Fifty Basis Points Decides Whether This Policy Survives

Quick Article Guide

Here’s what we'll cover in this post:

• What Policy is Being Tested?
• What Happens When the Crediting Model Drops by Half a Point?
• Why Does a Small Rate Change Cause Such a Large Outcome Change?
• What Does a Better Underwriting Class Actually Buy?
• Does This Apply to All Universal Life Policies, and to Whole Life?
• What Should You Ask Before Signing an IUL Policy?
• What Are the Limits of This Finding?
• What is the Underlying Lesson?

What Policy is Being Tested?

Everything below was read from carrier illustrations of a single design: a male, issue age 65, paying $50,000 a year for ten years into an indexed universal life contract with a level death benefit. The face amounts are $768,753 at Standard non-tobacco and $774,737 at Preferred non-tobacco. Every run is the same product on the same software version, so the only variables that move across the exhibits are the underwriting class and the assumed rate.

This is a maximum-funded design that takes no income. No policy loans, no distributions, no withdrawals. The policyholder pays for ten years and never touches the contract again. It is the simplest permanent-insurance design there is, which is exactly why what happens to it is worth reading closely.

The figures come from the carrier’s own printed ledgers and cost pages, not from a model.

What Happens When the Crediting Model Drops by Half a Point?

Carriers illustrate the same policy at more than one assumed crediting rate. The headline run uses the highest rate the carrier is allowed to show. The others, called alternate scales, show what the policy does if it earns less. A basis point is one-hundredth of a percentage point, so fifty basis points is half a point.

Here is the same policy on two alternate scales fifty basis points apart.

Read the Standard column first. The contract dies on both scales, two years apart. Fifty basis points buys it two additional years and nothing else. That is a design sitting well below the line where the policy can sustain itself.

Now read the Preferred column. At 4.50%, account value peaks around $568,000 in year 19 and then climbs to more than $1.8 million by age 120. At 4.00%, the same contract peaks at a similar level one year later and is gone by year 32.

The Preferred contract is not comfortably funded at 4.50% and marginally funded at 4.00%. It is balanced on a point. On one side of that point, the policy compounds for another sixty years. On the other, it terminates before the insured reaches 100.

Why Does a Small Rate Change Cause Such a Large Outcome Change?

The instinct is to assume a policy earning 4.00% instead of 4.50% simply accumulates a little less. That is not what happens, and the reason is the cost of insurance.

Cost of insurance is charged on the net amount at risk, which is the death benefit minus the accumulated value. It is what the insurer would have to pay out of its own pocket if the insured died that year. As cash value rises toward the death benefit, the amount at risk shrinks and the charge falls. As cash value drains away from the death benefit, the amount at risk widens and the charge rises — at mortality rates for a person in their nineties.

That is a feedback loop, and it runs in whichever direction the policy is already going

Here is the same Preferred contract’s cost of insurance on a healthy scale and on the 4.00% scale, taken from the carrier’s cost pages.

Twenty-nine times the cost of insurance in year 30, on the same contract insuring the same life. Nothing about the insured changed. What changed is the amount the carrier has at risk.

The death benefit column shows the mechanism plainly. On the healthy scale, cash value has grown large enough that the tax corridor lifts the death benefit to $1,704,271 while the account value rises underneath it, and the net amount at risk collapses to $16,874. On the 4.00% scale, the death benefit sits flat at the original $774,737 while the account value drains to $270,271, so the amount at risk widens to $504,466. Mortality is charged on that.

The cumulative effect arrives long before the contract is in trouble. Through year 20 alone, the 4.00% run has paid $157,746 in cost of insurance against $89,376 on the healthy scale — 76% more for exactly the same coverage, in years where the policy still looks perfectly healthy on the summary page.

What Does a Better Underwriting Class Actually Buy?

The conventional framing is that a better underwriting class buys a lower premium, or buys runway. In this design it buys position relative to the cliff, which is a different and larger thing.

On the healthy scale, the Standard contract pays $111,466 in cumulative cost of insurance through year 20 against the Preferred contract’s $89,376. That is 24.7% more, on a face amount $6,000 smaller.

The consequence is visible in the first table. Standard sits below the cliff at both alternate rates; it fails either way, and fifty basis points changes only the date. Preferred sits on the cliff, where fifty basis points decides between $1.86 million at age 120 and a terminated contract at 96.

A Preferred classification on this design is not a discount. It is the difference between owning a policy whose outcome depends on the crediting environment and owning one whose outcome is already settled.

Does This Apply to All Universal Life Policies, and to Whole Life?

Nothing above is peculiar to indexed crediting. The cliff comes from how universal life is built, and every universal life design shares it: indexed, fixed, or current-assumption.

