The answer is an emphatic NO.
Some permanent life insurance policies, specifically guaranteed universal life (GUL) and Whole Life (WL), have required premiums, though WL out of pocket premiums can be reduced by dividends, paid-up addition cash values or policy loans. But the premium paid is not the actual cost of the policy and finding the underlying costs on the policies is a challenge.
For many life insurance policies, there is no required premium. These policies – flexible premium universal life – have a target premium that is suggested, but the policyholder can pay as much or as little as they want. The cost of the policy is entirely different, but the cost can be found – on the expense pages of a policy illustration (that typically must be requested), or on the annual reports issued by the insurance company.
The costs include the cost of insurance (COI), the pure mortality charges, as well as policy loads, administrative charges, rider charges, surrender charges, and loan interest (if applicable). In a variable universal life policy, there will be investment fees and mortality and expense charges also taken from the policy.
Over the life of a policy, the cost of insurance is by far the most significant expense in the policy, though in the early year’s other charges (administrative charges or loads) may be higher to recoup the cost of underwriting the policy (mainly commissions).
There are two challenges for a TOLI trustee relating to policy costs.
- First, high underlying costs can be “hidden” by a high rate of return assumed in the as sold policy illustration. This is especially apparent in flexible premium products where the rate of return assumption can be chosen. A variable universal life (VUL) or equity index universal life (EIUL) policy may have higher costs than a current assumption (CAUL) product for the same insured, but the CAUL product may assume a 4% return while an agent can illustrate up to a 12% return in a VUL policy and up to 7% rate in an EIUL policy. We once had a replacement policy that looked prudent only because the rate of return assumed in the sales illustration was so high. That high return hid costs in the new policy that were 4 times that of the existing policy. Was the new policy “better” than the existing policy? Absolutely not – but the agent made it appear to be by illustrating a rate of return that most likely would not have been met. A trustee must control costs (see Section 7 of the Uniform Prudent Investor Act). Don’t be hoodwinked by the illustration game.
- The cost of insurance within a policy increases on a cost per thousand dollars of coverage each year and in the policy’s later years the increase is dramatic, as seen in the chart below from the TOLI Handbook (1). Cost of insurance is not charged on the total death benefit of the policy but on the net amount at risk, which is the difference between the cash value and the death benefit to be paid. As the cash value in a policy drops, the net amount at risk increases. Those trustees who allow policy cash value to dwindle on older policies will reach a point where the carrying cost of the policy going forward will be much higher than the original premium. Alerting your clients to this expense increase is not a happy discussion to have. To avoid that, you must look ahead and anticipate the coming issue, making the grantor aware well before it occurs.
Life insurance is not an easy asset to manage. For the responsible TOLI trustee, understanding the basics of life insurance is a must. It starts by knowing the difference between cost and premium.
- The TOLI Handbook, ITM TwentyFirst, available as a free download at TOLIHandbook.com
To be able to properly control costs in VUL, IUL or UL; carriers should support an option 2 death benefit with a mechanism to eventually decrease the face amount depending on funding. Do trustees have enough clout to get this service from carriers?