LOMA 280

Principles
of
Insurance:
Life,
Health,
and
Annuities

LESSON 6

Cash Value Life Insurance and

Endowment Insurance
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LESSON SIX

Lesson 6

Cash Value Life Insurance

A cash value life insurance policy grants the policyowner certain
ownership rights.
The policyowner generally has the right to surrenderor
terminatea cash value life insurance policy for its cash value
during the insureds lifetime.
The amount of the cash value that a policyowner is entitled to
receive upon policy surrender is referred to as the cash
surrender value or the surrender value.
The policyowner has the right to use the policys accumulated
cash value as security for a loan.
The policyowner can use the cash value of the policy as
collateral for a loan from another financial institution.
The policyowner can receive a loan, known as a policy loan,
from the insurer. If the insured dies before a policy loan is
repaid, the unpaid amount of the loanplus any interest
outstandingis subtracted from the policy benefit.
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LESSON SIX

Lesson 6

Traditional Whole Life Insurance

Despite their common characteristics, cash value plans
differ widely in their features and benefits.
whole life insurance: a form of cash value life
insurance that provides lifetime insurance coverage at
a level premium rate that does not increase as the
insured ages
Whole life insurance policies include a table that
illustrates how the policys cash value will grow over
time.
If the policy does not remain in force until the
insureds death, the insurer agrees to refund the
cash value to the policyownerless any surrender
charges and outstanding policy loans.
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LESSON SIX

Lesson 6

Traditional Whole Life Insurance

Whole life policies can be classified on the basis of the
length of the policys premium payment period. Most
whole life policies are classified as either continuouspremium policies or limited-payment policies.
continuous-premium whole life policy (sometimes
called a straight life insurance policy or an ordinary life
insurance policy): a whole life policy under which
premiums are payable until the death of the insured
Because premiums are payable over the life of the
policy, the amount of each premium payment required
for a continuous-premium whole life policy is lower than
the premium amount required under any other premium
payment schedule for a whole-life policy.
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LESSON SIX

Lesson 6

Traditional Whole Life Insurance

limited-payment whole life policy: a whole life policy for which
premiums are payable only until some stated period expires or until
the insureds death, whichever occurs first
Premiums payable for a specified number of years
Example: premiums payable for 20 years (called a 20-payment
whole life insurance policy)
Premiums payable until the insured reaches a specified age
Example: premiums payable until the insured reaches the policy
anniversary closest to or immediately following the insureds
65th birthday, when premium payments cease but coverage
continues (called a paid-up-at-age-65 policy)
paid-up policy: a policy that requires no further premium payments
but continues to provide coverage
single-premium whole life policy: a type of limited payment whole
life policy that requires only one premium payment
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LESSON SIX

Lesson 6

Modified Whole Life Insurance

As we have seen, traditional whole life policies provide
a constant face amount of coverage in exchange for a
series of level premiums or a single premium.
However, under some whole life policies either
the amount of the required premium payments
changes at some point in the life of the policy
(modified premiums)
or
the face amount of the coverage changes during
the life of the policy (modified coverage)

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LESSON SIX

Lesson 6

Joint Whole Life Insurance

joint whole life insurance: a type of insurance that has the
same features and benefits as individual whole life insurance,
except that it insures two lives under the same policy
Joint whole life insurance is often referred to as first-to-die
life insurance because, upon the death of one of the
insureds, the policy death benefit is paid to the surviving
insured and the policy coverage ends.
To allow the surviving insured to obtain coverage, joint
whole life policies usually provide a specified periodsuch
as 60 or 90 daysfollowing the first insureds death within
which to purchase an individual whole life policy of the
same face amount without evidence of insurability.
Some joint whole life policies provide the surviving insured
with temporary term insurance during the specified period.
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LESSON SIX

