Modified and Specialty Products
Beyond standard term and permanent policies, several specialized life insurance products address unique needs. Understanding these products is important for matching clients with appropriate coverage.
Adjustable Life Insurance
Adjustable life insurance allows the policy owner to modify the policy's features as needs change, essentially combining features of term and permanent insurance.
Adjustable Features
| Feature | Can Be Changed |
|---|---|
| Premium amount | Increase or decrease |
| Death benefit | Increase (with evidence of insurability) or decrease |
| Policy type | Switch between term-like and permanent-like |
| Premium payment period | Extend or shorten |
How It Works
- Policy owner can request changes at specified intervals
- Increasing death benefit typically requires underwriting
- Decreasing coverage generally allowed without restrictions
- Premium adjustments affect cash value and coverage period
Best For
- People whose needs are likely to change significantly
- Those uncertain about long-term coverage requirements
- Clients who want flexibility without buying new policies
Endowment Policies
An endowment policy pays the face amount either at death or at the end of a specified period (the endowment period), whichever comes first.
How Endowment Works
| Event | Payout |
|---|---|
| Insured dies before endowment date | Death benefit paid to beneficiary |
| Insured survives to endowment date | Face amount paid to policy owner |
Key Features
| Feature | Description |
|---|---|
| Guaranteed payout | Benefit is paid regardless of death or survival |
| High premiums | Must fund death benefit PLUS living benefit |
| Cash value growth | Rapid accumulation to equal face amount |
| Short maturity periods | Often 10, 15, 20 years, or age 65 |
Example
A 20-year endowment policy with $100,000 face amount:
- If insured dies in year 12 → $100,000 to beneficiary
- If insured survives to year 20 → $100,000 to policy owner
Current Status
Endowment policies have fallen out of favor due to:
- High premiums
- Unfavorable tax treatment under current law
- Almost always classified as MECs
- Alternative investments often provide better returns
Modified Endowment Contracts (MECs)
A Modified Endowment Contract (MEC) is a life insurance policy that has been funded with more money than allowed under federal tax law, resulting in less favorable tax treatment.
The 7-Pay Test
A policy becomes a MEC if cumulative premiums paid during the first seven years exceed what would have been required to pay up the policy in seven level annual payments.
| Status | Meaning |
|---|---|
| Passes 7-pay test | Not a MEC; favorable tax treatment |
| Fails 7-pay test | MEC; less favorable tax treatment |
MEC Tax Treatment
| Transaction | Non-MEC Treatment | MEC Treatment |
|---|---|---|
| Policy loans | Not taxable | Taxable as income (LIFO) |
| Partial withdrawals | FIFO (basis first) | LIFO (gain first) |
| Withdrawals before 59½ | Generally no penalty | 10% penalty on gain |
| Death benefit | Income tax-free | Income tax-free |
LIFO vs. FIFO
| Method | Order of Withdrawal |
|---|---|
| FIFO (First In, First Out) | Basis (premiums) comes out first—not taxable |
| LIFO (Last In, First Out) | Gain comes out first—taxable |
When Policies Become MECs
| Scenario | MEC Status |
|---|---|
| Single premium whole life | Almost always a MEC |
| Significantly overfunded UL | May become a MEC |
| Normal premium payments | Usually not a MEC |
| Lump sum payment into policy | Often triggers MEC status |
Important MEC Rules
- Once a MEC, always a MEC (cannot be "un-MECed")
- Death benefit still income tax-free
- Only loans and withdrawals affected
- Material change can trigger retesting
Exam Tip: The death benefit of a MEC is still income tax-free. Only lifetime distributions (loans, withdrawals) receive less favorable treatment.
Credit Life Insurance
Credit life insurance is designed to pay off a borrower's debt if they die before the loan is repaid.
How It Works
| Feature | Description |
|---|---|
| Purpose | Pay off loan balance upon borrower's death |
| Coverage amount | Equals outstanding loan balance |
| Death benefit pattern | Decreases as loan is paid down |
| Beneficiary | Usually the lender |
| Policy owner | Borrower or lender |
Types of Credit Life
| Type | Coverage Pattern |
|---|---|
| Decreasing term | Benefit decreases with loan balance |
| Level term | Benefit stays constant (may exceed loan balance) |
Common Loans Covered
- Mortgages
- Auto loans
- Personal loans
- Credit card balances (credit card protection)
Regulation
| Requirement | Description |
|---|---|
| Voluntary | Cannot be required as condition of loan |
| Disclosure | Costs must be disclosed to borrower |
| Reasonableness | Premium must be reasonable for coverage |
| Alternative allowed | Borrower can use existing life insurance instead |
Credit Life vs. Individual Life
| Factor | Credit Life | Individual Life |
|---|---|---|
| Beneficiary | Lender | Anyone you choose |
| Coverage amount | Loan balance | Any amount |
| Flexibility | Limited | Full control |
| Cost efficiency | Often more expensive | Usually less expensive |
| Portability | Ends when loan paid | Continues regardless |
Exam Tip: Credit life insurance is often more expensive per $1,000 of coverage than regular individual life insurance. Borrowers may get better value with their own policy.
Key Takeaways
- Adjustable life allows changes to premium, death benefit, and policy type
- Endowment policies pay the face amount at death OR at the end of a set period
- MECs are policies that fail the 7-pay test; loans and withdrawals taxed less favorably
- MEC status results in LIFO taxation and potential 10% penalty before age 59½
- Credit life insurance pays off a loan if the borrower dies
- Credit life is often more expensive than individual coverage for the same protection
A Modified Endowment Contract (MEC) is created when:
The primary tax difference between a MEC and a non-MEC life insurance policy is:
Credit life insurance:
An endowment policy pays the face amount:
9.3 Simplified and Guaranteed Issue
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