Glenn S. Daily Fee-only insurance consulting

No-waste UL™: No-lapse UL Optimized

November 10, 2011 (original: February 16, 2009)

Are you thinking of buying, or do you already own, a no-lapse universal life policy? A No-waste UL™ analysis will show you how to use the premium flexibility of your policy to save money.

A No-waste UL™ analysis leads to one of these outcomes:

Category 1: No change needed.

The illustrated premium schedule cannot be significantly improved, although adjustments may be advisable in the future if there is a change in the insured's health or the policyowner's opportunity cost of money.

Category 2: Possible savings.

A potential cost reduction is available, although the actual result will depend on the insured's future health and the policyowner's future opportunity cost of money.

Category 3: No-brainer.

A significant cost reduction is available by taking advantage of the policy design. No-brainers may involve modifying a rollover from another policy, shifting premiums from one year to another, or shortening or lengthening the premium-payment period.

I will explain how your policy works, so that you will be better prepared to take advantage of cost-saving opportunities in the future. If I can identify a better premium schedule, you will be able to verify the results by obtaining a new illustration from the insurance company.

I need these documents for my review:

1. Policy contract.

This is the most important document, because it provides the details of the no-lapse guarantee. I am interested only in the pages of the contract that relate to the no-lapse guarantee. However, it is not always easy to identify which pages matter, so it is safer to provide the entire contract (except for the medical application pages at the end).

2. Annual statements.

The most recent statement and any prior statements may provide information that I can use.

3. Schedule of premiums paid.

For an existing policy, the dates and amounts of all premiums paid since issue.

4. Illustrations.

I need at least one illustration that shows a premium schedule — such as a level annual premium — that maintains the no-lapse guarantee for life. Additional illustrations with different premium schedules — for example, a level premium to age 70 — may be useful.

5. Health information.

For existing policies, has there been a significant change in the insured's health since the policy was issued? Has the insured recently obtained a life expectancy appraisal report from an underwriting firm, or applied for a new policy? We can discuss a range of assumptions to use in the analysis; in most cases, the results are not highly sensitive to the assumed life expectancy.

For more information, including a cost estimate, contact Glenn S. Daily (gdaily@glenndaily.com, 212-426-6265).

In the news

• Mary Rowland, "Getting The Most From No-Lapse Coverage," Financial Advisor, January 2009

A brief description of no-lapse universal life

No-lapse universal life is a popular type of life insurance that is sold in the United States.

There are two broad types of life insurance policies: term and cash value. Term insurance is pure protection and has no cash surrender value. In contrast, cash value life insurance combines protection with savings. During the early years, the premium exceeds the actual death claims and expense loadings. This excess accumulates at interest and can be drawn upon in later years to reduce the premium that would otherwise be necessary or to provide funds for some other purpose.

The main types of cash value policies are traditional whole life, universal life and variable universal life.

Traditional whole life has premiums that are fixed and guaranteed. These guaranteed premiums are based on conservative interest and mortality assumptions. Each year the company pays a dividend that reflects the difference between actual and assumed experience. Among other options, dividends can be used to reduce the premium or to purchase additional whole life insurance — called paid-up additions — at bargain rates.

Traditional whole life has a rigid structure; there is a fixed relationship among guaranteed premiums, death benefits and cash values. To create some flexibility, many companies offer paid-up additions and term riders that allow the buyer to design a customized plan before issue and to make limited adjustments after issue.

Universal life and variable universal life have flexible premiums, and there is no fixed relationship among premiums, death benefits and cash values. Premiums are deposited into an accumulation account that earns interest, and charges are deducted each month for expenses and the cost of insurance. Most policies have a declining surrender charge.

Universal life policies are backed by the insurance company’s general account, which is invested primarily in bonds and mortgages. For most policies, the credited interest rate is set by the insurance company each month. For indexed policies, the credited interest rate depends on the performance of a reference index, such as the S&P 500, with adjustments specified by a formula in the policy.

In contrast, variable universal life policies let policyowners choose among a family of stock, bond and other funds whose fluctuating value will cause the accumulation account value to rise or fall each day.

