Universal Life Insurance – The Breakdown
The topic of this article will answer the question, “what is universal life insurance.” To have a good overview, we are going to explore different sub types offered in the industry. As we explore the different types of UL coverage, you will they are not all created equal or with the same level of guarantee.
Life Insurance is financial protection that many of us need to protect both our loved ones and/or our business interests.
It can be bought in many flavors so to speak.
The important item is to be sure you pick the appropriate product that meets your goals.
So, What is Universal Life Insurance Anyway? Is It The Same As A Whole Life Policy?
Universal life insurance (UL) for short, is a flexible premium adjustable life insurance product. What this means to you is that you have flexibility to increase or decrease the amount of premium you pay into your life insurance policy. In fact, you may even skip paying a premium and the policy will not lapse as long as there is enough cash value to cover the cost of insurance at that time. On the flipside, you can add additional premiums to increase the cash value in the policy.
While a UL policy is a form of permanent life insurance like a whole life policy, it is not the same thing. A whole life policy has a fixed, non flexible premium by default and guaranteed cash value accumulation.
UL is built on 1 year, annually renewing term insurance. As the insured ages, the cost of actual pure insurance “component” increases regardless of health each year. This is the nature of one year term insurance. It gets more expensive when the predetermined date of expiration arrives.
While this does not change your premium persae, it does result in an additional expense applied to the policy itself therefore using more of your premium rather than going into cash value accumulation instead.
Does that make sense?
Since Universal Life Insurance has flexible premiums, insurance companies offer a couple of options to their policy owners. Those options to pay either of these two types of premiums:
- One, pay the minimum premium amount, which is the amount needed to keep the universal life insurance policy in force for the current year. When you pay the minimum premium, the policy is designed to act like an annually renewing term life product.
- Option 2 is to pay the target premium. The target premium is a recommended amount that should be paid on a UL policy to cover the cost of the insurance protection and keep the policy in force for its lifetime. Remember, this is intended to be a permanent form of life insurance. Universal Life Insurance is not term life insurance that has a preset expiration date in the future.
In either case, the premium payments are dependent on the size of policy. If comparing apples to apples, the larger the policy, the higher each “option” will be.
Universal Life Cash Value
Universal life insurance does not have guaranteed cash values like whole life insurance.
Whole life insurance, requiring regular, fixed premiums does not suffer cash value fluctuation in times of low interest rates like UL does.
Over the last decade many policyholders who purchased a UL insurance policy years ago…the 80’s and 90’s in particular, have struggled.
A key point to remember about a UL policy…they are interest sensitive. Typical contract interest rates of 3-6% are pretty common.
While there is a opportunity for a policy owner to get a current interest rate, it is not guaranteed. That is important to remember. Current conditions can go up or down.
So, a universal life policy has two basic components at its heart. The first is simply an insurance component. The second component is the cash account.
The insurance component is always annually renewing term life insurance providing the death benefit. As a result of an annually renewing term insurance, the cost of the this component does increase as you age.
Combined with lower interest rate of say 3%, a policy that is funded with lower, flexible premiums may expire due to lack of funds in the cash account as a policyholder reaches there later part of their life.
A whole life policy will never expire as long as you pay your premiums due. You pay the “fixed” monthly premium that is essentially high for your early years of the coverage. Once you reach your later years it becomes low for the risk. Whole Life policies are more expensive than universal life insurance in the early years in particular.
Death Benefit Options of a Universal Life Insurance Policy
Another unique feature of flexible premium life insurance (UL) is its two different death benefit choices. The first option (A) is a level death benefit option. Next is option (B), an increasing death benefit option.
Option A actually allows a greater increase in cash value accumulation over time. A level death benefit of the policy is maintained while the cash value increases. While the cash value is rising, the pure insurance (annual renewing term) in later years becomes lower.
Option B is an increasing death benefit selection. The death benefit includes an annual increase in cash value which the death benefit is designed to match thereby having the gradual but proportional increase in both the cash value account and the death benefit.
Depending on a policyholders goals, one of these options will be more ideal…flexible in a manner of speaking.
Different Types of Universal Life Insurance
Other types of universal life you should be aware of. They are not all the same and do perform differently.
Traditional Universal life insurance is highlighted by a flexible premium option. What this means to you is that you have flexibility to increase or decrease the amount of premium you pay into your life insurance policy.
Performance of this product depends up your premium payments and the experienced interest rates and the cost of the annually renewing term insurance.
Since it is interest rate sensitive, there can be a good variance in the cash value in the policy.
Underpaid premiums can result in expiration. These policies require a watchful eye, but are designed to be permanent in nature.
The death benefit (annually renewing term insurance) is meant to be lifelong assuming the policy stays in force.
To ensure that your policy stays in force, payment of the target premium is recommended to ensure coverage in times of low interest rates.
Indexed Universal Life Insurance
Indexed universal life insurance (IUL) is a bit different then Traditional Universal Life insurance.
It includes a couple variances you do not find in all but 1 other UL policy.
First, it gives you the option of allocating any cash value of the IUL policy to an equity “indexed” option account and/or even a fixed interest account.
Typically offered are options to the S&P 500 or Nasdaq 100.
