Interest- and market-sensitive life products

Who carries the investment risk?

Traditional whole life is built on long-term, conservative estimates of interest, mortality and expense, and its premiums, death benefit and cash values are fixed in the policy. Interest- and market-sensitive products let current experience flow through to the policyowner more quickly. The trade-off is simple: when rates or markets improve, values grow faster. When they fall, the policyowner feels that quickly too. The further a product sits toward the market end, the more investment risk shifts from the insurer to the policyowner.

Interest-sensitive (fixed) products

Universal life (UL) unbundles the policy into premium, death benefit and cash value. Premiums are credited to the cash value account. Each month the insurer deducts the cost of insurance (the mortality charge) and expense charges. The remainder earns a current interest rate, which can never fall below the guaranteed minimum rate. Mortality charges can never exceed the guaranteed maximum. Key features:

• Flexible premiums. The owner may pay more, less or skip a payment, as long as the cash value covers the monthly deductions. If it cannot, the policy lapses after the grace period.
• Adjustable death benefit. Increases usually require evidence of insurability.
• Option A (Option 1, level). The death benefit stays level, so the amount at risk shrinks as cash value grows.
• Option B (Option 2, increasing). The death benefit equals the face amount plus the cash value.
• Partial withdrawals are allowed and reduce the cash value (and, under Option B, the death benefit).

Current assumption (interest-sensitive) whole life works like UL, but the insurer sets the premium and may raise or lower it as its experience changes. The death benefit does not fluctuate, and a minimum cash value is guaranteed. Excess interest whole life is a fixed-premium version: premiums must be paid when due, and any interest above the guarantee builds cash value.

Indexed universal life (IUL) credits interest based on the movement of a stock market index. The cash value is not invested in the index itself. Crediting is limited by a cap rate and a participation rate, and protected by a floor, often 0 percent, so a down year credits nothing but does not lose principal to the market. IUL is a fixed insurance product, not a security.

Market-sensitive (variable) products

Variable life holds its cash value in a separate account, kept apart from the insurer's general account. The owner chooses among subaccounts (stock, bond, money market and similar), and the investment gains and losses are credited to or charged against that account alone, without regard to the insurer's other results. Cash value is not guaranteed and can fall to zero. Traditional (scheduled-premium) variable life has fixed premiums and guarantees a minimum death benefit, so the death benefit can rise above the face amount but not fall below it.

Variable universal life (VUL) combines UL's flexible premiums and adjustable death benefit with variable subaccounts. It has no guaranteed minimum interest rate and usually no guaranteed death benefit. Poor investment results can force much higher premiums to keep the coverage in force.

Because the policyowner bears the investment risk, variable products are securities as well as insurance. The seller needs a life insurance license and a securities registration (FINRA Series 6 or Series 7). The buyer must receive a prospectus, and the sale must be suitable.

Exam tip: guaranteed minimum interest rate means fixed UL or IUL. Separate account, subaccounts and prospectus mean variable.