Most CAWL policies have low or no initial charges or front end fees. Rather, the insurer adds most or all the first year premium to the cash accumulation account which begins to earn interest immediately. However, the commission and other start-up costs of issuing new policies are substantial and the insurer must recover these costs somehow. Insurers generally recover these costs through a combination of annual expense charges and surrender charges.
Insurers may set the surrender charge in the first year as high as 100 percent of the first year premium. After the first year, insurers usually compute the surrender charge as a declining percentage of the cash accumulation account. The rate typically will reach zero in nine to fifteen years. As a result of competition in the industry, the trend has been towards shorter surrender charge phase-out periods.
Policyowners can determine the surrender charge explicitly by looking at the policy illustration or ledger statement. This statement shows both a cash value figure and a net cash value figure for each policy year. The cash value is the amount on which the insurer bases interest credits. The net cash value is the amount that the company would pay if the policyowner surrendered the policy. The difference is the surrender charge.
Commissions paid to agents are one of the principal components of the total issue costs. Commissions are commonly 50 percent or more of the first year premium for an ordinary whole life design policy. If the policy is of a limited-pay type, the insurer typically pays a lower effective commission rate ranging anywhere from 3 to 20 percent on the amount of premium in excess of the ordinary whole life premium. Commissions on renewal premiums are lower. Total initial and renewal commissions generally equal about one year’s level premium if the original plan of insurance remains the same.
Insurance Companies also must charge for ongoing administrative and state premium tax expenses. Furthermore, they typically include an allowance for contingencies and a margin for contribution to the company’s surplus or profit. Premium taxes average about 2.5 percent of the premium paid. The ongoing expenses vary by company but are reflected in their expense charges. Insurers often include allowances for contingencies and profit by grossing-up mortality charges and/or grossing-down the current interest rate from the net rate actually earned on company funds.
Insurers may recoup policy expenses and commissions in a number of ways including a flat policy assessment charge, a percentage of premium charge, a fee based on each $1,000 of face amount, or some combination of each. The trend has been towards lower policy assessment charges and level percentage of premium charges. Many insurers now charge about $25 to $50 per year plus 2.5 to 20 percent of each premium. The percentage of premium insurers charge generally is lower for higher premium, higher death benefit policies than for lower premium, lower death benefit policies.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM