People always wonder how underwriting works for life insurance. It is a personal thing to go through. I don’t think anyone is truly comfortable with a life  insurance company digging through their personal medical history. We all know that they are looking for the bad things not the good. The question is do you know how they go about underwriting a life insurance policy?

Develop a baseline

The first thing they want to do is fit you into the model.  The underwriters at the life insurance company will take the information passed on to them through your application and your paramed exam.  Much like auto insurance companies reviewing your driving record, life insurance companies are looking for red flags in order to get a baseline of where you fit.  What this means is if everything looks normal you start at a standard baseline which is the best place to start.

If something is questionable from the information the applicant provided then they begin to fit you in a table.  If the applicant’s build (height/weight) is not in normal ranges, there is a medical concern in your history, etc,  you begin to get put in a table rating baseline.  What this means is your starting point would be below standard.  Don’t get worried yet, stay with me.

There are seven main areas the life insurance company looks at to establish a starting point through underwriting (not necessarily in order of relevance):

1. Aviation: Any private aviation?
2. Cancer: Any previous history with cancer?
3. Driving History: Number of moving violations and/or DUI/DWI?
4. Drug/Alcohol: Any history of drug or alcohol treatment or abuse?
5. Ratings: Any medical impairments?
6. Residency: Meets residency guidelines (citizenship, country of residence, etc)
7. Tobacco/Nicotine: Do you currently or have you ever used?  Urinalysis results to support this.

At this point you’re not really a person to the life insurance company.  You are information on a piece of paper.  It is just a matter of matching the information with the underwriting charts to establish the starting point for your life insurance.  Keep in mind that most of the areas listed above will go back either 5 or 10 years.  Before that time and depending on the application you might not be required to disclose information.  It is important to read the application closely.  The questions asked will usually mention a time frame. If it doesn’t then do your best to remember back.  You should always be as honest as you can.

Medical Records

Now that the underwriting has established a baseline, if it is below standard the first thing the life insurance company  will probably do is review the information that was provided to them.  Their main purpose in doing this is to determine follow through on whatever red flag they noticed.  They might reach out to the applicant and/or the insurance person that took the application to get some clarification but ultimately they are most likely going to order the medical records from your doctor.

This seems to be the longest process through all of life insurance underwriting.  The life insurance company sends out a written request to the applicant’s doctor.  The doctor has 30 days to respond.  Now not all doctor’s offices are the same.  Some might respond right away but most likely the request will be put in a pile.  It will be processed when they get to it.  If the doctor is affiliated with a larger practice or a hospital they most likely have a separate department that handles all the medical records.  I haven’t figured out if this is better or worse.

Keep in mind that if you have a somewhat complicated medical history this could involve a few different doctors.  If the applicant had a cancer history, even if they have been cancer free for years, it is not unusual for requests to go out all of their doctors.  They might have seen an oncologist, a radiologist and then specialists depending on the location of the cancer.  Then that is just one red flag that the life insurance company is looking for more information on, there could be other things as well.

Tip: If time is of the essence the applicant has every right to contact their doctor’s office and request a copy of their medical records.  Most doctor’s offices will be able to produce these in a matter of days at the patient’s request versus weeks at the insurance company’s request.

Credit System

Most life insurance companies use a credit program or a point system during underwriting.  Once the baseline is established applicants earn credit, or points to reach a better underwriting class.  One thing to keep in mind is,  if your baseline is below standard then you are most likely not eligible to earn a better rating than standard.  In other words, a starting point of below standard probably makes standard the best rating you are eligible to receive.

The point systems will vary from company to company.  Some of the most common areas are:

• No rating for aviation
• Blood pressure averages
• Body mass index (height/weight charts)
• Cholesterol/HDL ratio
• Family history
• Lab results
• Nicotine/Tobacco use
• EKG (age specific criteria, usually 60+)

The areas listed above are all areas in which the life insurance applicant can earn points.  Some areas may only offer a point while others might offer points at different levels.  For example, the applicant might get one point for having blood pressure below 136/86 and another point for below 130/72 (don’t hold me to these numbers).  These requirements can vary from life insurance company to life insurance company.

Use of Credits/Points

Points are used under two different circumstances during underwriting.  First, if the applicant’s starting point is below standard then they can earn credits to climb the table ladder.  Otherwise if the applicant’s starting point is standard then they can earn points to be in either the preferred or better underwriting class.  How many points you need and how far you climb is the hardest part to determine because of variations from company to company.

The good news is that the credit system allows applicants to improve their underwriting class by showing patterns of good behavior.  What I mean by this is even if you might have been unfortunate enough to go through a bout with cancer, you might still be able to earn a standard rating by showing healthy habits.  If your health history is good, good blood pressure and cholesterol and you’re in good shape then you very well might earn enough credits to bump you up t0 standard life insurance rates.

Related posts:

1. Life Insurance Secret
2. Life Insurance Audit
3. Life Insurance Breakpoints

First to understand this post you’ll have to go read Term vs Whole Life Insurance – What Do The Numbers Show? from @freefrombroke.  To make sure I give proper credit, the post was actually written by Evan (@mjtm) from My Journey To Millions.  Definitely a great read and an interesting post.  Then the comments start flying.  I just can’t help but respond to the comment by “citishark”.  Keep in mind that I am cutting and pasting citishark’s comments word for word (I am not responsible for typos or misunderstandings in the questions posed).

