How to model cash value life insurance

Video: Income Lab | Cash Value Life Insurance

Types of Insurance Available for Plan

Income Lab allows in-depth integrated modeling of the following types of life insurance within a plan. The first two types (Term and Permanent) do not offer detailed modeling of cash value and cash distributions, whereas the other insurance types allow modeling of cash distributions (through loans or withdrawals) and how cash value and death benefits change over time.

Life Insurance Premium Modeling

All of these insurance types allow modeling of premiums on a monthly, quarterly, semi-annual, or annual frequency. You can also set a one-time premium. 

For policies set to the “Term” or “Permanent” insurance types, you will find the premium settings in the policy sidebar, toward the bottom in the “Expense” section. Here, you can also decide whether premiums appear as a line item in the plan and whether they appear as a baseline or other/variable expense.

For all other insurance types (Whole Life, UL, IUL, VUL, VL), premium settings are in the “Insurance Settings” section on the “Premiums” tab. 

You can exclude premiums by switching the “Are premiums being paid into this policy?” setting to “No” or by setting the premium amount to $0.

Whole Life and Universal Life Cash Value Growth

Only Whole Life (WL), Universal Life (UL), Indexed Universal Life (IUL), Variable Universal Life (VUL), and Variable Life (VL) model changes in cash value in the policy. For growth (or losses) in the cash value not related to premiums paid in or distributions taken, each insurance type is slightly different.

Cash value changes in Whole Life and Universal Life are the simplest of the options, with interest-rate-type changes credited to the cash value. Whole Life has guaranteed cash value growth much like a guaranteed interest rate, but some policies also offer non-guaranteed participating dividends. Universal Life policy cash values see the effects of an interest rate, usually a currently credited interest rate that can change over time, with a guaranteed minimum rate.

Indexed Universal Life Crediting Methods & Indexes

Indexed Universal Life cash values also change with interest crediting, but the actual credited rate in any given period is related to an index, such as a large-cap stock or other index. The actually credited rate may have a cap or a participation rate. You can set these in the Insurance Settings “Crediting Methods” tab.

By default, you can set a single cap or participation rate (or even a fixed rate) for the life of the plan. However, if you'd like to set a mix of crediting methods, you can uncheck the “Use a single crediting method for this policy” box. This allows you to allocate among the three crediting methods and set the values.

By default, the same crediting method values are applied across the life of the plan, but if you'd like to use two phases of crediting method values, uncheck the “Use same crediting method values throughout the plan” box. This will give you the option to set an “End of Term” date after which the crediting method value(s) will change from what's in the “Value” input to the “Value after Term” input (often a lower value).

You can also set two phases of values across multiple crediting methods by unchecking both the “Use same crediting method values through plan” and “Use single crediting method for this policy” boxes.

To set the IUL policies related index, choose either “IUL Index” (the default) or “Customize” from the Index Option chooser in the policy sidebar. If “IUL Index” is selected, the policy will be linked to that index. (Currently, the only available option is “Large Cap Price Index”.) If you choose “Customize”, you can allocate among asset classes to create a custom blended index. Since the asset class return indices you are choosing from may include returns from dividends, but many IUL indices are price-only, you can reduce the returns of your custom blended index by going to the “Insurance Settings” window's “Crediting Methods” tab and opening “Advanced Settings” at the bottom. This gives you access to the “Reduction in asset class returns to remove dividends” field.

Variable Life and Variable Universal Life Cash Value Modeling

Variable Life (VL) and Variable Universal Life (VUL) cash values reflect the investment performance of subaccounts. You can model those returns as you would an investment account, by allocating to different available asset classes. The plan's asset class level fees will apply to these returns, and returns will be further reduced by any policy-level fees.

Fees and Expenses

Cash values of any Whole Life, UL, IUL, VUL, or VL policy will also reflect fees. Different insurance policy types have slightly different available fee inputs. Insurance fees can be quite complex. The available fee inputs are meant to give advisors a range of possible fee inputs they can use to approximate how a given policy might work. They are not meant to provide insurance illustration-level precision and accuracy or to replace an illustration.

