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Universal Life: A Revolutionary Idea (Part 1)

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September 27, 2011 by wcobserver

The Carter administration era was a revolutionary time. The political revolution was in Iran, but a financial revolution was occurring in the USA. It was a time of high inflation, and high interest. Banks and Savings & Loans were paying extremely high interest rates (how does 12% grab you?), and inflation was sky high. Revolutionary times call for revolutionary ideas.

Life insurance underwent a revolution also. Before this time, life insurance policy design seemed pretty cut-and-dried. The typical whole life policy guaranteed the face amount at death, and had level premiums for life. Many policies also guaranteed 5% loans! Smart cookies would take a policy loan at 5%, go put it in the bank, and earn something like 12%.

Long-term contracts like life insurance were whipsawed. On the one hand, inflation was eating up the value of policies. On the other hand, the companies needed to be reinvesting those reserves for the new high yield, but the money was going out the back door as 5% loans.

Around 1980 there was also a computer revolution, which made possible a revolutionary new policy design. The idea was to “unbundled” the policy into a high-interest account, coupled with a term policy. In concept, you could put money (premiums) into the “pot,” the company could pay you a competitive interest rate, and take out monthly premiums equivalent to term insurance.
The policy design was said to be “transparent.”

There were four variables:

(1) The amount and timing of the premium payments,
(2) a floating interest rate,
(3) The insurance (mortality) charge, and
(4) A monthly account charge or premium load.

You (the policy holder) were in control of #1, and the company set the other parameters. In order to reassure you, they had a table of maximum insurance costs, and guaranteed a minimum interest rate.

It all looked fantastic, compared to the old structured policies. And the high interest rates looked like pie in the sky. Everyone thought interest rates would stay high.

Well, maybe you have one of these policies. As the football coach would say “to understand it, you need to diagram the play.” This is your homework assignment, should you choose to accept it. Pencils and paper ready? Let’s begin!
First, draw a very large letter “U” in the middle of the page. Then, draw an oval connecting the arms of the U at the top. This begins to look like grandmother’s wash pot, so go ahead and put some short legs at the bottom. Let’s make this a money pot.

Next, to the left of the pot, draw a long vertical line (like an elongated letter “I”). At the top, write “maximum” and at the bottom, write “minimum.” Call this a sliding scale for premium amounts. Put an “X” about the middle of the line, which represents your chosen payment level. Draw a curved line with an arrow from your “X” over into the top of the pot.

Now, in the upper right, put the label “interest” and minimum 4 ½ %. There is no maximum; only what the company is willing to pay currently. So, you put in premium money and the company adds interest; so far, so good.

Finally, tap into the bottom right of the pot so that insurance and monthly account fees may be drained out. Keep in mind that the drain will get increasingly larger with age, so you will need to earn lots of interest to take up the slack.

Now, color in the bottom half of the pot to represent a growing cash balance. Your objective is to always have the cash level growing. If it ever starts back down, the pot might run dry. When that happens, you’re out of business.
(To be continued)

P.S. save your homework for the next installment.

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