1) what is the interest rate earned you used to calculate the Whole Life Policy?

A participating whole life insurance policy does not have an interest rate, it participates in the earnings of the company and thus pays a dividend.  The dividend interest rate in 2010, for the policy illustrated, is 7%.  Interest rates are used in Universal Life insurance policies.

2) amazing what you can “create” when you compare plain policies avoiding to talk about the “whizzles and bells” in the Whole life insurance contract to make an “honest and plain ” comparison with PLAIN term insurance. No better way to deceive financially-uninformed people, uh?

I’m not really sure what the question is here.  I do think he means whistles when he says “whizzles”.  I do agree with him here when he makes the “plain” comment.  Except that I don’t know what he means by “plain term insurance”.  What other kind is there? There is return of premium term insurance and permanent term insurance but I haven’t seen either of those types beat a properly designed whole life insurance policy.

That being said my agreement to the plain comment is with the whole life insurance policy that is used.  It is a plain whole life insurance policy and I don’t believe it is properly designed.  If you’re looking to beat buy term and invest the difference, using the same information from the original post, my set up would look more like this…

3) Why cash value does NOT start growing from day 1? (err…if I am paying the same premium and YOU say it goes simultaneously to pay x insurance and the rest to “my” investment account)

The reason cash value doesn’t start growing in day is because a lot of initial expenses come out including, what no one wants to talk about, commissions.  I’m here to tell you the secret of whole life insurance…it doesn’t have to be this way.  I showed that above with my numbers which does have cash value from the start.

4) among the “perks of ownership” in Hole Life policy are that “you can take money out, right? if you ever want to take it out to use it since its yours, its considered a loan against the policy. Why do loans come with – interest – at 6-8%? See..you earn 1-4% and when you want to use whats yours, they charge u 6-8% to use it…again this is a great policy. Flock to it!

Interesting question.  The biggest thing this makes me think of is direct vs non-direct recognition.  With direct recognition any money that is taken as a loan is taken out of the cash value.  With non-direct recognition, when a loan is taken the money stays in the cash value and continues to participate in dividends.  Essentially what they are doing is collateralizing the loan with a portion of the cash value.

Using direct recognition most policies will charge an interest rate and then credit a portion of that interest rate back to the policy.  Non-direct recognition works differently.  The interest rate is variable at current market rates (varying from company to company) while the money stays in the cash value and continues to participate in the dividends.

On another note, you don’t have to take out a loan.  You can also surrender a portion of the policy.  In this case you would take a reduction of death benefit and receive monies directly from the cash value that never have to be paid back.  As long as the amount you receive is less than the amount you paid in there is no taxable consequences.

It is important to note that if you do take out a loan it may or may not have to be paid back.  If it is not paid back it will be deducted from the death benefit payout.  Planning is required to do this properly and this is just one of the many areas that most insurance people will let you down.

5) most people do not read the life insurance contract. Whole life contracts (ALL of them!!)If you would ever need to use this cash value, the insurance companies have a right to hold that money and not release it to you for up to 6 months. Say the market is booming and they are making great returns, they will hold your money as long as they can to yeild THEM the best profits. Sweet! (but …for whom?)

I’ve read life insurance contracts cover to cover.  I can’t think of anything specific that I remember in regards to this.  You could very well be right.  I would guess that some companies would have this language in their contracts and iw oudl guess that some won’t.  What I can say is that I have experience in helping people get access to their cash values immediately.  A top quality life insurance company can wire monies from the cash value of the policy to you, in some cases, in the same day.  Truth be told, life insurance companies don’t want to do this but in emergencies I’ve seen and had to lobby for this to happen.  Hopefully you never need it this quickly.

Life insurance companies have reserve requirements that mean there is liquid monies available and in my experience I’ve never seen or heard of a life insurance company saying no to someone trying to access their cash value.  This might speak to the important of only dealing with financially strong, top-rated life insurance companies.

In contrast, this question reminds me of 401ks.  I’ve definitely heard more and have more experience with them holding on to monies for longer periods of time.  But that’s a whole other story.

6) Why isn’t it deceiving the consumer to call the return of overcharged premiums “dividends” as if they were new money earned and created by a real investment of the policyholder money? FTC and IRS refer to them in clear terms, as what they really are: “…mere return of premiums the insurance companies overcharge to the unsuspecting policyholder”…

Dividends actually come from a companies divisible surplus.  The divisible surplus is monies available after a company meets contractual obligations, operating expenses, contingencies and other general business expenses.  The divisible surplus in a whole life insurance policy from a mutual insurance company comes primarily from 3 areas: 1. death claims (or mortality) savings, 2. investment results and 3. expense savings.

It is also important to note that with a true mutual insurance companies all areas of the company can have a surplus that contributes to the dividends.  This means that not just the life insurance branch contributes to the dividends but also other areas of the company including but not limited to an investment company that is owned by the mutual insurance company.  Whereas a non-mutual whole life insurance policy will only receive divisible surplus from the life insurance section of the insurance company.

7) How all this compare con Level and Plain TERM now?

Okay, I don’t really know what he means by this…is this English?  What I will say is truthfully, this whole comparison so far has left out the biggest cost and expense of term insurance, opportunity cost.

I’m not the writer of the post nor am I the one who posted it.  My guess is neither of them is willing to say that one type of insurance works in all scenarios.  What they are instead trying to do is have people keep an open mind and educate themselves more on the current state of life insurance.  Things are changing.  The most prominent changes in recent years are the cost of insurance for all types of life insurance and the increased flexibility of whole life insurance.

