This is a very important topic. Lots of policies today offer Accelerated Living Benefits. If you have advanced to the point where you are evaluating several different illustrations, you may find yourself having to choose between a policy offering this benefit and one that doesn’t. Or, possibly, two different companies may have different benefits.
If you are stuck making a decision, keep reading and I’ll give you some information to help you make the best decision.
The goal of this article is to help you understand that because the cash value is part of the Death Benefit, Accelerated Living Benefit riders have limited value in a maximum over-funded policy after the Death Benefit is reduced.
What Are Accelerated Living Benefits?
The first order of business is to explain Accelerated Living Benefits. It is important to understand that Accelerated Living Benefits are an early receipt of a portion of the policy’s Death Benefit while you are alive. Accelerated Living Benefits usually fall into 3 categories:
- Critical Illness Riders
- Chronic Illness Riders
- Terminal Illness Riders
Critical Illness Rider
A Critical Illness Rider will usually accelerate a portion of the death benefit if the insured suffers a serious (critical) illness such as a heart attack, stroke, cancer, etc. The amount of the death benefit that is advanced is dependent upon the severity of the incident.
Chronic Illness Rider
A Chronic Illness Rider will usually accelerate a portion of the death benefit if the insured becomes ill and cannot perform two out of the six Activities of Daily Living:
- Eating – Able to feed oneself
- Bathing – Able to bath or shower, brush teeth, and groom
- Getting Dressed – Able to dress and undress
- Mobility – Able to sit, stand, and walk.
- Continence – Able to control bladder and bowel functions
- Toileting – Able to get to and from the toilet and clean oneself
This benefit is usually accelerated after a waiting period and is paid as a monthly stipend until the condition no longer exists or the benefit is exhausted.
Terminal Illness Rider
A terminal illness rider will usually accelerate the death benefit when the insured receives a professional medical opinion that their life expectancy is less than 6 months.
Impact of Policy Design on Accelerated Living Benefits
It is important to understand two things:
- Accelerated Living Benefits are an early receipt of the Death Benefit.
- The Death Benefit includes the cash value.
Remember Life Insurance 101? The cash value in a life insurance policy is really just the policy owner saving up the death benefit for the insured over the insured’s lifetime. The insurance company covers the risk between the cash value and the death benefit. This “Net Amount at Risk” reduces each year as the cash value grows.
Since the goal in a Maximum Over-funded Policy is to maximize the cash value by keeping the death benefit as low as legally possible at all times, the benefit of the Accelerated Living Benefits will be kept as low as legally possible at all times too. This means that if this rider is really important to you, you may want to consider a policy design that maximizes the benefit instead of minimizing it.
Let’s take a look at a few examples to illustrate this. We’ll start with…
Maximum Over-funded Policy Designs
You’ve seen this same graph in many of my articles and videos. The reason I keep re-using the same graphs is that I want to show you that if you have a basic understanding of how life insurance works, you can debunk most myths and answer most of your own questions. Some great resources for the life insurance basics are:
- The download for Life Insurance 101 and
- The blog post on Minimum and Maximum Over-funded Life Insurance
This graph shows what a perfectly optimized, maximum over-funded policy looks like for a contract with only 10 annual premiums. The orange line shows the death benefit and the blue line shows the cash accumulation value. Understand that the death benefit is a function of the first year premium. We are solving for the lowest possible death benefit that will still meet the legal definition of life insurance. With each new premium payment each year, the initial increment of death benefit is simply pushed up by the amount of the new cash value.
After the 10th policy year, when the last premium payment is made, the death benefit is reduced to the absolute lowest amount that still meets the legal definition of life insurance.
Take note of the very small corridor of death benefit above the cash value from age 55 to 93. You can see that there is very little additional death benefit beyond the cash value. Since the policy owner can borrow against the cash value for any reason whatsoever anyway, they could borrow against the cash value to meet their health-related needs. This means that the rider is providing very little additional benefit beyond the cash value. Additionally, if the death benefit were accelerated, the policy’s cash value would not be available for leverage or for retirement income.
