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MTHEL 131 (32)
Chapter 6

Chapter 6 Reading Notes

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University of Waterloo
Mathematics Electives
David Kohler

Chapter 6: universal life insurance products Universal life insurance - Flexible premium, adjustable death benefit, unbundled life contracts - After initial payment, policy owners pay whatever and whenever they wish, as long as the cash value covers policy charges - Insurers introduced these in hopes of selling more policies  administrative costs are high, and uncertainty with cash flow has proven to be a challenge for many firms - Policy owner is able to see how money is allocated - Mechanics: o Policy owner pays first premium o From this, first period expense charges are subtracted o Mortality charges are subtracted o The resulting fund is the initial policy cash-value o It is then credited with interest o Cash value minus surrender charges = cash surrender value o Second policy period begins with previous period’s ending balance o Policy owner doesn’t have to add another premium, as long as cash- value covers expenses o If it doesn’t, and another payment is not made, the policy lapses o Process is repeated each year Product design Death benefit patterns - Option A: death benefit pattern o the death benefit is the face amount only - Option B: level net amount at risk o the death benefit is the face amount plus the policy value. Although its long-term cost is higher, there is a relatively larger death benefit - Premium payments - policy-owners pay whateer and whenever they want - disadvantage is that policy-owner might allow policy to lapse because there are no required premiums - many companies offer ‘no-lapse guarantee’ for a certain number of years after the minimum premium has not been paid Policy loadings - Front end loads: a commission or sales charge applied at the time of the initial purchase - Back end loads: The fee percentage is highest in the first year and decreases yearly until the specified holding period ends, at which time it drops to zero Mortality and other benefit charges - mortality charges are deducted monthly - rates vary, but never exceed a certain maximum - rates vary a lot from company to company Cash values - residual of each period’s funds flow - Cash value = previous period’s ending cash-value balance + any premium paid – expense/mortality charges + interest credits - Interest rate is decided by the company - Some have guaranteed rates (and usually exceed them) - Policy owners can obtain loans, on the security of their cash value - Most policies permit partial surrenders with a processing charge Uses and limitations of universal life insurance Simplified life cycle illustration EXAMPLE - Larry (25 year old) purchases $50k policy with a $500 premium - Larry marries, decides to increase coverage to $75k with a $1000 premium - Larry has a child, increases coverage to $200k, with no increase in premium - Larry withdraws $3k, increase coverage, cease making premium payments - 2 years later, resume $500 premium payments - 2 years later, increase to $1000 premium payments - Child enters college, withdraw $2.5k per year for 4 years - Child makes own money, Larry can decrease policy to $100k - Until retirement, Larry pays $1.5k per year - At retirement, he ceases to make premium payments, and begins withdrawing whatever he needs * this shows that universal life policy is very versatile and benefits families regardless of what stage of life they’re in Limitations
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