I’m with Evan and Craig when I say that I’m not willing to admit that term insurance is the answer for everyone and all situations.  In fact, I see a lot of places where a whole life policy will perform far better than term insurance.  That being said, for the average person out there, I will admit term insurance is probably better.  If you are above average (even if your not) you should have an open mind and educate yourself about what is out there and what your options are to determine what is best for your personal situation.  This probably means seeking helping from a qualified professional and/or asking questions.

Related posts:

1. Whole Life Insurance is Stackable
2. Life Insurance Secret
3. Life Insurance Audit

I was reading Clarifinancial’s post about whole life insurance that doesn’t last a lifetime.  That got me thinking about writing a blog post myself to get into more specifics about how permanent life insurance might not be permanent.  I then read Suburban Dollar’s request for more information. This made me make an outline for a blog post myself.  Then, Clarifinancial posted an other article in hopes of addressing parts of this question.

While I think that conceptually Clarifinancial is a very interesting concept and truly one-of-a-kind, I’m worried that this blog post doesn’t go far enough to answer some of the outstanding questions regarding his original post and permanent life insurance.  If you want people to compete for your life insurance policy (especially term insurance) Clarifinancial is a great first stop.  However, permanent life insurance policies need more design work to structure the policy for your personal situation (I’m right here).

1.  Guaranteed For A Certain Time Frame

Some life insurance policies are only designed to last for a certain period of time.  The prime example of this is term life insurance.  You pay your premiums for the duration of the term and the life insurance company guarantees that your policy will stay in force for the duration of the term you selected, usually 5, 10, 20 or 30 years (don’t forget about Annual Renewable Term and everything else in between).

With permanent life insurance things may change, more specifically Universal Life insurance policies (UL).  Traditional Whole Life insurance policies are built with internal guarantees that guarantee if you continue to pay the premium the coverage will be in force until you pass away or it endows.  Before January 1st, 1985 things were different but we’ll cover that later (#6).  Universal life insurance  policies are often marketed for their flexibility.  This is due to the structure of Universal life insurance policies and the way in which the cost of insurance, as well as other charges, are levied against the policy itself.  Whenever you purchase any type of life insurance policy the person helping you place the policy is required to show you an illustration.  With a Universal Life insurance policy illustration they will show you two types of projections:

• current assumptions – gives you how long the policy will last using the current assumptions in the illustration (i.e. cost of insurance, returns, charges, fees)
• maximum charges – this is the important number, it shows you how long your policy is guaranteed if the maximum amount was charged for cost of insurance, charges and fees AND the minimum return was earned within the policy.

It is important to note that Variable Universal Life insurance policies (VUL) may or may not have guarantees because of the varying returns within the policy.  Some VULs will have separate accounts, to allocate a portion of your excess premium to in order to have some built in guarantees.

Also Universal Life insurance policies are available with secondary guarantees which can give up the flexibility of your permanent life insurance policy.

2. Charges Go Up

With Universal Life insurance policies, insurance companies give you a bucket with holes in it.  This allows them the ability to change certain charges within your permanent life insurance policy.  Also with Universal Life insurance policies, the cost of insurance is going to increase slightly each month because you are getting older.   It is easy to account for the increases to the cost of insurance because the increases are pretty uniform.  However, you never know when the life insurance company is going to increase the administrative fees and charges associated with the policy.  If these charges eat away at the cash value more quickly than you originally thought, you’ll receive a lapse notice – more money or no policy.  To avoid this, check your guarantees with maximum charges as mentioned above.  The exception are secondary guarantees, just make sure to stay on top of those premium payments.

3. Returns Go Down

Again this doesn’t apply to all Whole Life insurance policies because they have a built in guaranteed rate of return, but it could be illustrated with a higher return than guaranteed.  Universal life insurance policies, however, may become dependent on the rate of returns within the policy to support the cash value and charges.  This was the problem with Universal Life insurance policies back in the late 1980s when there were double digit interest rates.  When interest rates started to be cut and the earnings within those policies went from 15% down to 5% it wasn’t enough to outpace the charges within the policies.  The result was that people were asked to put more money into their Universal Life insurance policies or risk losing their permanent life insurance policy.

Make sure to understand your guarantees.  Even Whole Life insurance policies sold during the 1980s had dividend protections that became unrealistic with a deflating economy.  Dividends are not guaranteed.

This is even more prevalent with Variable Universal life insurance policies because now you add the ability to have negative returns within the cash value of the policy.

4. Don’t Pay Premiums

This is a no brainer.  It doesn’t matter what type of permanent life insurance policy you have, if you stop paying planned premiums it’s just a matter of time until you lose the policy.  Remember to keep a close eye on your policy if your planned premiums rely on non-guaranteed elements of your permanent life insurance policy.  There are two ways to plan ahead so that you don’t have to continue paying premiums:

1. reduce paid up – this is when you reduce the face amount of a permanent life insurance policy to the maximum amount the cash value will guarantee for the rest of the policy.
2. policy loans – this brings us to #5

5. Policy Loans

Permanent life insurance policies today have changed; both Universal Life and Whole Life insurance policies allow you to miss premium payments.  They do have differences though.  With Universal Life policies nowadays, some policies will treat missed premiums as loans while others will just continue to take the charges out of the cash value.  Most Whole Life insurance policies, however, treat missed premiums as loans.  Watch out for those interest charges.

