Fund-and-Stop Universal Life for a Business Owner
Robert, age 58, owns a manufacturing company and holds a $1.5 million 10-year term policy that expires at age 68. His estate-planning attorney wants $1 million of permanent death benefit in place to age 90 for estate liquidity, and Robert also wants access to cash value at 70 to help fund a buy-sell obligation. A producer proposes a $1 million universal life policy, Option A, with planned premiums of $24,000 per year for seven years and then nothing. At the current credited rate of 5.75% the illustration shows $310,000 of cash value at 85; at the guaranteed 3.0% the policy lapses at 74. Midpoint assumptions lapse at 80. The producer notes that the policy qualifies under the guideline premium test if funded at the illustrated level.
1. Evaluate the proposed fund-and-stop design against Robert's two objectives. What would you require before signing off on the recommendation?
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The design fails the first objective on the producer's own numbers. Funding for seven years and stopping is only viable if the policy survives to 90 under assumptions Robert can actually rely on - and it survives only at the current 5.75% credited rate. At the guaranteed rate it dies at 74, twelve years short of the need, and at midpoint it dies at 80. A design whose success depends on the most favorable column of the illustration is not a plan; it is a bet that interest rates cooperate for 32 years.
What to require before sign-off:
- A guaranteed and midpoint run of the same premium pattern, with the lapse ages stated in writing to Robert, not buried in a supplemental page.
- A no-lapse shadow account test, or a secondary guarantee, if the death benefit is genuinely non-negotiable.
- A cost-of-insurance sensitivity run, since under Option A a rising internal cost of insurance against a level death benefit accelerates the drain precisely when the policy is oldest.
- A mortality assumption that reflects Robert's actual health and any business-travel or aviation exposure, since a table rating changes the answer materially.
The second objective - cash value access at 70 - conflicts with the first. Withdrawals and loans reduce the death benefit and accelerate lapse risk in exactly the scenario the design is least able to absorb. Present the trade-off explicitly.
2. The producer asks whether Option A or Option B is better given Robert's objectives. How do you reason to an answer?
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Map each option onto the two objectives.
Option A (level death benefit). The death benefit stays at $1 million; cash value accumulates inside it, so the pure amount at risk - and therefore the cost of insurance charge - declines over time. That is the right structure when the dominant need is a fixed death benefit of a stated amount, and when the policyholder may need to take withdrawals, because a withdrawal from an Option A policy reduces the death benefit by the amount withdrawn and behaves predictably.
Option B (increasing death benefit). Death benefit equals the specified amount plus cash value. The amount at risk does not shrink, so cost of insurance charges are higher and the policy is more sensitive to a drop in credited interest - the exact exposure that already threatens this design at guaranteed rates. It is better suited to a policyholder whose need grows with the cash value and who intends to fund it for life, which Robert does not.
Given a stated $1 million liquidity need and an intention to take money out at 70, Option A is the defensible fit. But note that the choice is second-order next to funding adequacy: an Option A policy that lapses at 74 delivers nothing, and the producer should not let the A-versus-B discussion substitute for fixing the premium pattern.
3. Robert says he would rather put in $45,000 a year for seven years. What must be tested, and what is the risk if the producer simply accepts the higher number?
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Test the higher premium against the modified endowment contract limits before anything is submitted, and test it against the guideline premium test because the two ceilings are different tests with different consequences.
- Seven-pay limit. If $45,000 for seven years exceeds the level premium that would have paid up the policy in seven years under the applicable mortality and interest assumptions, the contract becomes a modified endowment contract at issue. The consequence is not that the policy is illegal or bad - it is that lifetime distributions are taxed income-first, to the extent of gain, and pre-59½ distributions carry the 10% additional tax, and the loan provisions lose favorable treatment. For a client who explicitly plans to take cash value at 70, that is a direct hit on objective two.
- Guideline premium test ceiling. Overfunding past the guideline premium also forfeits the policy's qualification as life insurance, which is a far more serious outcome than MEC status.
The producer's risk is that the higher premium performs better on the illustration and worse for the client. Ask for a seven-pay premium figure and a guideline premium figure for this exact insured and specification, then choose a premium at or below those ceilings - or, if the client wants maximum funding, deliberately accept MEC status and tell him in writing that the 70-year-old withdrawal will be taxed income-first.