What may be the next wave of universal life contract designs?
UL contracts have been readily available in the insurance marketplace for well over 25 years, and they are accepted and popular insurance instruments.
But the supply of certain variants of these contracts, arguably those that are the most popular, is shrinking. Specifically, several major carriers have announced that they are pulling out of the secondary guarantee UL market. Such plans have accounted for a major portion of UL sales in recent years.
Meanwhile, it has become clear that, for many situations, a product much better suited to client need could be designed. This would be the “income UL.”
Consider these sales situations:
1. An individual wants to provide an income flow to his spouse.
2. An individual wants to provide income to his children for several years.
3. A couple has wealth tied up in an illiquid but profitable property. One child works with the father in the food business, but the other two do not. The couple wishes to share the wealth among all three children when both have passed away.
4. An individual or couple must provide for the welfare of a severely handicapped child if he or they pass away.
In each situation, the financial need at time of death is for income, not a lump sum. (Yes, the situation in the third example could be addressed by a lump sum benefit as well. However, the child who is the business partner realizes the value of the wealth through annual income, so it is plausible that the other children should get income flows themselves.)
A typical UL meets a need that arises upon death by providing a lump sum death benefit in virtually all circumstances. Yet to meet the need in the above situations, the lump sum payment is unnecessary. Not only is it unnecessary, it is costly.
What makes the lump sum costly? There are two factors, at least. The first concerns timeframe over which the benefit needs to be paid. The longer the deferral, the more expensive relative to real need is the cost of the coverage.
More important is whether the present value of the income should take into account the continued survival of the beneficiary. Furthermore, if the beneficiary’s insurability can be reflected in the cost, then the relative cost of the lump sum vis-?-vis the income payout is great and, conversely, opportunities for cost reduction are dramatic.
Let’s examine two related examples. In each case, the comparison is between a UL for a given lump sum death benefit and a UL benefit structure that promises $8,000 a month for the life of the spouse. The lump sum is determined as the largest amount needed by the survivor to buy a single premium immediate annuity that provides $8,000 a month. At female age 65 under representative current conditions, the annuity would cost about $1,270,000.
Thus, the chart compares the cost of a traditional UL with a lump sum death benefit bought by a male age 65 (preferred non-tobacco) with the cost of a special contract providing $8,000 to the man’s spouse while she is living. The lump sum contract costs about $25,400, while the monthly pay contract costs about $15,200. The chart shows a similar great differential when both lives are rated standard.
No one gets something for nothing. Therefore, under the income UL:
o The income amount is guaranteed.
o The income product builds no cash value. (None is required under state law.) Some may view this as a negative, but it works to reduce the income UL’s cost.
o In some cases, the benefit can be structured as a combination of a modest lump sum and a more significant stream of income benefits.
o The $8,000 is payable only during the life of the spouse. There could be a major windfall if she lives 25 years, say, or monetary disappointment if she dies after one payment.
o The basic contract structure provides for no benefit if the spouse predeceases the insured. Alternatives exist that can provide for a benefit of some sort in this case.
o Underwriting the beneficiary opens up the possibility for further cost reductions.
The contracts need to be structured carefully to address both state regulations and policyholder tax issues, but they can be and are being successfully designed, and some companies have already entered the market. This opens up major business opportunities, especially since there are some specialty markets of considerable size.
Cary Lakenbach, FSA, MAAA, CLU, is president of Actuarial Strategies, Inc., Bloomfield, Conn. E-mail him at email@example.com