Cost of insurance charges are a central component of universal life insurance and play a major role in determining how long a policy remains in force. Unlike whole life insurance, where insurance costs are built into a fixed premium, universal life insurance deducts insurance costs directly from the policy’s cash value or premium payments.
Understanding how these charges work is critical for managing policy performance and avoiding lapse.
What Cost of Insurance Charges Are
Cost of insurance (COI) charges represent the monthly cost the insurer charges to provide life insurance coverage. These charges are:
- Deducted monthly
- Based on the net amount at risk
- Separate from premium payments
The net amount at risk is generally the difference between the death benefit and the policy’s cash value.
How COI Charges Are Calculated
COI charges are influenced by several factors, including:
- The insured’s age
- Sex and underwriting class
- Policy type and features
- Death benefit amount
As the insured ages, mortality risk increases, which causes COI charges to rise over time.
Monthly Deduction Process
Each month, the insurer deducts:
- Cost of insurance charges
- Administrative expenses
- Rider costs
These deductions come from:
- Premiums paid that month, or
- Existing cash value
If deductions exceed available funds, the policy is at risk of lapse.
How COI Charges Increase Over Time
COI charges typically start low and increase gradually, then more sharply later in life. This increasing cost structure is a primary reason universal life policies require:
- Adequate early funding
- Ongoing premium adjustments
- Regular monitoring
Policies that are underfunded early often struggle as charges accelerate.
Impact on Cash Value
Rising COI charges can:
- Reduce cash value growth
- Deplete existing cash value
- Increase reliance on higher future premiums
If cash value is exhausted, the policy may terminate.
Relationship Between COI and Death Benefit Options
Policies with increasing death benefits generally have higher COI charges because the insurer’s risk remains higher over time.
Reducing the death benefit can lower COI charges and improve policy sustainability.
Policy Illustrations and COI Assumptions
Policy illustrations assume certain COI rates. Actual charges may differ within contract limits.
Policyholders should:
- Review in-force illustrations periodically
- Compare projected vs actual performance
- Adjust premiums if needed
Managing COI Risk
COI risk can be managed by:
- Funding policies at or above target premium levels
- Monitoring annual statements
- Adjusting death benefits when appropriate
Proactive management reduces lapse risk.
Key Takeaways
Cost of insurance charges increase over time and directly affect the sustainability of universal life insurance policies. Understanding how COI charges work and monitoring their impact is essential to maintaining coverage for the long term.
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