Adjustable life insurance

What Is Adjustable Life Insurance?

Adjustable life insurance is a type of permanent life insurance policy that offers policyholders significant flexibility in managing their coverage. It is a product within the broader category of Insurance. Unlike traditional whole life insurance, which has fixed premiums and a predetermined death benefit, adjustable life insurance allows policyholders to modify these elements to suit changing financial circumstances. This adaptability can include increasing or decreasing the death benefit, adjusting the premium payments, and altering the policy's cash value accumulation. The adjustable life insurance structure aims to provide long-term coverage with a dynamic approach, allowing individuals to adapt their policy as their life stage and financial needs evolve.

History and Origin

Adjustable life insurance emerged as part of a broader evolution in the life insurance industry, driven by a desire for more flexible products than traditional whole life policies. Its development paved the way for more modern flexible premium policies. While the specific term "adjustable life insurance" might be less common today, its core features of flexible premiums and adaptable death benefits were foundational to the rise of what is now widely known as universal life insurance. The concept behind universal life, which shares many similarities with adjustable life, began to be publicly discussed in the 1970s and saw a meteoric rise in the 1980s.¹⁹, ²⁰ Companies like Life Insurance Company of California (later E.F. Hutton Life) were pioneers in combining term life insurance with an accumulation fund into a single contract, effectively creating products with features akin to adjustable life policies.¹⁷, ¹⁸ This innovation sought to address the challenges faced by traditional whole life insurance during periods of high inflation and shifting economic conditions, offering consumers greater control over their investment portfolio within their life insurance.¹⁶

Key Takeaways

• Adjustable life insurance offers flexible premiums and death benefits, allowing policyholders to modify coverage as financial needs change.
• A portion of the premium contributes to a cash value component that grows on a tax-deferred basis.
• Policyholders can increase or decrease premiums or the death benefit, often subject to underwriting for increases.
• The cash value can be accessed through policy loans or withdrawals, or by surrendering the policy for its surrender value.
• It provides permanent coverage, unlike term life insurance, making it suitable for long-term financial planning needs.

Formula and Calculation

Adjustable life insurance policies do not typically involve a single, universally applied formula for their overall value, as their flexibility allows for various moving parts. Instead, their financial mechanics involve the continuous interaction of several components: premiums paid, the cost of insurance, administrative fees, and the interest rate credited to the cash value.

The growth of the cash value can be conceptualized as an iterative process:

Where:

• (CV_{t+1}) = Cash Value at the end of the period
• (CV_t) = Cash Value at the beginning of the period
• (P_t) = Premiums paid during the period
• (CoI_t) = Cost of Insurance during the period (which typically increases with age)
• (AF_t) = Administrative Fees during the period
• (r_t) = Interest rate credited to the cash value during the period

Policyholders can adjust (P_t) (premiums) and the death benefit, which directly impacts (CoI_t). The insurer determines (r_t), (CoI_t), and (AF_t).

Interpreting Adjustable Life Insurance

Interpreting an adjustable life insurance policy primarily revolves around understanding its dual nature: a protection component and a savings or investment component. The flexibility inherent in adjustable life insurance means that its value and effectiveness are highly dependent on how the policyholder manages these two aspects. For instance, increasing the death benefit typically leads to higher costs of insurance, which can slow the growth of the cash value if premiums are not also increased. Conversely, reducing premiums might draw down the cash value more quickly or necessitate a reduction in the death benefit.

The tax-deferred growth of the cash value is a significant feature.¹⁵ Policyholders should regularly review their policy statements to monitor the cash value's performance relative to the costs of insurance and fees. This ongoing evaluation is crucial to ensure the policy remains adequately funded to provide the desired death benefit and to avoid potential lapse. Understanding the interplay between premium payments, the cost of insurance, and the credited interest rate is key to maximizing the benefits of this type of permanent life insurance.

Hypothetical Example

Consider Sarah, a 35-year-old professional who purchases an adjustable life insurance policy with an initial death benefit of $500,000 and a planned monthly premium of $200. For the first few years, her career flourishes, and she consistently pays her premiums. A portion of each premium goes towards the cost of insurance and administrative fees, while the remainder accumulates in the policy's cash value, earning interest.

At age 45, Sarah decides to start a family and temporarily reduce her work hours, impacting her income. She utilizes the flexibility of her adjustable life policy to lower her monthly premium payments to $100 for two years. During this period, the policy's internal costs are covered primarily by the accumulated cash value. Once her income stabilizes, she resumes her original premium payments and considers increasing her death benefit to $750,000 to better protect her growing family. This increase typically requires new underwriting to assess her current health and eligibility.

Later, at age 60, Sarah plans for retirement. Her adjustable life policy has accumulated substantial cash value. Instead of making monthly payments, she opts to use a portion of her cash value to pay future premiums, ensuring her coverage remains in force through her retirement years without direct out-of-pocket payments. This hypothetical scenario demonstrates how the adjustable nature allows the policy to adapt to different stages of life and financial circumstances.