There are two types of universal life policies in the marketplace. The older version, which can be called nonguaranteed universal life, has two sets of values: guaranteed and nonguaranteed. The guaranteed values are based on the maximum expense and cost-of-insurance charges and the minimum interest rate. The nonguaranteed values are based on the current (nonguaranteed) expense and cost-of-insurance charges and the current interest rate.

The nonguaranteed values of universal life policies are almost always much higher than the guaranteed values, because the current cost-of-insurance charges are almost always much lower than the guaranteed charges. In fact, the guaranteed values shown on sales illustrations are useless for making purchase decisions, because they implicitly assume that the insurance company will increase the expense and cost-of-insurance charges to the maximum and decrease the interest rate to the minimum as soon as you buy the policy, and that you will continue to hold the policy even though it is obviously a bad deal.

In the 1990s, many policyowners discovered that the planned premiums for their universal life policies were insufficient to keep them in force for life, because those premiums had been based on optimistic assumptions, such as the continuation of high credited interest rates. In response to consumer dissatisfaction with premium uncertainty, insurance companies began to add no-lapse guarantees to universal life policies. These guarantees supplemented the primary guarantees of the policies, so they were called secondary guarantees.

Under the secondary guarantees, a policy could be kept in force for a specified period, such as 10 years, with a premium that was lower than what would be required based on the guaranteed expense and cost-of-insurance charges and the guaranteed interest rate (the primary guarantees). Insurance companies gradually extended the secondary guarantees to keep policies in force for life. A universal life policy with a no-lapse guarantee stays in force as long as the no-lapse guarantee is in effect, even if there is not enough money in the policy to cover the nonguaranteed monthly charges.

The premiums required by the secondary guarantee are always less than the premiums required by the primary guarantee; after all, the purpose of the secondary guarantee is to provide a lower guaranteed cost. The premiums required by the secondary guarantee may be higher or lower than the nonguaranteed premiums; that depends on the pricing of each contract and on future interest rates and mortality experience.

No-lapse universal life (no-lapse UL), also called guaranteed universal life or secondary guarantee universal life (SGUL) or universal life with secondary guarantees, is functionally equivalent to term insurance. You can think of it as term insurance for life. Cash values are relatively low, and there may be no cash values in the early years or in the later years.

You can also find no-lapse guarantees on some indexed and variable universal life policies. When you are buying a policy for its no-lapse guarantee, the chassis shouldn't matter much.

There are now three main no-lapse guarantee designs in the marketplace: stipulated premium, shadow account, and hybrid (which combines stipulated premium and shadow account). Variations are possible, so these descriptions may not fully describe all policies.

Stipulated premium designs

This is the simplest design. The policy stays in force if the actual premiums paid, accumulated at a specified interest rate, are at least equal to the specified no-lapse premiums accumulated at the same interest rate. The no-lapse test calculation is usually done each month.

Policyowners have the flexibility to pay more than the no-lapse premium each month, and this flexibility creates opportunities to reduce the effective cost of the policy.

Shadow account designs

With a shadow account design, the policy stays in force if the shadow account has a positive balance. The shadow account is a reference value that is used solely for the purpose of determining if the no-lapse guarantee is in effect. It is similar to the accumulation account of nonguaranteed universal life policies, but the value is determined by using a different set of charges and credits.

A no-lapse UL policy with a shadow account design has three sets of values: the primary guarantee values, the current (nonguaranteed) values, and the no-lapse (secondary guarantee) values.

Shadow account designs can appear to be unnecessarily complex. The complexity is driven primarily by U.S. statutory reserving requirements, which create an incentive for actuaries to come up with unusual product designs that may allow lower reserves. In turn, lower reserves lead to a lower cost of capital, a lower premium, and therefore a more competitive product.

Shadow account designs give policyowners a lot of flexibility to choose how much premium to pay each month. The complex mechanics of the no-lapse guarantee can create opportunities to save money.

Hybrid designs

Hybrid designs have a dual test for satisfying the no-lapse provision. During an initial period, such as 10 years, there is a minimum premium test. After that, there is a shadow account test.

Hybrid designs provide premium flexibility, subject to the dual tests for maintaining the no-lapse guarantee, and this can create cost-saving opportunities.