Lesson 6

Monthly Debit Ordinary

monthly debit ordinary (MDO) policy: a whole life
insurance policy marketed under the home service
distribution system and paid for by monthly premium
payments
The home service distribution system is a method of selling
and servicing insurance policies through commissioned sales
agents, known as home service agents, who sell a range of
products and provide specified policyowner services, including
the collection of renewal premiums, within a specified
geographic area.
A home service agents assigned territory is referred to as a
debit, agency, or account.
MDO policies have many of the same characteristics as
traditional whole life insurance, but MDO policies tend to be sold
in smaller face amounts than other whole life policies.
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LESSON SIX

Lesson 6

Universal Life Insurance

universal life (UL) insurance: a form of cash value
life insurance characterized by its flexible premiums,
its flexible face amount and death benefit amount, and
its unbundling of the pricing factors
Term life insurance and most forms of whole life
insurance state the gross premium that the
policyowner must pay to keep the policy in force.
However, some policiesmost notably universal life
insurance policieslist each of the three pricing factors
(mortality, interest, and expenses) separately.

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LESSON SIX

Lesson 6

Universal Life Insurance

Mortality charges. The insurer periodically deducts a mortality
charge from the universal life policys cash value. This mortality
charge is the amount needed to cover the mortality risk the insurer
has assumed by issuing the policy.
The amount of the mortality charge is based on the insureds risk
class; it typically increases each year as the insured ages.
The policy guarantees that the mortality charge will not exceed a
stated maximum amount.
Usually, the policy provides that the mortality charge will be less
than the specified maximum if the insurance companys mortality
experience is more favorable than expected.
The policy expresses the mortality charge as a charge per
thousand dollars of net amount at risk.
The net amount at risk for most life policies is the policys face
value minus its reserve, but the net amount at risk for a universal
life policy depends on whether the death benefit payable is level
or varies with changes in the policys cash value.
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LESSON SIX

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Lesson 6

Universal Life Insurance

Interest. A universal life insurance policy guarantees that the
insurer will pay at least a stated minimum interest rate on the cash
value each year. It also provides that the insurer will pay a higher
interest rate if conditions warrant. For example, the policy may
state that the interest rate paid will
Reflect current interest rates in the economy or
Be tied to the rate paid on a standard investment, such as a
specified category of U.S. government Treasury Bills or
Be at the guaranteed interest rate on cash values up to a stated
amount, such as $1,000, and be at the higher current interest
rate on cash values greater than the stated amount
Most universal life policies provide that any portion of the cash
value that is being used as security for a policy loan will earn
interest at a rate lower than the current rate, but this reduced rate
will not fall below the guaranteed minimum interest rate.
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LESSON SIX

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Lesson 6

Universal Life Insurance

Expenses. Each universal life insurance policy lists the expense
charges that the insurer will impose to cover the costs it incurs to
administer the policy. The following expense charges may apply:
A flat charge during the first policy year to cover sales and policy
issue costs
A percentage of each annual premium (such as 5 percent) to
cover expenses
A monthly administration fee
Specific service charges for coverage changes and cash
withdrawals
A chargecalled a surrender chargewhich reduces the
policys cash value if the policyowner surrenders the policy
In policies with a surrender charge, state regulators may require
insurers to use a term such as account value, reserve value, or
accumulation value, to describe the accumulated cash value.
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LESSON SIX

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Lesson 6

Universal Life Insurance

A universal life policy gives policyowners a great deal of flexibility to
decide (1) the policy's face amount and the amount of the death
benefit payable and (2) the amount of premiums they will pay.
Face Amount and Amount of Death Benefit. At the time of
purchase, the policyowner specifies the policys face amount and
decides whether the amount of the death benefit payable will be
level or will vary with changes in the policys cash value.
Under an Option A plan (also
known as an Option 1 plan),
the amount of the death benefit
is level; the death benefit
payable is always equal to the
policys face amount.

Under an Option B plan (also

known as an Option 2 plan),
the amount of the death benefit at
any given time is equal to the
policy's face amount plus the
amount of the policys cash value.

