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Question for the Money Doctors

Question submitted on Jul 26, 2013.

Question

How does Indexed Universal Life and Equity Indexed Universal life policies differ from Universal Life Policies?

Answer

Life insurance has a number of variables to consider. There is the policy, what the policy invests in, and the various riders that are offered. In general, the types of polices are:

1. Whole life: a premium is made for a guaranteed face value and cash value.

2.Universal life: a premium is made and there is no guarantee of cash value or face value. Many times, if not structured properly, the policy runs out of cash value, and may cease to be in force depending on the riders.

3. Term insurance: a premium is made for a policy for a temporary term. At some point the policy expires.

A Universal Life Policy may invest in.

1. The assets of the insurance company that gives you a minimum interest rate or a current interest rate which may be greater than the interest rate.

2. Access to the various capital markets in separate accounts. The risk of investing is transferred to the insured.

3. Equity indexed options. Some have said that the original intent of the equity indexed annuity was to provide an alternative to Certificates of Deposit. The intent was not to achieve a market rate of return, but to have the potential to return more than a CD, but less than a market investment with no downside potential. These equity indexed policy values are not direct investments in the various indexes, but give the insured a return on a modified index with no loss of principal provided a number of conditions are met such as not surrenduring the policy early.

How this policy differs from a variable universal life insurance policy is that there are a number of inhibitors on the market rates of return. For instance, most policies do not include dividends in the computation of the index. Dividends can account for 60 percent or more of the return of the markets under certain conditions.

There are a number of methods to compute how an index rises during the year. For instance, many policies evaluate the index on a monthly basis. The upside may be capped at a percentage rate (this varies by policy), say 2 percent with no downside cap. Say a market goes up by 7 percent during the one month, you are limited to 2 percent. Now suppose the next month goes down by 3 percent. For computation purposes, you lost 1 percent between the two months. So, you can see it is easy to wipe out gains with losses.

Participation Rate: This is another mechanism that can be reset by the company annually. It determines to what extent you participate in the index rise. The first year may even be in excess of 100 percent of the rate. I have seen these rates as much as 130 percent in the first year. However, the insurance company may determine to reset that rate to the minumum rate, or some rate in between, which I have seen as low as 30 percent.

There is also the potential to have a rider listed that will make sure as long as you make your premium payments, regardless of cash value, you will have the policy in force. Complicating this guarantee, is the fine print that usually stipulates late payments are subject to a catch up provision. If that catch up provision is not followed, the policy may lapse the guarantee, and hence the policy.

In short, one must be diligent and read the fine print. I recommend prior to purchase obtaining a specimen policy so you can read all of the details and ask the relevant questions. If your agent refuses, go to the next agent who complies with your request.


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