You are also allowed to take out policy loans from the cash value of your life insurance policies anytime.  In order to not be taxed on these distributions, loans need to have interest charges, which if not paid will add up over time and eat into the cash value of the policy.  Watch out for those interest charges.

Once loans and withdrawals begin in your life insurance policy it also now becomes extremely important to keep this policy in place for the rest of your life.  If not, there could be some adverse tax consequences.

6.  Endowment (or as Clarifinancial called it, maturity)

January 1st, 1985 marked a huge change for the life insurance industry.  This is when the Tax Reform of 1984 went into affect.  This tax reform stated than any policy that endowed before the policy owner reached the age of 95 would no longer qualify as life insurance.  This meant that the proceeds of an endowment policy became fully taxable.  Older policies were grandfathered in but it has virtually eliminated endowment policies in the life insurance industry.

An endowment policy is is an agreement that at a set period of time, usually an attained age, whether the insured has died or not the policy will pay the death benefit.  Sometimes the payouts if the person is still living could vary but it is previously agreed on and disclosed within the permanent life insurance policy.

7. Human Error

In #4, I mentioned planned premiums.  This is an important concept because the life insurance guy that you are working with is someone you are relying on to properly design your permanent life insurance policy.  If they make a mistake or don’t know what they are doing, you’re the one that has to deal with the consequences.  Unfortunately, you probably won’t realize for a while after the policy has been put in place.  It becomes that much more important to work with someone who specializes in designing permanent policies.  Every successful insurance person can tell you horror stories and messes they have of cleaning up other people’s mistakes.

Get it done right the first time, either let the insurance people compete for your business or work with a specialist.

Related posts:

1. What Every Life Insurance Policy Shouldn’t Be Without
2. Life Insurance Secret
3. Whole Life Insurance is Stackable

There was a huge change that took place in the life insurance industry recently.  This is driven by a new rule for calculating insurance costs that went into effect January 2009.  Truth be told the change has been a lot more gradual than that though.  What has been happening is that life insurance costs have been decreasing dramatically since about 2000.  The Insurance Information Institute says that term life insurance premiums are now 50 percent lower than they were a decade ago.  The internal cost of insurance of cash value life insurance polices, such as Whole Life, Universal Life and Variable Universal Life, have also dropped causing a noticeable reduction in premium rates for these policies.

The average consumer isn’t even aware of this.  The life insurance companies aren’t coming out and saying “it’s cheaper to get a new policy today even if you’ve had your current policy for 4, 5, 6 years”.  They don’t mind collecting the higher premiums.  It then becomes up to the life insurance agents to communicate this to the consumers.  Did your agent tell you?  Have you heard from him/her?  With such a high turnover rate in the industry as well as a pretty uniform misunderstanding of life insurance there has been a huge disconnect between the insurance companies and the consumers.  Again, the life insurance companies don’t mind.  They are the ones that are profiting off of you, the consumer, paying more than you need to for your life insurance.

Why Cheaper?

The biggest driving force behind cheaper life insurance is simple; people are living longer.  With all the advancements in technology and medicine people have been experiencing longer lifespans, thus longer life expectancy.  The costs of life insurance are based on the probability of you passing away.  With longer lifespans, those probabilities are decreasing greatly.  Since life insurance is such a competitive industry, the insurance companies are passing this savings onto the consumer.  What they aren’t complaining about is the old policies that many consumers continue to keep in place and continue to pay.  These are the real money makers for the life insurance companies.

What Happened In January 2009?

The mortality tables have changed.  Effective January 2009, all life insurance companies must use the Commissioners 2001 Standard Ordinary Mortality (CSO) table to calculate insurance rates on new policies.  This is an update to the the Commissioners 1980 Standard Ordinary Mortality (CSO) table that was previously used.  Under the new 2001 CSO, the average 65-year-old male is expected to live to age 81, up from 78 under the previous table. Meanwhile, a 65-year-old female is expected to live to age 85 today, compared with 81 under the old table.  A lot can happen in 21 years and a lot has changed.

As I said earlier this has been a gradual change.  In fact, life insurance companies started incorporating the 2001 CSO years before they were required to.  However, as more and more life insurance companies started to transition to these new insurance rates it caused competition in the industry to heat up.  This further drove down the price of life insurance.

There Must Be A Downside…

With every positive there must be negative right?  Well maybe not always but in this case there is.  The biggest downside to this is seen in cash value life insurance.  The IRS has rules and restrictions about how much money can go into permanent life insurance policies.  With the costs of insurance within these policies decreasing so isn’t the overall amount of money that can be in the policy.  This makes the design and funding of permanent and cash value life insurance policies all that much more critical.  The typical life insurance agent doesn’t fully understand these concepts properly and could end up doing one of two things: leaving you paying more costs and fees than necessary or leaving you with a tax nightmare that you weren’t prepared for.

It is easier than ever to save money on your term life insurance policies, get your insurance assessment today.  With cash value life insurance policies it has become even more important to work with a qualified professional that truly understands the inner workings of the type of policy that you have and the funding that is available, to make sure you are putting yourself and your life insurance policy in the best situation, contact me.

