The principal source of information regarding a new policy, and something that should be reviewed every closely with your financial representative, is the policy illustration or ledger. The table above shows an annotated policy illustration. You should be told either verbally or in writing the following additional information:
- The separate investment account, which is analogous to the reserve (cash value) of traditional whole life, graded premium life, interest sensitive, and universal life, is made up of four divisions: (1) stock; (2) bond; (3) money market; and (4) master portfolio. The master portion typically consists of common stock, other equity securities, bonds, and money market instruments. Inquire about what percentage of your net premium can go into each. In addition, find out how often you can change from one to the other.
- Note whether the various expenses and deductions are contractually guaranteed not to increase. For this company, variable life policy charges to the policy are: sales loads, policy fees, annual administration charges, state premium tax, and risk charge. Charges to the separate investment account are: cost of insurance (mortality charges), mortality and risk expense, and management fees and expenses. Ask for a total disclosure of each.
- The rate of return expressed in terms of compound interest should be given either on the ledger statement or by the life insurance agent. Ideally, it should be provided for each year.
- The rate of return upon death for this policy for sequential years is as follows:
- The above rates are based on a 12 percent interest assumption death benefit.
- The rate of return upon death can be used when comparing various variable life policies among respected companies. (It can also be used for any life insurance policy.) Consider the following example:
- How were these numbers determined? $1,000 is the future value (death benefit) to be paid, twenty years is the time. Interest is known (14.25 percent, 14.23 percent, 13.25 percent, 13 percent). You then solve for payment – how much must be spent each year to accumulate $1,000 in twenty years at the various interest rates?
- Once the rate of return upon death is known, then it can be determined what would have to be earned before taxes in other financial services products such as mutual funds, certificates of deposit, real estate, or commodities to duplicate the tax-exempt rate of return provided by life insurance. (For this purpose, it is assumed that the death benefit is considered life insurance proceeds and as such not subject to federal or state income taxes.) The before-tax rate of return is determined by dividing the life insurance rate of return by the marginal tax bracket subtracted from 100 percent (for 15 percent, the factor is 0.85; for 25 percent, 0.75; for 28 percent, 0.72; for 33 percent, 0.67; and for 35 percent, 0.65). The result is shown in the below table.
- The rate of return upon surrender should also be provided. When the rate of return upon surrender is positive, it means that taxes are due. Taxes are due on the difference between the cash surrender value and the premiums paid. The result before taxes is as follows:
- The above rates of return are based on a 12 percent interest assumption separate investment account performance. The rate of return upon surrender even before taxes never equals the separate investment account investment performance of 12 percent.
- The Premiums Accumulated at 5 percent column on the ledger statement replaces the Interest Adjusted Index. This is what your money would be worth at 5 percent net after taxes if not used to purchase life insurance. In order to net 5 percent after taxes, the before-tax rates of return in the following tax brackets are:
- The ledger statement should be the official ledger statement produced by the computer service of the life insurance company. It should be bug-free.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM