Adjustable Life Insurance FAQs

There are questions surrounding adjustable life insurance. Life insurance is a big deal in any household. Without it, you’d have to worry about your loved ones. There are many options to choose from when it comes to buying life insurance. Let’s answer some questions revolving around adjustable life.

Question – How does the adjustments provision of AL differ from the change provision often found in ordinary whole life insurance policies?

Answer – Adjustments in AL policies are made prospectively only, affecting the future but in no way amending the past. The change provisions in traditional policies typically require payment of back premiums and/or other retroactive adjustments that may affect cash values. Such changes typically become increasingly and prohibitively expensive the longer the policy has been in force.

Question – Do AL policies offer dividend options that are not available with ordinary whole life policies?

Answer – Adjustable Life insurance policies offer the conventional dividend options—cash, premium reduction, accumulate at interest, and paid-up additions. Some AL policies offer what is called a policy improvement dividend option. With this option, dividends become a part of the cash value and thereafter lose their separate identity. If the current plan of insurance is equivalent to some form of whole life insurance, this option causes the face amount to increase without an increase in premiums or without changing the premium paying period. The effect is essentially the same as buying paid-up additions, except that the policyowner cannot later surrender these amounts without surrendering the policy as a whole. Generally, policyowners of traditional whole life policies may surrender regular paid-up additions separately. If the current plan of insurance is of a term nature, this option will increase the term of coverage.

Question – Can policyowners make unscheduled additional premium payments on AL policies similar to those permitted for universal life?

Answer – Most AL policies permit unscheduled additional premium payments. Such payments will lengthen the term of coverage or shorten the premium paying period depending on whether the current plan of insurance is in a term mode or a whole life mode. For example, a large enough payment might change a plan from term to age fifty to term to age sixty-five, or from a life paid-up at age seventy-five to a life paid-up at age sixty-five. Some companies restrict the availability of this feature in the first few policy years.

Question – Will a change in the plan of insurance cause an AL policy to become a modified endowment contract (MEC)?

Answer – Generally, a change in the plan of insurance that either lengthens the period of coverage or increases the face amount of coverage is treated as a material change in the policy that triggers a new seven-pay test. However, the reconfigured policy is treated as a MEC only if it fails the seven-pay test in its new configuration. In general, the insurance company will inform the policyowner if the desired change may cause the policy to fail the seven-pay test.

Also, a reduction of the face amount of coverage (or, in the authors’ opinion, a shortening of the term of coverage) within the first seven policy years triggers a recomputation of the seven-pay test that is based on the reduced death benefit level and is retroactive to the original policy issue date. The closer earlier premium payments were to the original seven-pay premium limit, the more likely is a reduction of death benefits within the first seven years to trigger reclassification as a MEC.

In the authors’ opinion, a change in the premium payment plan that does not change the level of benefits, such as a change from a whole life level premium payment plan to a paid-up at age sixty-five plan, should not be treated as a material change and should not require new seven-pay testing. However, if the change in premiums requires a change in the face amount to meet the requirements of life insurance under Code section 7702, the change should be considered material and require new seven-pay testing. See Chapter 22 for a more complete discussion of the material change rules and the seven-pay test.

Question – If the option to increase the face amount of coverage requires new evidence of insurability, of what benefit is this option if a person becomes uninsurable?

Answer – The companies that offer AL policies realize that the flexibility to increase the face amount is not that significant if increases require evidence of insurability. Consequently, most companies offering AL policies issue them with guaranteed purchase or insurability riders. This provision allows the policyowner to periodically purchase (e.g., every three to five years) a limited amount of additional coverage without proving insurability. In general, a purchase option expires if the policyowner does not exercise it when it matures, but the later options remain open without proof of insurability. Any desired increase in face amount beyond the limits set in the guaranteed insurability option will require evidence of insurability.

Do not confuse the guaranteed insurability option with the Cost-Of-Living Adjustment (COLA) provision that most companies also offer in their Adjustable Life insurance policies. The companies generally grant the COLAs without proof of insurability. In some cases, the insurer increases the policy face amount automatically each year by the increase in the Consumer Price Index (CPI) unless the policyowner elects otherwise. The insurer also correspondingly adjusts the premium payment plan upwards. In other policies, the insured has the option to periodically (e.g., every three years) increase the face amount by the change in the CPI since the last adjustment period. In contrast with the guaranteed insurability option, if the policyowner declines the additional coverage at any time, the insurer will permit future COLA increases only after the insured proves insurability.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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