Related posts:

1. Whole Life Insurance is Stackable

Some of you might being wondering why the title of my last post on mortgage acceleration included the words “tunnel vision” at the end.  The reason is because I really approached that experiment with tunnel vision.  I only looked at two different scenarios, I touched upon a decent amount of other scenarios, over a 20 year time frame.  I don’t really think that does the experiment justice.

Today we are going to look at 3 different outcomes built off of the mortgage acceleration experiment.

1.  Sell or Refi

I’m going to consider these the same because both will result in the mortgage getting paid off in a lot shorter time than 20 years.  If Elle were to sell she would then have the option to rent or buy another house and there are just too many scenarios to cover of what could happen.  What we are going to do instead is just look at how this house would work in the first 7 years or so.

In order to take a look at this I made the following table.  I’m using the assumption that if she were to sell the house she would get $123,239 which is the value of the original mortgage.  Whether she gets more than that is arbitrary because it would be an equal addition to each.  Then I am subtracting the mortgage payoff amount in each scenario and determining how much money she would put in her pocket.  For the life insurance value I’m using the surrender value of the life insurance.  If anyone is wondering there are no surrender charges on this particular policy.  Here’s what it looks like:

What we see here is that liquidity is costing a little bit of money in the early years.  It looks like the differences peak around year 3.  It will cost you upwards of about $770 for extra liquidity if you were to sell your house in the early years of this experiment.  Since cost is only an issue in the absence of value, do you see the value in the extra liquidity?

2. 30 year view

This is a 30 year mortgage so truthfully we should take a 30 year perspective on this.  What we learned from the first experiment is that over a 20 year period it’s a bit of a coin flip.  What about a 30 year period?

This would mean that Elle would have to be okay still having a mortgage for an extra 10 years, although I wouldn’t consider her being in debt.  With her paying off her mortgage after 20 years it would free up $811.57 per month for her to invest for the next 10 years at least and let’s say she gets a 6% rate of return.  After the 10 years it becomes arbitrary.  So let’s look at the two scenarios:

This is where I see a lot of people get surprised.  People assume that since the mortgage is paid off and Elle would be putting away almost 5 times as much money that it has to be better to pay off the mortgage and then save the difference.  When you look at it over a 30 year period it’s because of the head start the money on the side gets.  You might find out that that 30-year mortgage can beat a 20 or even a 15-year mortgage.

I even left out taxes.  The whole life insurance policy allows your money to grow tax-deferred and when accessed properly it can be accesses tax-free.  The investment account that she starts after paying off her mortgage mostly likely will have some tax consequences.  I’ll leave the tax discussion for another time but things can get real complicated really quick.

3. Life Happens

Well today we saw that if Elle were to sell her house in the first few years (or refinance her mortgage) as most people tend to do then there is a small cost for having more liquidity.  We also saw yesterday that over a 20 year tunnel vision approach to mortgage acceleration that the whole life insurance policy isn’t going to be the best way to pay the mortgage off exactly at that 20 year point because of an access problem.  Then, today, we took a 30 year view at the issue and realized that the life insurance begins to have more benefits after 30 years vs 20 years.

The basis of the experiment is still, what if life happens? The only reason the concept of liquidity, and not giving too much money too quickly to the bank, comes up is because of flexibility.  Flexibility to adjust to the curveballs life throws our way.  I don’t know enough about Elle’s situation to know what is going to derail her personally but what about you?  What things are going to affect you in a way that you might need to go into the bank and ask for help?

• job loss
• injury
• sickness/illness
• extended leave from work
• disability (waiver of premium)
• death
• natural disaster

It could be a bunch of things or anything.  You could probably think of more or better things that apply to you and your situation.  My point is that life will happen.  That is a certainty.  If you don’t have some flexibility to do things and make changes when something does happen, then things could get real bad real fast.

Related posts:

1. Mortgage Acceleration Experiment – Tunnel Vision
2. Your Mortgage: When 30 beats 15
3. The Way The Banks Want You To Pay Your Mortgage.

I was reading Accelerating Our Mortgage Payments to Save Money and it included a lot of personal information on her mortgage situation.  It listed out all the numbers that went into her decision making.  I took this as an opportunity to try out an experiment for all you readings.  I e-mailed @Elle_CM to see if it would be okay with her and to get a few more vital pieces of information.  Being a fellow Yakezie I’m sure helped and she agreed.  I can’t wait to hear what you think.

Hypothesis

Elle can pay her mortgage off quicker and with more flexibility by putting the extra $150/month towards a whole life insurance policy rather than the principle of her mortgage.

The concept of saving the money outside of your mortgage is nothing new, I’m adding in the whole life insurance policy because of the liquidity, guarantees, death benefit and tax treatment of it.  In my last link rodeo, I referenced two great posts about saving instead of prepaying your mortgage.  I just disagree with using a retirement vehicle and using stocks/mutual funds.

Things Needed

I had all the information I needed in regards to her mortgage from the post itself.  I reached out to Elle to get her age (she told me she’s turning 29, I hope it’s okay if I right that) and information about any current life insurance that she has.

It turns out that she has a 30-year term life insurance policy for $150,000 for $239 per year and she is elite preferred (the best rate class, congratulations).  I couldn’t help but see what I thought of this premium since insurance has gotten so much cheaper.  I got a quick quote for her and it turns out that for $198 per year she could get a new 30-year term life insurance policy with a company that has a comdex rating of 92 and it would include waiver of premium.  That would save her over $1,200 over the length of the policy.