Practical Applications

Adjustable life insurance offers several practical applications in personal risk management and financial planning due to its inherent flexibility:

• Changing Financial Capacity: Individuals whose income or expenses fluctuate can adjust their premiums up or down, within specified limits, to match their current financial situation. This is particularly useful for business owners or those in commission-based roles.
• Adapting Coverage Needs: As life events occur—such as marriage, the birth of children, or significant debt acquisition—the death benefit can be increased to provide greater protection. Conversely, if financial obligations decrease (e.g., children become independent), the death benefit can be reduced, potentially lowering the cost of insurance.
• Accessing Cash Value: The accumulated cash value can serve as a readily available financial resource. Policyholders can take tax-free policy loans against the cash value, which can be used for various needs like educational expenses, down payments on a home, or supplementing retirement income. Unl¹⁴ike a bank loan, policy loans do not typically require a credit check and are repaid at the policyholder's discretion, although unpaid loans reduce the death benefit.
• Estate Planning: Adjustable life insurance can be a useful tool for estate planning, providing a tax-free death benefit to beneficiaries upon the insured's passing. The¹³ flexibility allows the policy to be structured to meet evolving estate liquidity needs or to address potential estate taxes.

##¹² Limitations and Criticisms

While adjustable life insurance offers considerable flexibility, it also presents certain limitations and criticisms that policyholders should consider. A primary concern for some is the lack of guaranteed interest rates or returns on the cash value component, which can make long-term planning challenging. While some policies offer a guaranteed minimum interest rate, actual returns can vary based on the insurer's investment performance.

Th¹¹e cost structure of these policies can be complex and may include various fees and charges, such as mortality charges, administrative fees, and surrender charges, especially in the early years of the policy. The⁹, ¹⁰se internal costs tend to increase with the policyholder's age, which can erode the cash value over time, particularly if investment returns are lower than anticipated or if premiums are insufficient.

An⁸other significant drawback is the risk of policy lapse if the cash value is depleted due to insufficient premiums or underperforming investments. Thi⁶, ⁷s can lead to the policyholder losing coverage and potentially facing unexpected tax consequences if the policy terminates with outstanding loans or if withdrawals exceed the total premiums paid. The⁵ responsibility for actively monitoring the policy's performance and adjusting payments falls largely on the policyholder, which some find burdensome.

##⁴ Adjustable Life Insurance vs. Universal Life Insurance

Adjustable life insurance and universal life insurance are often used interchangeably or are considered very similar types of permanent life insurance due to their shared characteristic of flexibility. Historically, adjustable life insurance was an early iteration that offered flexibility in premium payments and death benefits, often allowing the policyholder to switch between whole life and term life features.

Universal life insurance, which became prominent in the 1980s, effectively refined and expanded upon these flexible features. Both types allow policyholders to adjust their premiums and death benefit amounts after the policy is issued, within certain parameters. They both also feature a cash value component that grows tax-deferred. The key distinction, if one is made, often relates to the degree of flexibility and how the cost of insurance and cash value components are handled. Universal life policies typically separate the savings component more distinctly from the cost of insurance, providing greater transparency and control over how much premium goes towards each. While some may consider adjustable life insurance a predecessor or a specific flavor of universal life, the operational characteristics are very much alike, centering on the ability to modify the policy to fit evolving financial needs.

FAQs

Q: Can I change my premium payments at any time?

A: Yes, one of the main features of adjustable life insurance is the flexibility to adjust your premiums. You can often increase or decrease payments, provided the policy's cash value is sufficient to cover ongoing costs, or you meet minimum payment requirements to keep the policy in force.

Q: How does the cash value grow in an adjustable life policy?

A: The cash value grows based on an interest rate credited by the insurance company. A portion of your premium payments, after covering the cost of insurance and administrative fees, is allocated to this cash value account, where it accumulates on a tax-deferred basis.

Q: What happens if I stop paying premiums?

A: If you stop paying premiums on an adjustable life insurance policy, the policy will typically use its accumulated cash value to cover the ongoing costs of insurance and fees. The policy can remain in force as long as the cash value is sufficient. However, if the cash value is depleted, the policy may lapse, meaning your coverage would end.

Q: Is the death benefit taxable for my beneficiary?

A: Generally, the death benefit paid to your named beneficiary from an adjustable life insurance policy is federal income tax-free. How², ³ever, there might be exceptions for estate taxes or if the beneficiary chooses to receive the payout in installments with accrued interest.

Q: Can I take money out of my adjustable life insurance policy?

A: Yes, you can access the cash value through policy loans or withdrawals. Policy loans are generally tax-free as long as the policy remains in force. Withdrawals are also typically tax-free up to the amount of premiums you've paid into the policy (your cost basis).¹