The net amount at risk for an Option A plan decreases as the

amount of the cash value increases. The net amount at risk for an
Option B plan is always equal to the policys face amount.
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LESSON SIX

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Lesson 6

Universal Life Insurance

After a universal life policy has been in force for a specified
minimum timeoften one yearthe policyowner can request an
increase or decrease in the policys face amount.
Flexible premiums. The owner of a universal life policy can
determine, within certain limits, how much to pay for the initial
premium and for each renewal premium. The policyowner also
has great flexibility to decide when to pay renewal premiums.
The insurer imposes maximum limits on premium amounts so
the policy will maintain its status as an insurance product.
The insurer requires at least a stated minimum initial premium.
As long as the policys cash value is large enough to pay the
periodic mortality and expense charges, the policy remains in
force even if the policyowner does not pay renewal premiums.
If the policys cash value is insufficient to cover the periodic
charges, the policy lapses unless the policyowner pays an
adequate renewal premium.
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LESSON SIX

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Lesson 6

Universal Life Insurance

How a Universal Life Policy Operates
When an insurer receives a premium payment, it first deducts
the amount of any applicable expense charges and then credits
the remainder of the premium to the policy's cash value.
Each month, the insurer deducts the periodic mortality charges
from the cash value and credits the remainder of the cash value
with interest.
The more a policyowner pays in premiums above the amount
needed to pay the policy's costs, the greater the cash value.
If the cash value is not sufficient to pay periodic charges, the
insurer gives the policyowner a stated amount of timeat least
60 daysin which to pay a premium to cover those charges.
If the policyowner does not make the premium payment, the
policy lapses.
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LESSON SIX

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Lesson 6

Universal Life Insurance

U.S. federal tax laws treat life insurance more favorably than
investments. These laws establish limits on the size of a life
insurance policys cash value in relation to its face amount. If the
cash value exceeds regulatory limits, then the policy is treated for
tax purposes as an investment rather than an insurance product.
In the U.S., the difference between a policys face amount and
the cash value required to qualify as a life policy is often called
the Section 7702 corridor in reference to the section of the
Internal Revenue Code that establishes the applicable limits.
Insurers do not allow a policyowner to pay a premium amount
that would result in the policys cash value exceeding the
legislatively defined percentage of the face amount.
Most universal life policies provide that if the cash value
exceeds the specified percentage, then the face amount
automatically is increased to an amount that meets the
legislative requirements.
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LESSON SIX

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Lesson 6

Universal Life Insurance

Many aspects of a universal life policy change over the course of
a year, so insurers send each policyowner an annual, semiannual,
or quarterly report providing the policys current values and
benefits. Generally, the report shows the following amounts:
Death benefit payable
Policys cash value

Mortality charges deducted

Expense charges deducted

Cash surrender value, if

different from cash value
Interest earned on cash
value

Premiums paid during

reporting period
Policy loans outstanding

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Any cash value withdrawals

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LESSON SIX

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Lesson 6

Variable Life Insurance

variable life (VL) insurance: a form of cash value life insurance in
which premiums are fixed, but the face amount and other values
may vary, reflecting the performance of the investment subaccounts
selected by the policyowner
subaccount: one of several alternative pools of investments to
which a variable life insurance policyowner allocates the premiums
paid and the cash values that have accumulated under the policy
separate account (also known as a segregated account): the
subaccounts in which variable insurance premiums and cash values
are invested; the insurer maintains this investment account
separately from its general account to isolate and help manage the
funds placed in its variable products
general account: an undivided investment account in which an
insurer maintains funds that support its contractual obligations to pay
benefits under its guaranteed insurance products, such as whole life
insurance and other nonvariable products; the funds in the general
account are placed in relatively secure investments
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LESSON SIX

