DEFRA / 7-PAY / MEC

[1695814]

I pretty much understand how the DEFRA Single & Level premiums work, but I don't quite comprehend the 7-Pay Premium Limit.

Why is it called that?

What is a Modified Endowment Contract?

It seems that the 7-Pay limit is higher than the DEFRA limit, so you must only have problems when there are decreases in face amt, huh?

A little insight would be appreciated. Keep it simple, if you can.

Sincerely,
:duh:

[JoJo]

This is IRC section 7702A

It is called the 7pay because the calculation is the PV of the death benefit spread over 7 years, equal to the Net Single Premium divided by a 7 year life annuity. (This is adjusted by cash value for a material change or rollover money at issue).

A MEC is a contract that exceeded this 7pay limit. If this person wished to take distributions in loans or withdrawals, they are now taxed gain first before the cost basis is accessed. As opposed to a non-MEC, which can take out basis first and then tax-free loans as long as the policy stays inforce. Basically, if a person is certain they do not want to take distributions, it really doesn't matter if they are a MEC or not.

If a policy decreases within 7 years of issue or the last material change, the 7pay limit is recalculated the policy may immediately become a MEC.

[Old Timer]

Also, if you are funding at the 7-pay limit on a guideline premium tested contract and you have no adjustments on the policy, you can pay between 4 and 5.5 (approximate numbers) of the 7-pay premiums before you hit the guideline limit.

[1695814]

Followup question, for 10 bonus points: Can a policy become a MEC if it has been more than 7 years since issue?

[Old Timer]

Sure. There are a couple of ways. It can be a survivorship policy with a decrease in benefits. The look back rule is back to issue in this case. Also, if there has been a material change since issue, this would start a new 7-pay test period and the premiums paid could then exceed the 7-pay limit.

[CDesRochers]

If you are really motivated, and an insomniac, you can read our book on the subject. It's on amazon.com, which my kids think is really cool!

[wat?]

If you are really motivated, and an insomniac, you can read our book on the subject. It's on amazon.com, which my kids think is really cool!

Or take ILA DP, where you can read it for the exam!!

:tup: Chris, your book did make the material a bit easier to digest, though. Thanks!

[1695814]

If you are really motivated, and an insomniac, you can read our book on the subject. It's on amazon.com, which my kids think is really cool!When my wife is suffering from insomnia, she rolls over, pokes me in the back, and says, "Honey, tell me again, what is it you do for a living?"

[amoore824]

If you are really motivated, and an insomniac, you can read our book on the subject. It's on amazon.com, which my kids think is really cool!
I am new to this forum but have a question about your book. We are implementing new 2001 CSO and our guaranteed mortality is 3%. We use the prospective method of calculating 7 Pay premium. On page 45 of my edition, you present an argument that the retrospective method is equivalent. However, that would only be true if the NAR is determined using 1 divided by the same guaranteed interest rate prescribed by the law (i.e. 4%). Yet, we contractually state that we determine NAR to be Selected Amount / (1+monthly guaranteed intereste). Must we use 4% instead of our 3% guarantee?

What this would say is if we filed that same contract but had a 4% guarantee, the benefits of the two policies would only differ because of our NAR risk rate divisor, but the 7 pay premium would have different results.

[CDesRochers]

You're right. Most companies interpret the death benefit discount rate to be a contract factor and not an interest rate (thus holding it constant for the guideline single and level premiums) but for rttrospective and prospective to be equal, you would have to adjust the rate.

Chris

[amoore824]

You're right. Most companies interpret the death benefit discount rate to be a contract factor and not an interest rate (thus holding it constant for the guideline single and level premiums) but for rttrospective and prospective to be equal, you would have to adjust the rate.

Chris
Thanks for the reply. My position was that the guideline calculations are an accumulation type and the prospective is clearly appropriate. However, the 7702A calculations are more akin to present value of benefits and it is not as clear that an unadjusted prospective calculation is justifiable, since using 3% as the DB discount may imply we are not using the greater of 4% and the guaranteed. I hate these grey areas!