A universal life contract is unbundled. Premiums go into an account value, and each month the carrier deducts the cost of insurance and the policy charges from that account. The contract stays in force only as long as the account can cover those deductions. The crediting method decides how much accumulation arrives. It does not change the fact that the policy lives or dies on whether the account keeps up with charges that rise every year the insured ages. When it falls behind, the feedback loop described above takes over.

The one exception inside the universal life family is a secondary or no-lapse guarantee, which keeps the death benefit in force as long as a required premium is paid, whatever the account value does. That is the design logic of guaranteed universal life, covered in JRC’s “When Guaranteed Universal Life Is the Right Answer”, and it is available as a rider on some indexed contracts. It removes the cliff by contract rather than by performance, and it is priced accordingly.

Whole life is a different animal. The premium is fixed, the cash values are guaranteed and printed in the contract year by year, and the death benefit is guaranteed as long as the premium is paid. The carrier, not the policyholder, carries the risk that interest rates or mortality turn out worse than expected. There is no account value that can drain to zero on a bad crediting scale, because the guaranteed values do not depend on one. How that cash value works, and how to use it while you are alive, is covered in “What Whole Life Cash Value Actually Does”.

Whole life has non-guaranteed parts too, and they deserve the same scrutiny. Dividends are not guaranteed. A lower dividend scale means slower growth in cash value and a smaller increase in the death benefit — the policy grows less, but it does not end. The caution is with designs that use dividends to pay future premiums: if dividends fall, premiums can resume. That is a cost risk rather than a lapse cliff, but it is worth asking about directly.

The trade is real on both sides. Whole life costs more per dollar of death benefit, because the guarantee has to be paid for. Indexed universal life costs less and offers upside, but the long-run expectation for that upside is modest — in my assessment, roughly half a point to a point and a half above what a traditional universal life product credits. The question a buyer should put to any illustration is whether that edge is worth owning the cliff. For some buyers it is. For a buyer who needs the coverage to be there at 95 and has no appetite for finding out otherwise, a contract without a cliff is worth what it costs.

What Should You Ask Before Signing an IUL Policy?

Four questions, and all four can be answered from documents the carrier already produces.

Where does this design fail? Not "what does it show at the illustrated rate," and not only "what does it show at the alternate rate." Ask for a run at each of several rates below the illustrated one until the contract stops surviving. The gap between the illustrated rate and that failure point is the only honest measure of how much margin you are buying.

How far apart are the runs I have been shown? If two exhibits are fifty basis points apart and produce dramatically different endings, you are standing on a cliff and should be told so. If they are fifty basis points apart and produce similar endings, the design has margin.

Show me the cost of insurance year by year, on the lower scale. The supplemental Statement of Deductions and Earnings holds this. It is frequently omitted by default and is available on request. The account value ledger tells you what the policy is projected to do; the cost pages tell you why, and they are where a widening amount at risk becomes visible years before it becomes fatal.

What happens to the death benefit as cash value falls? A contract whose corridor has lifted the death benefit well above the original face is in a fundamentally different cost position from one sitting flat at face while its account value drains. The two situations look similar on a summary page and behave nothing alike.

What Are the Limits of This Finding?

Stated plainly, because they matter.

This is one design at one carrier: a ten-pay, maximum-funded contract issued at age 65 with a level death benefit, taking no income. Short-pay designs at older issue ages concentrate cost into a narrow funding window and have less room to absorb a shortfall than a level-pay design at 45 does. The mechanism described here applies to universal life designs generally; the steepness is specific to designs of this shape.

Alternate scales are not forecasts. They are lower crediting assumptions the carrier is required or permitted to display, and the real crediting sequence will be neither a flat 4.00% nor a flat 4.50%. The point is not that the policy will earn one of these numbers. It is that the distance between two numbers this close should not determine whether the contract exists at age 100, and on this design it does.

Current cost structures are not guaranteed. Every figure above comes from the current, non-guaranteed scale. The guaranteed scale is worse arithmetic, and it is the one that binds if the carrier exercises its discretion.

What is the Underlying Lesson?

A universal life contract, indexed or otherwise, is a death benefit product funded by accumulation. The accumulation is real, but its job inside the contract is to hold the net amount at risk down so the cost of insurance stays affordable as the insured ages. When accumulation falls behind, that job goes undone, and the charges that the accumulation was supposed to suppress are the same charges that finish the policy.

Which means the question to ask about any permanent policy is not what it earns. It is how much the design can fall short before the arithmetic turns against it — and whether anyone has shown you where that line is.

Evaluating an IUL illustration, or already own a universal life policy? JRC will run the same check described here — where the design fails, what the cost pages show, and how much margin it really has — at no charge. Send the complete illustration, including the expense pages, to Louis@JRCInsuranceGroup.com or call (855) 225-6014.