between the cash value and the death benefit to be paid. As the cash value in a policy drops, the net amount at risk increases. Those trustees who allow policy cash value to dwindle on older policies will reach a point where the carrying cost of the policy going forward will be much higher than the original premium. Alerting your clients to this expense increase is not a happy discussion. To avoid that, you must look ahead and anticipate the coming issue, making the grantor aware well before it occurs.
Managing Life Insurance
Life insurance is not an easy asset to manage. For the responsible TOLI trustee, understanding the basics of life insurance is a must. It starts by knowing the difference between cost and premium.
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- The TOLI Handbook, ITM TwentyFirst, available as a free download at TOLIHandbook.com