Process

Using a top rated (comdex of 99) mutual life insurance company, I would design a specially funded participating whole life insurance policy and project out (at current dividend rates) when the cash value in the policy would allow her to pay off the mortgage.

Her current loan is a 30 year fixed rate at 5% for $123,239.  This means her payments are $661.57 per month.  Elle’s plan is to pay an extra $150 per month to her mortgage.  This extra payment each month will allow her to pay her mortgage off in 20 years.

Findings

The whole life insurance policy I designed was set up with a total premium of $2,039 per year.  This is the $150 per month in extra payments plus the $239 per year for her current term life insurance policy.  I needed to make sure the death benefit was equal to her current policy, $150,000.  Then I tweaked a few things in the way the money goes into the policy and the type of whole life insurance policy that I used.

After the 20th year the whole life insurance policy is projected to have a surrender value of $63,663.  The mortgage payoff amount would be $61,972.

Benefits

Why would you want to use a whole life insurance policy to accelerate your mortgage?

• Liquidity – You can access the cash value of a life insurance policy the same day if you needed to.  If you put extra money to your mortgage, in order to try and get access to it you need to go ask your bank’s permission.  They may or may not okay you depending on why you need it (when you need it most the answer will probably be no) and then you have to qualify for it.  If there are fluctuations in the value of your home or in your financial situation, you may not qualify.
• Guarantees – The policy that I used is a participating whole life insurance policy.  This means a portion of the cash value is guaranteed and the policy will earn dividends.  The dividends are not guaranteed but the company I used has paid a dividend for over 100+ years straight.  In this policy after year 20 the guaranteed portion is $49,160.
• Death Benefit – Here I just wanted to make sure she would be in the same situation if not better.  Truthfully, if the amounts were larger this would have worked better because I hit minimum death benefits.  Because of those minimums there were higher internal costs than I had thought and wanted.
• Tax Treatment – The whole life insurance policy allows the cash value to grow tax deferred.  When done properly you are also able to access the cash value tax free.
• Mortgage Interest – This is an other benefit affected by the amounts we are dealing with.  It’s not a huge mortgage so the mortgage interest deductions probably wouldn’t be higher than the standard deduction though I didn’t ask Elle for more personal information.  The tax benefit would be extra money in the pocket.  With my concept, if Elle was getting the full mortgage deduction, she would pay an extra about $27,000 in interest.  In a 25% tax bracket that’s an extra $6,250 over the life of the loan.  There’s a lot you could do with this found money.
• Waiver of Premium – If you wanted to you could add the waiver of premium benefit to this policy which would mean that the premiums of your whole life insurance policy would continue to be paid in the event that you became disabled.  This could keep you on track to paying your mortgage off even if you were out of work.

Problems

There’s always problems right?  Well this might sound too good to be true and here’s the dilemma.

• Access – For life insurance policies, you can surrender up to the cost basis, in this case $40,780 and then you would be able to take a loan for the rest of the monies.  The whole life insurance policy that I used uses non-direct recognition so that the loan is collateralized rather than taken directly out of the cash value.  But you are only allowed to loan up to 90% of the cash value at one time.  90% of the approximately $23,000 left in the policy is about $20,700 which would be enough to pay off the mortgage.  Then you just have to figure out how to work with the loan on the policy.  This might be an alternative to getting another term life insurance policy later in life?
• Rate of Return – I hate talking about rates of return because it’s kind of arbitrary.  You can’t control it.  All you can do is try to position yourself for better rates of return by taking more risks.  I used an online calculator to calculate the rate of return on this policy to be 5.28% which is dependent upon the access mentioned above.  If the economy improves this rate could improve as well because the dividend rate within the policy would likely improve but it’s not going to get much higher.  It will never compete with stocks.
• Early Years – As we all have probably heard, the cash value will not equal what you pay in the early years of the policy.  For this particular whole life policy the cash value outpaces the cost basis in the 7th year.  Of course  with the alternative (money to your mortgage) you might not be able to access any of it.

Conclusion

This experiment is a bit of a coin flip for me.  My original hypothesis is about 50% right.  It turns out she can’t pay off her mortgage quicker but by having the money in a liquid side account (cash value life insurance) she would have a lot more flexibility.  My take away from this is that, as I already knew, it doesn’t work for everyone.  Hopefully, a few readers will understand the concept, rather than the numbers, and it will open their minds to another way of doing things that might be worth taking a look into.

For the record, for this to work in a more ideal situation you would need at least a $200,000 mortgage (to avoid some minimums I mentioned) and someone who itemizes their deductions.  Larger mortgage amounts, thus larger incomes will only make this concept work better from a tax standpoint.  In higher tax brackets, the whole life insurance policy would give added tax benefits rather than using a side account that could add a lot of tax headaches.

What do you think?

Maybe we need another volunteer to show what this might look like at higher dollar amounts?  If you want to learn more about the concept or how it works for you, contact me.

This story continues with the full picture of mortgage acceleration.

Related posts:

1. Mortgage Acceleration Experiment – Full Picture
2. Your Mortgage: When 30 beats 15

There’s one thing that every life insurance policy you have should not be without: waiver of premium.

Waiver of premium is a rider that you can add to any type of life insurance policy.  It pays the premium for you if you are disabled.  This rider will vary slightly from company to company but will usually kick in after you are disabled for 6 months.  What premium is paid will vary slightly depending on the type of policy.

