One month inside a universal life policy: every deduction in order

Once a month, usually on the same day, the insurer's system runs the same short routine on your universal life policy. It adds the premium you paid, takes out a fixed list of charges in a fixed order, credits interest and writes a new account value. Nothing about the routine is mysterious, but few owners ever see it laid out line by line, and the line items are where a policy's cost hides. This post follows one month for one invented policy, then a second month in which no premium arrives.

Every number is a hypothetical chosen so the arithmetic is easy to check. The order of operations and the names of the charges differ from contract to contract, so use this as a map and then compare it with the "monthly deduction" and "charges" sections of your own policy.

The policy we will follow

Marcus, 50, owns a universal life policy with a $400,000 level death benefit, often called option A. The account value at the start of the month is $22,000. Marcus pays a premium of $500 each month. The invented contract terms are:

• Premium charge: 6% of each premium.
• Monthly administrative charge: $12.
• Per-thousand expense charge: $0.06 per $1,000 of face amount per month, which for a $400,000 policy is 400 × $0.06 = $24.
• Rider charge: $9 a month for a waiver-of-premium rider.
• Cost of insurance: $0.30 per $1,000 of net amount at risk per month. This is an illustrative current rate for a standard-rated 50-year-old, not a market figure.
• Interest: a declared 4% annual rate, applied monthly at about 0.3274% (the monthly equivalent of 4% compounded annually).

If you want the vocabulary first, how universal life insurance works and fees and charges inside permanent life insurance cover the pieces; here we put them to work.

Step 1: the premium arrives

Marcus's $500 payment lands on the due date. The first deduction happens before any money touches the account.

The premium charge is sometimes called a load or expense charge. In many contracts it is a percentage that covers state premium taxes and sales costs; some contracts have a higher percentage in the early years and a lower one later, and some charge only on premiums above the target. Whatever the form, it is taken first, and the owner's account never sees the $30.

The net premium joins the opening balance: $22,000 + $470 = $22,470.00.

Step 2: the fixed monthly charges

Next come the charges that do not depend on the insurer's mortality assumptions.

Together these are $45 for the month. The administrative charge is a flat fee for servicing the contract. The per-thousand charge scales with the face amount and, in some contracts, applies only for the first 10 or 15 years. The rider charge buys a promise: if Marcus became disabled in the way the rider defines, the insurer would pay the policy's charges. Riders that scale with the net amount at risk or with the account value are priced differently, so read the rider page of the contract rather than assuming a flat dollar amount.

Step 3: the cost of insurance

The cost of insurance charge is the price of the death benefit that is not already funded by Marcus's own account. Insurers call that gap the net amount at risk. With a level death benefit it is the face amount minus the account value.

• Death benefit: $400,000
• Account value after the earlier deductions: $22,425.00
• Net amount at risk: $400,000 − $22,425.00 = $377,575.00

The rate is $0.30 per $1,000, so the charge is 377.575 × $0.30 = $113.27 (rounded to the cent). Marcus's balance becomes $22,425.00 − $113.27 = $22,311.73.

Two details matter here. First, many contracts discount the net amount at risk by a small factor reflecting the interest the insurer expects to earn during the month; we ignored that to keep the arithmetic clean. Second, the order is a contract choice. Some insurers take the cost of insurance before the other charges, which makes the net amount at risk a little smaller or larger and changes the answer by a few cents. If you are reconciling your own statement and your arithmetic is off by a small amount, the order or the discounting is the first place to look, and your insurer can send a worked example from the contract's formulas.

The cost-of-insurance rate itself rises with age and depends on the underwriting class. It is also the charge the insurer can raise within the contract's guaranteed maximum, the subject of universal life cost-of-insurance increases and what to do. That is why a statement that shows a rising charge from one year to the next is worth a question; the blog post a worksheet to test your universal life statement for charge creep gives a way to test it.

Step 4: interest is credited

Last, the insurer credits interest on what remains. At about 0.3274% for the month: $22,311.73 × 0.003274 = $73.04.

The new account value is $22,311.73 + $73.04 = $22,384.77.

Contracts differ about which balance earns interest. Some credit interest on the balance after all deductions, as here. Others credit on the opening balance plus the net premium, which would be slightly more favorable to the owner. A few credit daily. The crediting rate for a standard universal life policy is declared by the insurer subject to a guaranteed minimum written in the contract. In an indexed policy the monthly step is the same except that money in an index account earns nothing during the month; the credit arrives later, at the end of the segment, as described in From index move to account value: one IUL crediting year in order.

The month at a glance

Check the arithmetic the way you would check a bank statement. The charges total $30.00 + $12.00 + $24.00 + $9.00 + $113.27 = $188.27. The account changed by +$500.00 − $188.27 + $73.04 = +$384.77, and $22,000.00 + $384.77 = $22,384.77. The table ties out.

Notice also what the month says about cost. The $188.27 of charges equals about 38% of the $500 premium, and the $73.04 of interest was earned on money that was already in the account rather than on the new premium. If we annualize the month, which is crude because charges change as the account and Marcus's age change, the charges would be about 12 × $188.27 = $2,259 on $6,000 of premiums. The difference between $6,000 and $2,259 is what could build the account, and it only builds if the interest credit holds.

A month with no premium

Say Marcus misses the payment next month, or never planned to pay one. The same routine runs, with one difference: nothing goes in at the top.

Charges for the month are $12.00 + $24.00 + $9.00 + $113.30 = $158.30, interest is $72.76, and the account falls by $85.54. The policy stays in force; the account simply pays for itself out of savings. This is what "skipping a premium" means in a universal life policy. Nothing is due on a specific date. The account pays, and the question is how long the account can keep paying.

