Adjustable death benefit

What Is Adjustable Death Benefit?

An adjustable death benefit refers to a feature in certain permanent life insurance policies that allows the policyholder to increase or decrease the coverage amount over time. This flexibility, a hallmark of universal life insurance, distinguishes it from policies with fixed coverage. The ability to modify the death benefit is an integral part of life insurance product design, allowing policies to adapt to changing financial needs and economic conditions.

History and Origin

The concept of flexible premium and adjustable death benefit policies, most notably universal life insurance, emerged in the 1970s and gained significant traction in the 1980s. Prior to this, traditional whole life policies offered fixed premiums and death benefits, which became less appealing during periods of high inflation and fluctuating interest rates. Actuaries and insurance innovators began exploring product designs that could offer greater adaptability. The underlying ideas for universal life, combining term insurance and an accumulation fund, had existed for over a century, but packaging them to allow such flexibility was a key innovation of this era. By 1985, sales of universal life policies in the United States accounted for over 38% of new individual life premiums, reflecting a significant shift in the market.⁴

Key Takeaways

An adjustable death benefit allows a life insurance policyholder to change the coverage amount.
This feature is common in universal life insurance policies, offering flexibility as life circumstances evolve.
Increases to the death benefit often require additional underwriting to assess the insured's health.
Decreasing the death benefit can reduce premiums or accelerate cash value growth.
The flexibility of an adjustable death benefit aims to align a policy with the policyholder's changing financial planning needs.

Interpreting the Adjustable Death Benefit

The adjustable death benefit provides a dynamic tool for policyholders to tailor their coverage to evolving life stages. For instance, a young family might initially opt for a higher death benefit to protect dependents and cover substantial debts like a mortgage. As debts are paid off, children become financially independent, or assets grow, the need for a large death benefit may diminish. At such a point, the policyholder could decrease the death benefit, which typically results in lower premiums or allows the cash value to grow more rapidly. Conversely, if new financial obligations arise, such as starting a business or inheriting new dependents, the policyholder might seek to increase the adjustable death benefit, subject to the insurer's underwriting approval. This adaptability is central to the appeal of flexible life insurance products.

Hypothetical Example

Consider Maria, a 35-year-old professional who purchases a universal life insurance policy with an initial adjustable death benefit of $500,000. Her goal is to protect her young children and ensure her mortgage is covered.

Year 10: Maria's mortgage is significantly paid down, and her children are older. She assesses her needs and decides she no longer requires $500,000 in coverage. She requests to decrease her adjustable death benefit to $300,000. The insurer approves this change without additional underwriting. As a result, her monthly premiums are reduced, or more of her existing premium payment is allocated to the policy's cash value, accelerating its growth.
Year 20: Maria's children are now adults, but she has recently taken on the responsibility of caring for an elderly parent and wishes to provide for their future care. She decides to increase her adjustable death benefit from $300,000 back to $400,000. Because this is an increase in coverage, the insurer requires her to undergo a new medical exam and underwriting process to assess her current health and insurability. Upon approval, her premiums adjust upwards to reflect the increased coverage and her older age.

This scenario illustrates how the adjustable death benefit allows Maria's policy to remain relevant throughout different phases of her life.

Practical Applications

Adjustable death benefits are predominantly found in permanent life insurance policies, primarily universal life insurance, and its variations like indexed universal life and variable universal life. This feature provides flexibility in several real-world scenarios:

Changing Family Needs: A growing family might need to increase coverage, while an empty-nester might reduce it.
Debt Management: As significant debts like mortgages are paid off, the need for extensive coverage may decrease, allowing for a reduction in the adjustable death benefit and potentially lower premiums.
Business Planning: Business owners might adjust their policy to align with business debts, buy-sell agreements, or key-person insurance needs.
Estate Planning: Policyholders might adjust the death benefit to align with evolving estate tax laws or charitable giving goals.
Financial Market Adaptability: For policies with investment components, adjusting the death benefit can help manage the relationship between the cash value and the death benefit, especially when investment performance fluctuates. The Financial Industry Regulatory Authority (FINRA) provides detailed information on various types of life insurance, including universal life, highlighting their flexible nature.³ The life insurance industry as a whole plays a significant role in the economy by providing financial protection and acting as a source of long-term capital.²

Limitations and Criticisms

While providing significant flexibility, the adjustable death benefit also comes with limitations and criticisms. One primary concern is the complexity of these policies. Unlike simpler term life insurance, understanding how premium payments, policy charges, and cash value growth interact with the adjustable death benefit can be challenging for policyholders.

A significant risk is that if the cash value performs poorly (e.g., due to low interest rates or high internal costs), it may not be sufficient to cover the policy's charges. This can lead to the policyholder needing to pay higher premiums than initially anticipated, or even face the risk of the policy lapsing if insufficient funds are maintained. Regulatory bodies have noted instances where the complexity and potential for overfunding in universal life policies have led to situations where policyholders face unaffordable premiums or policy lapses, often due to misleading sales practices or insufficient needs analysis at the point of sale.¹ Therefore, careful monitoring and understanding of the policy's mechanics, including how changes to the adjustable death benefit impact its long-term viability, are crucial for policyholders. The mortality tables used in calculating the cost of insurance also evolve, influencing policy charges over time.

Adjustable Death Benefit vs. Guaranteed Death Benefit

The primary distinction between an adjustable death benefit and a guaranteed death benefit lies in the flexibility offered to the policyholder and the certainty of the payout amount.

Adjustable Death Benefit: As discussed, this feature allows the policyholder to modify the coverage amount over the life of the policy, typically in universal life insurance. This offers adaptability but often means the ultimate death benefit is not fixed from the outset, depending on the policyholder's choices and policy performance. Changes to the death benefit may require new underwriting or impact future premiums and cash value accumulation.
Guaranteed Death Benefit: Found in policies like whole life insurance or specific universal life riders, a guaranteed death benefit provides a fixed, predetermined payout to the beneficiary upon the insured's death, provided premiums are paid. This offers predictability and peace of mind, as the death benefit amount will not fluctuate due to market performance or policyholder adjustments. The trade-off is often less flexibility in premium payments and no option to modify the coverage amount post-issuance, apart from specific policy provisions or riders.

The choice between the two depends on an individual's preference for flexibility versus certainty in their life insurance coverage.

FAQs

Q: Can I increase my adjustable death benefit at any time?
A: You can typically request an increase, but it is usually subject to re-underwriting by the insurance company. This means they will assess your current health and other risk factors, similar to when you first applied for the policy, and may adjust your premiums accordingly.

Q: Will decreasing my adjustable death benefit lower my premiums?
A: In most cases, yes. Lowering the death benefit reduces the insurer's risk, which often results in lower premiums. Alternatively, if you keep your premiums the same, more of your payment may go towards building the policy's cash value.

Q: How does an adjustable death benefit impact the policy's cash value?
A: Increasing the adjustable death benefit typically increases the cost of insurance, which can slow down cash value accumulation if your premiums remain constant. Conversely, decreasing the death benefit can reduce the cost of insurance, allowing the cash value to grow faster or enabling you to pay lower premiums.

Q: Is an adjustable death benefit suitable for everyone?
A: The suitability depends on individual needs and financial goals. Those who anticipate significant changes in their financial obligations or family situation may find the flexibility appealing. However, the complexity of managing such policies requires a greater understanding than fixed term life insurance or whole life insurance policies.