Universal Life Insurance

The waiver of premium on most Universal Life insurance policies will pay the greater of the monthly charges within the policy or a specified amount designated by the policy owner at issue.

Whole Life Insurance

The waiver of premium on most Whole Life insurance policies will provide the premiums for the base policy as well as most additional riders.

Term Life Insurance

The waiver of premium on most term life insurance policies will provide the premiums for the policy.  Convertible term insurance will usually have a added waiver benefit which would allow the policy owner to convert the term insurance into a more permanent policy during the disability thus having the waiver of premium continue to provide the premiums for the policy as long as the disability continues.

For example, if you had a 20 year convertible term insurance policy with the waiver of premium and you became disabled during that policy, while the waiver of premium rider was providing the premiums, you would have the option to convert to a more permanent life insurance policy and continue to have the waiver of premium provide the premiums for the life insurance policy.

Waiver of premium, it’s your life insurance’s sidekick.

Related posts:

1. Hidden Gem of Life Insurance Policies
2. Life Insurance Secret
3. Life Insurance Breakpoints

The earliest life insurance policy on record was issued on June 15, 1583 in London on the life of William Gybbons.  It was for a 12-month period.

Life insurance was born as annual renewable term (ART).  What ART is is life insurance coverage one year at a time.  What this means is the cost of the coverage is projected out but not guaranteed.  You find out each year what your premium will be for that given year.  Then you decide if you want to keep the coverage.  Sounds a bit crazy doesn’t it.

However, if you are looking for to save money on short term coverage you should definitely consider annual renewable term insurance.  What do I mean by short term?  Well most life insurance companies offer term policies in increments.  The most common are 5, 10, 20 and 30 years of coverage.  ART is something that you should look at as an alternative to 5 or 10 year coverage.

What annual renewable term insurance can do for you in the short term is save you money and provide the ability to carry your coverage for an extra year or two at a reasonable rate.  As anyone who has read their term life insurance policies (anyone?) knows, after your coverage period is up the premiums increase dramatically.  This happens with ART as well but since the guaranteed coverage period is one year it happens more gradually over a period of time.  In fact, a competitive ART policy only starts to see drastic increase after about 12 years (give or take).

Let’s give you an example:

I chose a life insurance company with a 99 Comdex rating.  I’m running a few illustrations for a 35 year old male, in Massachusetts and I’m running them at preferred rates for $1,000,000 of coverage.

For 5-year Term life insurance, this person would pay $510 per year.

For 10-year Term life insurance, this person would pay $700 per year.

Now it gets tricky for annual renewable term insurance but the estimations for the first 11 years (the drastic increase happens in year 12) are: $295, $325, $375, $425, $465, $515, $555, $595, $645, $695 and $775.

This example seems like a bit of no-brainer.  There is a bit of a risk though.  The future premiums on annual renewable term insurance are not guaranteed, they are projected rates. Only the first year premium is guaranteed.  The future premiums could very well increase.  However, when thinking about shorter term policies an ART policy could allow you added flexibility of keeping that policy an extra year or two at a reasonable premium.  That’s an option you wouldn’t get with traditional term insurance.

It can be a great way to save some money. If you have thoughts or plans to convert to a more permanent policy in the near future this will allow you to minimize the short term costs.   The most competitive policies will have full convertibility options as well as the waiver of premium feature just like all other term life insurance policies.

Go ask your financial guy about annual renewable term. When he/she doesn’t know or stumbles, come back here ask your questions, contact me or get an insurance assessment.

Related posts:

1. Life Insurance Breakpoints
2. Whole Life Insurance is Stackable
3. Universal Life Failure Part I

One of the biggest selling points for Universal Life insurance policies today are their secondary guarantees. Have you ever heard of them?  What’s been happening with Universal life insurance policies is that they are very reliant on interest rates.  How are interest rates today?  Lower than anyone ever thought they would be, even the life insurance companies, but especially the agents selling you the policy.  Well, truthfully, I don’t think the agents really cared, but that’s a whole other can of worms.

If we look back at the history and structure of a Universal Life insurance policy you can begin to understand how much they rely on the return the cash value of the policy receives.  If you think of your Universal Life insurance policy as a bucket you need water in that bucket in order to keep your policy.

The life insurance companies got smarter again. They realized that consumers where having problems with their Universal Life insurance policies as interest rates fell.  They can’t have people upset with them because that means people will buy less life insurance.  So how did they fix this?  The created secondary guarantees for Universal life insurance policies.

Universal Life insurance policies were born out of the ‘buy term and invest the difference’ concept. Life insurance companies knew they needed to compete with that concept so they created a life insurance policy that allowed you to ‘buy term and invest the difference’ within the policy.  This internal structure also created a lot of flexibility for the life insurance policy as well.  That’s how they where sold throughout the 80s and 90s, as flexible life insurance.

This flexibility meant that you life could happen and you could still keep your life insurance policy. If you miss a premium payment, they just take the money out of the cash value.  If you want to increase or decrease your life insurance coverage you no longer had to get a whole new policy, they just adjusted your current policy.  If you didn’t want to pay for your life insurance for the rest of your life, you could now pay more in the early years so that you didn’t have to pay later on and your life insurance would still be there for you.

These were just some of the great benefits that the flexibility of Universal Life insurance provided for the policyholders.  However, with extra flexibility comes more places that mistakes can be made. This is where your life insurance person becomes that much more important.  Most of the life insurance agents didn’t understand how Universal Life insurance policies worked.  In fact, most still don’t.  Insurance agents were selling the policies the way people wanted them regardless if it was best for the person.  They gave people what they wanted.

