Funding a life insurance contract efficiently is a target sport. It is very much like docking a boat or lagging a putt where just enough force is given so that, accounting for outside factors such as the wind and the current or the slope and the grain, the boat or the ball runs out of energy at the moment it nestles up to the target. In the same way, funding a universal life insurance contract to its maximum efficiency requires using the policy’s built-in flexibility with a certain element of touch.
Appreciating how this is true requires a basic understanding of how a universal life insurance contract operates. At the very core, the only elements in play are cash value and death benefit. Universal life policies can be structured to focus on maximizing either or both of these elements, but no matter the structure, two things are always true: i) the policy will remain in force as long as the cash value has a positive balance, and ii) only the death benefit is paid at the insured’s death (the cash value balance goes away).
In an estate planning strategy, the liquidity need arises at death, so the policy is best structured to produce the highest rate of return on the death benefit proceeds at life expectancy—the most death benefit for the least investment. The role of the cash value is reduced to supporting the death benefit for the insured’s life by staying above zero.
The cash value balance is affected positively by the premiums contributed and the investment earnings credited, and negatively by the policy charges (e.g. administrative fees, commissions, etc.) and the cost of insurance (the cost of insurance rises as the insured ages, increasing its drain on the cash value as time goes on). With respectable insurance carriers, policy charges and the cost of insurance are reliably certain at the time the contract is issued. (There have been recent cases that most insurance professionals consider abusive breaches of trust in which some carriers have raised their costs of insurance on existing policies to make up for lost profits. The legality of those increases currently is being disputed in several class action lawsuits.)
With these variables in mind, planning an efficient policy structure is simply picking a premium schedule (i.e. amount and frequency) that will produce a positive cash value balance for a safe duration beyond life expectancy, taking into account expected policy charges and assuming a particular interest crediting rate that will be earned on the cash value (or return on its investment, depending on policy type). Assuming a higher crediting rate will project a lower premium schedule, and vice versa; however, the crediting rate assumed in setting the initial premium schedule has no impact on how the policy actually performs in due course. If the crediting rate proves to be lower than initially assumed, the cash value balance will zero-out sooner than expected, so more premium dollars will need to be paid into the policy to maintain the initially selected duration. In the same way, if the crediting rate exceeds initial expectations, the cash value will be higher than expected, so the premiums can be adjusted downward.
The essential point is that the flexibility built into universal life contracts allow for incredible efficiency if understood and applied properly. Our first objective always is to explain these mechanics so that our clients and their advisors can knowledgeably structure a policy to be as conservative or aggressive in its design assumptions as wanted. Our ongoing promise is to evaluate the policy at least annually to monitor performance versus expectations and to advise adjustments accordingly.