Just like any other savings or investment plan cash value life insurance requires some degree of management, especially when it's purchased for income or wealth accumulation purposes. So what aspects are important and need some degree of periodic check? That's what we'll be reviewing today.
Different Policies have Different Pieces and Parts
Depending on the type of policy, there are a few different aspects, some are fairly ubiquitous and others not so much. The big takeaway for the day is simply this: we want to review these items from time to time to determine how the policy is performing. We also want to be able to check on and cease upon certain opportunities that might exist throughout the life of the policy.
Due to the variances that exist among different policy types, we'll discuss each one independently. We'll start with the oldest form of permanent life insurance, whole life insurance.
Whole Life Insurance Periodic Management
Not surprisingly, the big thing we monitor every year regarding whole life insurance is the dividend interest rate. This isn't the only component to the total dividend payout, but it is usually the largest. The dividend interest rate shows us how the insurance company is doing with regards to investment yield on the general account (the pool of money established by the collection of premiums and technically where your cash surrender value sits).
It's important to keep in mind that the dividend interest rate doesn't tell us precisely what is being paid, but it does tell us if the investment component (again historically the largest factor) of the dividend is declining or increasing.
Every year the insurance company will announce it's dividend interest rate for the following year. These announcements are traditionally sent both to the client and the agent. It also should be no problem for an agent to look this rate up at anytime (it doesn't change more than annually, but if you lost the notice from the insurance company and wanted to know what the current rate was, it should be no problem to acquire.
As a general rule of thumb, an income stream taking 5% of the present cash surrender value is typically a safe distribution from a participating whole life policy if income starts at age 65+ on a policy at least 10 years old. Keep in mind I'm generalizing so there will be some variance. In any event, once you are taking income from a whole life policy, you can check the policy for a max income projection once income begins (it may very well be a higher number than 5% of cash surrender value). If you choose to do this, it's highly advisable that you update this projection annually to ensure you current yearly income is sustainable long term. This is an easy determination to be made with your agent.
Modified Endowment Contract Limit Testing
You'll generally find that the illustration software was a tad conservative regarding modified endowment contract limits (i.e. you can often put more money into the contract before tripping the MEC trigger than the software said you could).
Because of this, it's prudent to check the modified endowment contract limits on an annual basis. If you're sitting on some extra money, and your policy allows flexible paid-up addition payments, you may be presented with an opportune time to stash a little more money in your policy.
At the same time, even though there are several safety mechanism in place to prevent inadvertent modified endowment contracts, it's prudent to keep an eye on this yourself. Determining the maximum premium before triggering a MEC is a very easy job for an agent, and something that should be checked once a year.
Universal Life Insurance Periodic Management
Universal life insurance cash performance is driven by an interest rate rather than a dividend when we're talking fixed universal life (i.e. current assumption and indexed).
This rate should be reviewed once per year on current assumption universal life insurance as the rate paid on the cash surrender value is declared annually. Indexed policies sometimes require more frequent review due to either the indexing strategy, or any periodic payments made that create a new indexed “bucket” (e.g. monthly payments or dollar cost averaging strategies).
Some agents or clients like to try and get too sophisticated for their own good and dive into complex indexing strategies that are best left alone, so if you're having to keep an eye on your indexed universal life policy because you though the monthly averaging strategy was a good idea, you might want to rethink that approach.
If on the other hand, your checking your indexed universal life policy because you're making monthly payments to an annual point to point strategy (or using some sort of dollar cost averaging approach) you'll be creating numerous one year indexing buckets and you'll want to review how each of these buckets are performing under the indexing strategy. It's not something to spend much more than an hour once a month review (if that long), but it's helpful to know.
Identical to the whole life discussion above, you'll want to perform the same review on a universal life policy once generating income. On the indexing side, if you're creating multiple indexing buckets throughout the year, it's not really worth reviewing income projections more than once a year (in large part because there's little you can do).
There's one crucial step you'll want to take once generating income with a universal life policy that has been designed for income purposes. That step is to switch the death benefit from increasing to level. The exact year in which you do this should involve a little bit of review on the behalf of your agent, but generally it should either be the year you begin income or within a few years thereafter.
Guideline Death Benefit Management
Because most universal life policies that are designed for income purposes make use of the Guideline Premium Test, you can do well performance wise to keep an eye on the death benefit relative to the DEFRA regulations. When income is an important goal, squeezing the death benefit as much as possible will help maximize performance. Again, this is an area where you'll often fine the illustration software from the company was more conservative than reality.
Each year it's prudent to look at the death benefit and contemplate a reduction (if you are okay with the loss of death benefit) to mitigate insurance expenses.
There are two CRUCIAL side notes to this
- You probably won't be able to make any use of this until after the first 15 years. This is due to the 15 Year Force Out Rule. This is an additional rule regarding DEFRA compliance that causes certainly taxable implications for death benefit reductions within the first 15 years.
- You need to be careful if you are still within the policy's surrender period. Ideally, it's nice to be in a universal life policies with a surrender period no longer than 15 years, but there are some worthwhile contracts that stretch on to 20 years. If you are in this sort of product, or you started with a higher death benefit than the absolute guideline minimum, than you need to ensure that you reduce the death benefit by no more than the annual surrender free amount. All policies have a percentage of the death benefit you can reduce without incurring surrender penalties while you are still within the surrender period (this is most frequently 10%). If you go beyond this amount, the surrender charge in that year will apply to reductions over this amount. Once outside of the surrender period, this is no longer a concern.
It's important to remember that reductions are way easier to perform than increases. So there could be times when you might want to skip a reduction due to a plan to place more money into the policy.
Once you begin generating income, its highly advisable that you entertain reductions to further mitigate insurance expenses.
Typically the DEFRA restrictions comes into play prior to the TAMRA restrictions (TAMRA = Modified Endowment Contract). But it's important to keep this in mind as well, though unlikely it'll be an issue.
Variable Universal Life Insurance Periodic Management
Everything above about fixed universal life insurance applied to variable universal life insurance. The one addition or variance is the fact that variable universal life insurance involves an investment aspect and requires your periodic review of how those investment are performing. Because it's variable, the reporting requirements for variable universal life insurance is more frequent (quarterly rather than annually). A good agent will update you monthly and more frequently, any time a policy value rises or drops by more than a few percentage points.
Anytime a policy loan exists on a policy beyond income purposes, it's prudent to keep an eye on the interest rate (if it's variable) and the interest accrued. The insurance company will update you annually at the policy anniversary. A proactive agent will review the status of the policy more frequently and at least be in contact to, if nothing more, remind you the loan exists. It's not super critical in most cases that you worry a lot about repayment on a life insurance policy loan (they are super flexible and accommodating) but it's one of those things you shouldn't neglect either.
And for the most part, these are the most critical aspects to a policy that should be reviewed and managed. I've outlined all of this so the general consumer can follow along, but the expectation should be that the agent is taking the lead role in ensuring this management and review takes place. If you have a policy that you need some help managing, please feel free to reach out to us. We frequently receive request to do this and have no problem in assisting you with the management of cash value life insurance policy.