Life insurance is typically broken into two separate and distinct types: term and permanent. Term insurance provides life insurance coverage at a fixed cost for a predefined period. The primary purpose is to provide a death benefit for a specified time period at a more affordable rate. In general, once the “term” is up, a new policy must be purchased at prevailing rates. If allowed under the policy, the consumer may convert the policy to permanent insurance before the term ends without providing evidence of insurability.
Permanent insurance has an indefinite term, as long as the policy has sufficient cash value to pay policy expenses. Cash value is the “investment component” in addition to the life insurance coverage. Credit unions use different types of permanent insurance for investments. Insurance products, especially permanent insurance, come in many varieties and may have features not described in this section. The complexity of insurance products requires an enhanced amount of due diligence and familiarity that may require certain credit unions to obtain third-party assistance.
Permanent insurance products vary significantly based on the intended purpose and on whether the buyer is an institutional or consumer client. Products designed for companies are referred to as institutional insurance, and products designed primarily for individuals or households are referred to as retail insurance. Some retail policies behave more like institutional policies, as they have policy riders that can be added to minimize surrender charges in the early years of the policy. Policy performance changes over time and credit union boards are responsible for conducting ongoing due diligence to assess surrender charges and what effect they may have on the credit union.
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Typically:
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General Account Permanent Insurance
Separate Account Permanent Insurance
General Account Permanent Insurance
General account permanent insurance cash values are backed by the creditworthiness of the life insurance company. Investment returns on general account permanent insurance may be credited in various ways to increase the cash value of the policy. Costs related to mortality and insurer expenses are an expense of the policy cash value.
Whole Life Insurance
The cost of whole life insurance is determined at the time the policy is written. Whole life premiums are generally higher than term premiums. The crediting rate for a whole life policy has guaranteed minimums, with the potential of added dividends (in participating policies) based on the carrier’s general earnings. Whole life policies also have maximum policy expenses. Whole life policies typically offer the most stable investment returns for life insurance investments.
Universal Life Insurance
Universal life policies have flexible premium payments and death benefits, while the cash value accumulation is dependent upon the type of universal life policy. The key difference between universal life and whole life is that universal life is operated like a savings account.
The policy owner makes premium payments (deposits), while the insurance company deducts policy expenses, invests the net cash value (balance), and credits interest. If there are insufficient funds to cover the policy expenses, the policy owner must pay an additional premium to keep the policy active. The larger the balance, the more likely it is that the cash value’s credited interest will be sufficient to pay policy expenses into the future.
Crediting for general account universal life can happen in two ways:
- Normal Universal Life—As with whole life, investment returns are based on the carrier’s General Account and have guaranteed minimums.
- Index Universal Life—Investment returns are based upon index returns and cash values are backed by the insurance company. The index may have an annual floor and cap (for example, S&P 500 returns with a 0 percent floor and a 10 percent cap).1 Investment returns for an indexed universal life policy vary from year to year depending on the actual performance of the index.
Separate Account Permanent Insurance
As its name implies, separate account permanent insurance funds are invested in separate accounts from an insurance company’s general account. Investment risk is based on the underlying assets in the account similar to mutual funds. The risk is a function of the assets in the account. The underlying assets can range from relatively safe fixed-income bonds to more risky equities. The death benefit payment is an obligation of the insurance company. Separate account permanent insurance is commonly known as variable universal life.
Some separate accounts can have built-in protection features such as stable-value wraps, which can limit the downside price risk of the chosen investment. Some separate account permanent insurance is priced with fixed premiums and some offer less premium flexibility with less certainty of cash value and/or death benefits.
Last updated September 25, 2017