One way of conceptually looking at this is to divide the death benefit up into “your money” and “the insurance company’s money”. The cash value belongs to you and can be accessed by withdrawal or policy loans. The gap between the total death benefit and the cash value is “the insurance company’s money”. That is how much they are responsible to pay if the insured dies. In insurance company parlance, this is known as the “Net Amount at Risk“
You can see that if you try to execute the Accelerated Living Benefits riders after the death benefit is reduced, most of the benefit is your money. Only in the very early years is the benefit being paid by the insurance company’s money.
This was an example of a policy that was funded with only 10 annual premiums. Now let’s take a look at a policy design for someone younger and who is making premium payments through age 65.
This is an illustration for a 34 year old female with a $6,000 premium that she is paying until age 65. You’ll notice that even though the premiums continue for over 30 years, the death benefit can still be reduced to the minimum non-MEC level at age 65. You’ll also notice that the initial death benefit increment is continually pushed up by the cash value until that change takes place. Also notice how most of the total death benefit is being provided by your money after age 65.
You can see that the initial death benefit is about $150,000. If the Accelerated Living Benefits riders were exercised at any time between ages 34 and 65, there would be up to $150,000 of benefit on top of the cash value. The Accelerated Living Benefits rider certainly offers value during this time period.
But you have to ask yourself: “When do I think I’m going to need that rider?”. More than likely when you are older, right? Not necessarily, but certainly more likely. So just be aware that its possible that when you need this rider the most, it may not offer as much value as you might think.
One alternative would be to not reduce the death benefit at age 65. To see what that looks like, imagine the orange line continuing on without the drop off at age 65. In a policy like this where premiums have been paid for over 30 years, the growth of the policy’s cash value can easily keep up with the rising cost of insurance even when no additional premium is paid. This is actually the way most agents design their life insurance policies.
In the case of the earlier 10-pay design, the policy would not likely have sufficient cash value to maintain the higher death benefit for the insured’s lifetime. A short pay policy design like that requires the death benefit reduction at the end of the funding period.
So am I stating that you should not purchase a policy with Accelerated Living Benefits? Not at all. If you are looking at two illustrations that show similar cash value growth, then by all means take the one with more benefits. You never know if you’ll need them. BUT, if your goal is cash value accumulation, you may want to consider whether or not it is worth it to take a policy with lower accumulation just to get those Accelerated Living Benefits riders.
So what should you do if you place a lot of value on those Accelerated Living Benefits?
Minimally-funded Policy Designs
Purchase a minimally-funded life insurance policy with Accelerated Living Benefits. This is what the death benefit and cash value look like in a minimally-funded policy design. You can see that your money is minimized and the insurance company’s money is maximized. In this case, the insurance company is trying to offer as much death benefit as possible for every premium dollar. They are not collecting any more premium than is absolutely necessary for the contract to perform.
Since the insurance company is responsible for the portion of the death benefit between the cash value and the death benefit, you can see that this design places much more of the risk on the insurance company. This also means that the internal costs of the policy are much higher because more money must be pooled to cover the expected claims each year.
You will notice that there is much more of the insurance company’s money available at and beyond age 65 in this design than in the two earlier, maximum over-funded designs. Because the cash value represents the policy owner saving up the death benefit over the insured’s lifetime, the Net Amount at Risk does still continue to get smaller with each passing year. But since the policy goal is not cash value accumulation, this is not usually an issue to policy owners.
Another option would be to purchase a separate Long Term Care policy. But most Long Term Care policies do not cover critical illness. Their trigger to pay benefits is the same as the chronic illness rider: when the insured can no longer perform 2 out of the 6 activities of daily living.
If your goal is building wealth with The Double Play or maximizing tax-free retirement income, you may want to consider a separate policy if accelerated living benefits riders are important to you. Because there is very little “additional” benefit beyond the cash value in an optimally-designed policy, the rider’s benefit may not be there when you need it most. That means you should consider a separate minimally-funded policy to provide accelerated living benefits.
 And that higher death benefit equals higher internal costs and a higher load on the cash value. Be aware that this will result in lower retirement income and lower cash value growth. Most agents do not know how to properly design a maximum over-funded life insurance policy.