Lecture Notes on Net Amount at Risk and Universal Life Insurance

Introduction

• Net Amount at Risk (NAR): A key concept in universal life insurance.
• Determines monthly charges for the insurance portion of universal life policies.

Term Insurance vs. Universal Life

• Term Insurance: Primarily covers risk, e.g., $100,000 coverage is $100,000 risk.
• Universal Life:
  • Allows for cash accumulation.
  • Difference between death benefit and cash value determines the NAR.

Importance of NAR

• Calculated monthly to determine the cost of insurance for that month.
• Higher NAR means higher premium costs.

Graphical Representation

• Axes:
  • X-axis: Time
  • Y-axis: Dollar Amount
• Death Benefit: Horizontal line representing the policy's face amount (e.g., $100,000).
• Cash Value/Account Value: Increases over time as the policy matures.
• NAR: Difference between death benefit and account value at any point in time.
  • Decreases as policy matures and cash value increases.

Calculation of Net Amount at Risk

• Formula: NAR = Death Benefit - Cash/Account Value
• Monthly Calculation: Insurance company calculates NAR monthly to determine monthly charges.

Cost of Insurance

• Universal Life Premiums: Not a fixed annual premium.
• Monthly Charge: Taken from account to cover insurance costs.
• Formula: Cost of Insurance = NAR x Cost per Thousand per Month of Mortality

Payment Options

1. Yearly Renewable Term (YRT):
   • Costs increase each year as risk of death increases with age.
   • Lower costs when young, but can become expensive with age.
2. Level Cost of Insurance:
   • Fixed rate per thousand per month.
   • Higher initial costs, but remains consistent over the life of the policy.

Example Calculation

• Scenario:
  • Death Benefit: $100,000
  • Current Account Value: $11,500
  • NAR = $100,000 - $11,500 = $88,500
  • Cost Calculation: $88,500 x $1.30 per thousand = $115.50/month
• Monthly Adjustment:
  • Account value changes lead to recalculations of NAR and costs.

Review of Cost Options

• Yearly Renewable Term:
  • Lower initial costs, higher costs as age increases.
  • Early cash values grow faster.
  • Later years may deplete account value if deposits are insufficient.
• Level Cost of Insurance:
  • Higher initial costs, but consistent over time.
  • Long-term growth in account value expected.

Conclusion

• Understanding NAR and cost structures in universal life insurance is crucial for financial planning.
• Consumers have flexibility in premium payment structures to suit their financial goals.