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Lesson 6

Variable Life Insurance

Most variable life policies permit the policyowner to select from
several subaccounts and to change selections at least annually.
The insurer follows a different investment strategy for each
subaccount. For example, some subaccounts concentrate on
investing in high-growth stocks, while others invest in bonds.
The amount of the policys death benefit and cash value depend
on how well the separate investments perform. Most variable life
policies guarantee that the amount of the death benefit will not fall
below the amount initially purchased. However, variable life
policies do not guarantee either investment earnings or a
minimum cash value.
Because the policyowner, not the insurer, assumes the investment
risk of a variable life policy, the U.S. Securities and Exchange
Commission (SEC) has determined that variable life policies are
securities and, thus, are subject to federal securities regulation.
In addition, variable life products must comply with applicable state
insurance regulatory requirements.
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LESSON SIX

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Lesson 6

Variable Universal
Life Insurance
variable universal life (VUL) insurance (also called
universal life II and flexible-premium variable life insurance):
a form of cash value life insurance that combines the
premium and death benefit flexibility of universal life
insurance with the investment flexibility and risk of variable
life insurance
Under a variable universal life (VUL) insurance policy, the
policyowner chooses from among several subaccounts and
may change the chosen options at least annually.
Most insurers allow the policyowner to choose whether the
policys death benefit will remain level (an Option A account)
or will vary along with changes in the investment earnings of
the subaccounts (an Option B account).
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LESSON SIX

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Lesson 6

Variable Universal
Life Insurance
Like a universal life policy, a variable universal life
policy allows the policyowner to choose the premium
amount and face amount.
Like a variable life policy
The cash value of a variable universal life policy is
placed in the separate account.
A variable universal life policy does not guarantee
investment earnings or cash values.
A variable universal life product is considered a
security in the U.S. and, thus, must comply with
federal securities laws.
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LESSON SIX

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Lesson 6

Indeterminate Premium
Life Insurance
indeterminate premium life insurance policy (also known
as nonguaranteed premium life insurance policy and
variable-premium life insurance policy): a type of
nonparticipaing whole life policy that specifies two premium
ratesa maximum guaranteed premium rate and a lower
premium rate
The insurer charges the lower premium rate when the policy is
issued and guarantees that rate for at least a stated period of
time, such as 1, 2, 5, or 10 years.
After that period, the insurer uses its actual mortality, interest,
and expense experience to establish a new premium rate that
may be higher or lower than the previous premium rate.
In no case, however, will the new premium rate exceed the
maximum rate guaranteed in the policy.
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LESSON SIX

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Lesson 6

Interest-Sensitive
Whole Life Insurance
interest-sensitive whole life insurance (also called current
assumption whole life insurance): a type of whole life policy in which
(1) premium rates vary to reflect changing assumptions regarding
the mortality, investment, and expense factors and (2) the cash value
can be greater than that guaranteed if changing assumptions
warrant such an increase.
Policyowners usually decide whether they want favorable changes in
pricing assumptions to result in a lower premium or a higher cash
value; they can change the decision after the policy is in force.
If changes result in a higher premium, then the policyowner may
choose to (1) lower the policys face amount and maintain the
original premium amount or (2) pay the higher premium and maintain
the original face amount. But in no event can the premium rate
increase above the guaranteed rate in the policy.
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LESSON SIX

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Lesson 6

Endowment Insurance
Endowment insurance provides a specified benefit amount
whether the insured lives to the end of the term of coverage or
dies during that term.
Each endowment policy specifies a maturity date, which is the
date on which the insurer will pay the policys face amount to the
policyowner if the insured is still living. The maturity date is
reached either
(1) at the end of a stated term (e.g., 20 years) or
(2) when the insured reaches a specified age (e.g., age 65)
Because of the maturity date, an endowment policys cash
value builds rapidly. Also, the cash value of an endowment
policy is large in relationship to the policys face amount.
For these reasons, endowment policies in the U.S. do not
maintain the required Section 7702 corridor and do not receive
favorable federal income tax treatment, which has resulted in
dwindling sales of endowment policies in the U.S.
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LESSON SIX

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Lesson 6

End of Lesson 6

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LESSON SIX

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