Fee types that can be modeled in Income Lab include:

Note that Premium Load Rate may aggregate several real-world charges, such as sales load, state premium tax, and federal DAC-related charges. Some contracts itemize these separately; others effectively present a combined premium expense charge.

Note also that Net value at risk (NAR) is the difference between the death benefit and the cash value. So, if in a given month a policy's death benefit is $400,000 and cash balance is $300,000, NAR is $100,000. If cost of insurance is $0.40 per $1,000, this would lead to a $40 charge in that month. Note that Cost of Insurance (COI) in real-world policies is actually based on insured age, with a schedule of COI that changes over time. Here we use a simplified single dollar cost per $1,000 of NAR. (COI and per-thousand fees are often less than $1 per month.)

Also, Per Thousand, Rider fees, and other charges may not appear in all policies. To omit a fee that does not apply, set it to 0% or $0.

Fund expenses apply to the returns of subaccounts in VUL and VL policies. These fees are not set separately for the insurance policy. Instead, the plan will apply the asset-class-level fees to the overall plan.

The fees marked X below are available in the policy types shown.

* Rider fees on whole life policies may not be stated in some policies as a fee, but could instead take the shape of a rising premium or other structure. However, they are modeled here as a fee.

Cash Value Life Insurance Distribution Modeling

If you are modeling a whole life, UL, IUL, VUL, or VL policy, you can include distributions from the policy in the plan. These distributions can serve as important sources of income, often tax-free. To do so, go to the “Distribution Settings” tab of the Insurance Settings window.

The options for distribution amounts and timing are the same as you will see in annuities with custom distribution plans and overlap substantially with how distribution plans can be set on individual investment accounts. You can have one or two phases of distributions, with different and possibly overlapping time periods. You can distribute dollar amounts or percentages, or even do a “stretch” distribution akin to how inherited IRAs are sometimes distributed.

The important difference between the distribution settings for cash value life insurance and annuities (or investment accounts) is the tax treatment of the distribution. Distributions can be treated as policy loans or cash balance withdrawals, or they can be phased as first withdrawals of tax-free basis and then, when this is exhausted, as policy loans. You can make these settings at the bottom of the “Distribution Settings” tab.

Here you also have the opportunity to set a cash value floor - a level below which the plan will not make distributions. If you set this floor, the plan will automatically limit distributions to prevent the cash balance from falling too low.

In this same section, you can set the loan interest rate and determine whether the interest will be paid from the cash balance or accrue on the loan.

Other Settings

Insurance policies have several other settings that are more advanced, but they can be adjusted to more accurately model the policy. For example, in the Fees & Other tab, you can indicate that the policy is a modified endowment contract (MEC) and set the anniversary month (the month in which interest is credited in some policies).

In the DB & Basis tab, you'll find ways to set the covered life, policy maturity age, death benefit option (level, increasing, or return of premium), whether to apply a corridor, and the cost basis and gross premiums paid (if the death benefit is return of premium).

• Covered life: The person whose life is insured by the policy.
• Maturity age: The age at which the policy contract reaches its stated maturity date. At maturity, the policy generally terminates and pays the applicable maturity value in accordance with the contract.
• Death Benefit Option: Determines how the policy’s death benefit relates to its cash value. Level death benefit generally stays at the specified amount, and increasing death benefit generally equals the specified amount plus cash value.
• Apply Corridor (yes/no): Whether to enforce the minimum death-benefit-to-cash-value relationship required for the policy to remain treated as life insurance under applicable tax rules. If Yes, the death benefit may automatically increase when cash value becomes too high relative to the death benefit. Defaults to yes.
• Cost Basis: The policyholder’s tax basis in the contract, generally premiums and other amounts paid into the policy, adjusted for certain prior distributions or other basis-reducing events. It is used to determine how much of a withdrawal or surrender may be taxable.
• Gross Premiums Paid: The total amount of premiums paid into the policy before subtracting premium loads, fees, cost of insurance, or other policy charges.