What happened was Universal Life insurance policies were too lean. What I mean is that they became too dependent on the returns the cash value got.  If the returns dropped (as they did) the policies need more money.  No one likes being told they had to payment, so it was time for the life insurance companies to step up.  The stepped up with secondary guarantees.

Most Universal Life insurance policies sold today are sold with a secondary guarantee. What the secondary guarantee says is something along the lines of, if you continue to pay at least $X amount of premium, this life insurance policy is guarantee by the good faith and claims paying ability of ABC Insurance Co. regardless of the cash value in the policy.  The key is the ‘regardless of the cash value’ in the life insurance policy.  This meant that if your Universal Life insurance policy ran out of cash value, you could still keep the policy in force and your premium stayed the same.

Great.  Now you don’t have a life insurance policy that is as reliant on the cash value within it.  Now you can save policyholders and insurance agents from themselves.

What people don’t understand is that these secondary guarantees are basically minimum premiums. If you fall below that minimum premium (i.e. miss a premium payment), this secondary guarantee will most likely go away.  Most life insurance policies won’t let you re-instate a lost secondary guarantee or if they do it will be a higher premium than it originally was.  You’ve now lost that flexibility that was the huge selling (or buying) point of Universal Life insurance.

Today’s Universal Life insurance policies are glorified permanent term insurance. People pay the secondary guaranteed premium which usually means the policy will have little or  no cash value build up.  The secondary guaranteed premiums are the minimum to keep the policy in force so they are not set to help you build cash values in any way.  They become term insurance, policies that will cover you for a set period of time (in this case permanently) with little to no walk away value.  Just make sure you don’t miss a premium, because as with term insurance, you just might lose your permanent policy.

If you read this policy and are wondering what kind of Universal Life insurance policy you have, I completely understand.  Pick up the phone and ask your financial planner and/or life insurance guy.  What did they say?  If their answer doesn’t sound quite right or you still have questions, contact me.  Or better yet, just get an insurance assessment.

Related posts:

1. Universal Life Failure Part II
2. Whole Life Insurance is Stackable
3. Life Insurance Secret

I was reading a post over a Clarifinancial titled, Can You Own More Than One Life Insurance Policy?

His post got me thinking about the changes that have come about in the the life insurance industry.

Due the their cost structure, Universal Life insurance policies have often been touted as the most flexible life insurance policies.  I’m hear to tell you times have changed.  The new Whole Life insurance policies that have been rolled out with the updated CSO tables are more flexible.  Yes, you heard me right, more flexible than even the Universal Life insurance policies.

One of the ways they have become more flexible is the ability to stack life insurance policies.  What I mean by this is if you have the need to increase your insurance with the new Whole Life insurance policies you are able to do so without getting another policy. Universal Life insurance policies have been able to do this since they came out due to the core cost structure.  At it’s core a Universal Life insurance policy is annual renewable term insurance.  This means that each year the cost of insurance within the policy goes up.  It also makes it easy to increase the face amount of the policy because the cost of insurance is determined per $1,000 of coverage.

You use to have to get a whole new policy anytime you wanted to increase the coverage amount of your Whole Life insurance.  What this would mean is redundancy in some of the charges that occur to you.  Such is the case with term life insurance.  In order to increase coverage you need to take out a new term insurance policy.  This means selecting the length and amount of coverage.  This also means a new policy fee.  By stacking policies or adding to existing coverage on the same life insurance policy, you might very well be able to save yourself between $50-$100 or more per year.  Not too shabby.

With older Whole Life Insurance policies, you use to have to take out a new policy if you wanted to increase your coverage.  This often meant that, and it is not unusual to find, people might end up with 5 or 10 whole life insurance policies.  In the old days, you would buy extra life insurance when you insurance guy came around.  Buy $10,000 here, $5,000 there, an other $10,000, maybe even a $25,000 life insurance policy.  All of a sudden these policies and fees start adding up.

Life insurance agents figured this out and started showing people how they could consolidate their old dozen or so Whole Life insurance policies into one Universal Life insurance policy.  Between consolidated fees and rolling over the cash value, people are able to increase their life insurance coverage with little or no out of pocket expense.  It’s hard to believe it but it’s true.  People are living longer today and the cost of insurance is less than it use to be.

Life insurance companies got smarter as well. They knew that they needed to compete with the flexibility of Universal Life insurance policies.  They have definitely stepped up to the plate.  The new Whole Life insurance policies usually will allow at least three ways to increase your coverage amount without getting a new policy.

1. Increase the face amount of your Whole Life insurance policy
2. Add on (or increase) term life insurance attached to your policy
3. Add on (or increase) supplemental life insurance attached to your policy

All of this without adding on redundant fees.  Keep in mind that anytime you want to increase your life insurance coverage and/or get a new policy you are almost always required to go through underwriting.  As I always find, no one wants to increase their coverage more than someone who just got bad medical news.  By then it is usually too late.

If you have multiple life insurance policies or are looking to increase your life insurance coverage you should talk with a qualified life insurance professional to go over your options with you.  They should be able to do an insurance assessment to determine your best course of action.

Related posts:

1. Hidden Gem of Life Insurance Policies
2. Life Insurance Audit
3. Life Insurance Breakpoints