Marcus could do this for a long time. A balance of $22,000 against roughly $158 of monthly charges would last well over a decade at today's charges, longer if interest keeps coming in. But the charges are not frozen. The cost of insurance per $1,000 rises each year as he ages, and the net amount at risk rises as the account falls. Run the same routine for a policy whose account is already thin, and the month in which the deductions exceed the balance arrives much sooner. That is when the policy enters its grace period; see a universal life policy in its grace period: notices and deadlines in order for the notices and deadlines in order.

How a small rate change shows up

The cost-of-insurance rate is the line that moves most from year to year, so it is worth seeing what a modest change does. Say that at the next policy anniversary the rate per $1,000 goes from $0.30 to $0.33, a rise of 10% that might reflect a year of age. Keep everything else the same, including the net amount at risk of $377,575.

• Old monthly charge: 377.575 × $0.30 = $113.27.
• New monthly charge: 377.575 × $0.33 = $124.60.
• Difference: $124.60 − $113.27 = $11.33 a month, or about $136 a year (12 × $11.33 = $135.96).

That is a small amount against a $6,000 annual premium, which is the point: charge growth is usually gradual and the account can hide it for years. But the increase compounds with age, because the rate rises every year and, if the account is not growing, the net amount at risk does not shrink to offset it. A 10% annual rise doubles a charge in about seven years. A statement that shows the charge for the past three years side by side is the quickest way to see whether the trend matches the illustration.

If the rise is larger than the contract's published scale, or the insurer announced a class-wide increase, that is a different matter and is covered in universal life cost-of-insurance increases and what to do and, for the contract language behind disputes, in how cost-of-insurance disputes begin in the contract language.

Reading the same month on a statement

Insurers do not use the labels in this post. Expect some combination of "monthly deduction," "policy fee," "expense charge," "mortality charge," "cost of insurance," "rider charges" and "interest credited." A statement may show only the monthly total and a year-to-date summary by category, so you may never see the month as a table. Three habits help.

1. Find the year-to-date totals for premiums, charges by category, interest and the ending balance, and confirm that they tie out the way the opening-to-closing arithmetic did above. The annual checklist in a universal life annual statement checklist: ten things to verify shows the reconciliation in full.
2. Ask for the monthly detail if the statement only gives annual totals. Many insurers can provide a transaction history on request or through an online account.
3. Keep a copy of the illustration from the year you bought, so the monthly charges on today's statement can be compared with what the illustration said would happen.

What changes the routine on your statement

The cycle above is the simplest case. Real statements add complications, and each one is a place where a question to the insurer is reasonable.

• Loans. If you have borrowed against the policy, a loan balance and loan interest enter the routine. The loan interest is usually charged at the policy anniversary or monthly, and the collateral sits in a separate loan account that may earn a different rate.
• Death benefit option B. With an increasing death benefit the net amount at risk stays level instead of shrinking as the account grows, so the cost of insurance keeps rising with the age-based rate. The difference between the options is in Universal life death benefit options A and B.
• Policy anniversary. On the policy anniversary many contracts change the charge rates, declare a new interest rate, reset the surrender-charge schedule by one year and reissue the annual statement. A jump in the monthly deduction after the anniversary is normal; a bigger jump than the illustration showed is a question.
• Other riders. A chronic illness or long-term care rider often adds a charge computed on the net amount at risk, so it grows with age as well.
• Corridor increases. Federal tax law requires the death benefit to stay above a minimum percentage of the account value. If the account grows into that corridor, the insurer must raise the death benefit, the net amount at risk and the cost of insurance rise, and the monthly deduction changes shape.
• Indexed accounts. The monthly deduction has to come from somewhere. Some contracts take it from the fixed account first, others pro rata from every account. Which one applies affects how much of the index account stays invested until the credit date.

Why this matters for the owner

Reading the monthly cycle once changes how the annual statement looks. A few uses:

1. Spot the biggest line. At 50, the cost of insurance is a modest part of the deduction. At 75 or 80 it often dominates. If you can see the trend now you can plan for it.
2. Understand the premium. A premium is not "the cost of the policy." It is the amount that, after the load, covers the charges and leaves a balance to earn interest. Pay more than the charges and the account grows. Pay less and it shrinks.
3. Compare policies by the same routine. Two proposals with the same face amount and different premiums do not necessarily differ in price; they may differ in how much account value they build. A table like the one above, filled in for each contract, is a better comparison than the premium alone. minimum, target and maximum premium in universal life compared does that for three funding levels.
4. Ask for the formula in writing. The insurer can provide the monthly deduction formula, the order and the current and guaranteed rate for each charge. If it will not, treat that as information about the product.

Questions to ask about your own policy

• In what order are the monthly deductions taken, and is the net amount at risk discounted?
• What are the current and the guaranteed maximum rates for each charge, by age?
• Which of the charges stop after a set number of years?
• Is interest credited on the balance before or after the monthly deductions?
• If I pay no premium, what balance is needed to keep the policy in force for the next 12 months, and what does the insurer project for the next five years?
• Where on the annual statement can I see each charge separately?

Key takeaways

• A universal life policy runs the same routine every month: premium in, premium charge, fixed charges, cost of insurance, interest credited, new account value.
• In the worked month, $500 of premium and $73.04 of interest produced a $384.77 increase after $188.27 of charges; with no premium, the same policy lost $85.54.
• The cost of insurance is based on the net amount at risk and rises with age; it is the charge to watch over the long run.
• The order of deductions, the discounting and the day interest is credited vary by contract, so ask for your contract's formula before reconciling a statement.
• Skipping a premium does not lapse the policy right away. The account pays the charges until it cannot, which is why a thin account makes a missed premium dangerous.