Over-funding Universal Life Policy - Part 2

Most people fail to appreciate the interest rate sensitivity of these policies. Let's use an example to try to increase our understanding. In 1980 a 45-year-old nonsmoking male in good health purchased a $1 million universal life insurance policy on option A. Remember, option A is the one in which the $1 million will be made up of part policy owner money (the account value) and part amount at risk (life insurance company money). He asked the agent how much he should put into the policy each year so that at age 100, should he be so fortunate to live that long, the $1 million death benefit would be made up entirely of his money, the account value.

At that point, there would no longer be any amount at risk and consequently no more COIs to be paid. The illustration system calculated, using the 12 percent level interest rate available in 1980, that the amount he needed to pay into the policy each year was $7160. The illustration showing the account growing in value until it equals the policy death benefit at age 100. The arrival of a policy at this point is referred to as policy maturity or endowment.

Neither the policy owner nor the agent had the tools in those days to show what we can now show using a newly developed software program currently going through the regulatory approval process. This software is called Dynamic Insurance Solutions, Historic Variability Module and is being brought to market by Financial Profiles of Carlsbad, California. Using this software you can reduce the assumed interest rate. If we reduce the interest rate by just 0.05%, from 12 percent to 11.95 percent, what impact do you think it would have on our ending account value at age 100?

Instead of that account being worth $1 million, how much do you think it might be worth? When we execute this change with the software, the value of the policy owner's account at age 99 as a result of reducing the interest rate is $0 instead of $1 million. It is entirely possible that the policy terminated without value before the insured terminated. Of course, the policy owner would have the right to pay an amount to keep the policy in force for one more year. The software informs us that we could expect a bill for $400,000 to do that rather than the $7160 that we had been paying. Of course, that bill alone might be enough of a shock to kill the insured.