We now review in more detail the key design features of a UL policy.
- Death Benefit: On the policyholder’s death the total benefit paid is the account value of the policy, plus an additional death benefit (ADB). There are two types of death benefit:
- Type A offers a level total death benefit which is the Face Amount of the policy. Here, Face Amount = AV + ADB. As the account value (AV) increases, the ADB decreases.
- Type B offers a level ADB. The amount paid on death would be the AV plus the level ADB selected by the policyholder. The policyholder may have the option to adjust the ADB to allow for inflation.
- Corridor factor = (frac{text{AV + ADB}}{text{AV}}).
- The ADB is required to be significant, e.g., around 2.5 at age 40, decreasing to 1.05 at age 90.
- Premiums: These may be subject to some minimum level, but otherwise are highly flexible.
- Expense Charges: These are deducted from the account value. The rates will be variable at the insurer’s discretion, subject to a maximum specified in the original contract.
- Credited Interest: Usually the credited interest rate will be decided at the insurer’s discretion, but it may be based on a published exogenous rate, such as yields on government bonds. A minimum guaranteed annual credited interest rate will be specifiedin the policy document.
- Cost of Insurance: Each year the UL account value is subject to a charge to cover the cost of the selected death benefit cover.
- The charge is called the Cost of Insurance, or CoI.
- Usually, the CoI is calculated using an estimate (perhaps conservative) of the mortality rate for that period, so that, as the policyholder ages the mortality charge (per $1 of ADB) increases.
- The CoI is then the single premium for a 1-year term insurance with sum insured equal to the ADB.
- Surrender Charge: If the policyholder chooses to surrendet the policy early, the surrender value paid will be the policyholder’s account balance reduced by a surrender charge.
- The main purpose of the charge is to ensure that the insurer receives enough to pay its acquisition expenses.
- The total cash available to the policyholder on surrender is the account value minus the surrender charge (or zero if greater), and is referred to as the Cash Value of the contract at each duration.
- Secondary Guarantees: A common feature is a no lapse guarantee
- Coverage continues even if the account value declines to zero, provided that the policyholder pays a pre-specified minimum premium
- This guarantee comes into play if expense and mortality charges exceed the minimum premium
- Policy Loans: Option: policyholder takes out a loan using the cash value as collateral.