Depending on the particular IUL policy and insurance company issuing the coverage, policy owners can allocate certain percentages of their cash account in fixed or equity indexed accounts. Now, on the other side of the policy, we have annually renewing term insurance. Monies are pull annually from the cash account to pay the cost of the annually renewing term insurance.
The design of the policy provides a no loss guarantee of cash value in down years protecting the accounts value. This is done thru the purchase of options in the stock index the cash account is allocated to. You have options to choose from.
Even if the stock market index takes a loss, the cash account will not be depleted due to poor performance.
However, be aware that the cost of insurance rises each year in a universal life policy.
This is an expense to the policy that goes up each year to offset your age and risks related to it.
This is an expense to your policy account each and every year regardless of performance of the indexed account.
Permanent in nature, but not for someone who does not understand investments reasonably well.
While they have become “all the rage” in recent years, these policies are a bit more complicated and not recommended for those who do not invest.
There is a possibility if the market is down over a course of years that you may have a loss on the cash account do to account fees related to the underlying investment. This is charged regardless of whether the market performs well or not.
There are some specific applications for IUL and how the market gains are credited. This is beyond the scope of this article.
Compared to the next type of coverage, it does have less upside performance limitations but without the high risk downside.
Variable Universal Life Insurance
Variable Universal Life Insurance (VUL) is another flexible premium life insurance policy that also has two separate components. Sometimes this product is referred to as Variable Life Insurance.
A key difference from other “universal life” products…This one is regulated by both the State and Federal Government as it is considered to have investment risk.
With VUL, there is a definite element of higher risk not found in other life insurance policies in this article.
Variable Universal life insurance can only be sold by agents who have a securities license in addition to their life insurance license.
There are two components of this policy: one, the actual death benefit (annually renewing term insurance). Two, a cash account held outside the insurance companies general account.
In a VUL policy, the cash value is called the “separate account.” The separate account allows investment in stocks, bonds and other securities options.
There can be significant loads and fees built into these policies to be aware of. However, the potential for higher growth or loss is the highlight of Variable Universal Life.
It is not for the faint of heart.
This product is not recommended for most people due to the inherent risk of loss. VUL has stock market like risks. Unlike Indexed Universal life, which does not have significant risk to the cash value due to the market protections integrated in the policy, Variable UL passes the risk of loss onto you, the policy owner.
Both the separate account and death benefit can go down due to volatility of the underlying investments and or underpayment of necessary premiums.
With that said, there is a minimum death benefit guarantee even in Variable policies combined with more upside gain potential.
My suggestion would be a Indexed UL policy combined with an investment recommended by a good CFP if you like “upside potential” of your premium dollars.
Due to the risk involved in this type of life insurance, it might be prudent to speak with a certified financial planner before going down this road. Discuss other investment opportunities.
Variable life insurance would be best suited for someone who is very comfortable with investments for any consideration at all.
Variable Universal Life is not the product to provide what most investment minded people are looking for and need life insurance.
We have chosen not to offer it.
Guaranteed Universal Life Insurance
GUL or Guaranteed Universal Life Insurance is a completely different kind of universal life insurance.
While it typically offers no cash value accumulation, it instead offers a death benefit up to age 121…guaranteed.
It offers a “no-lapse” policy guarantee which removes risk that your premium would ever increase do to market volatility or low interest rates.
Guaranteed UL has a level premium for life and a death benefit that will not go down.
The premium is not designed to be flexible as with other “types” of universal coverage, but in return offers “term like” life insurance rates.
It is a permanent form of coverage for those not concerned with building cash value and want absolute assurance of a death benefit to any obtainable age.
Pay the no lapse premium each month and the full death benefit is guaranteed all the way out to age 121!!
For a better background on this product you should read our more extensive article on Guaranteed Universal Life Insurance and its common uses.
Cheap Life Insurance Quotes
Folks, Universal life insurance is not cheap. It is affordable, yes, but the benefits built into the policy make it a larger expense then simply purchasing a simple term life insurance policy.
The insurance company is taking more risk offering you permanent coverage. Term life does not offer permanent coverage nor any cash account in it.
It usually expires with no benefits paid out. While that is good, it demonstrates why it is cheap.
The odds are in favor of the insurance company, right?
Determining whether you need temporary or permanent coverage is the first step before considering a UL policy.
Make sure if you are going down the “universal”path that you look over the mandatory policy illustration before applying for coverage. Plan on paying the target premiums not the minimums in case the policy under performs. Over funding it is another option, but that is getting beyond the scope of this article so I will leave it here.
Many agents highlight the high end of the return spectrum but fail to discuss the possibility of paying more than expected to keep the policy in force permanently.
The exception here is the Guaranteed Universal Life Insurance.
It has a built in no lapse guarantee and does not have a cash account as part of the policy.
Remember, permanent policies, if kept in force for a lifetime, will be paying out to a beneficiary at some point. It is a larger risk to any insurer which makes it more costly to own than term life insurance.
Traditional Universal life insurance is a flexible premium life insurance policy that offers potential for solid cash accumulation and lifelong protection.
With that said, in tough times, a UL policy may under perform requiring you to increase your premiums. Many UL policy holders of the 80’s and 90’s were hit hard by this as their premiums rose drastically due to low interest rates of recent years.
Universal Life policies can add a good degree of flexibility but offer complexity in return.
The exception to this would be Guaranteed Universal Life Insurance which is simple in nature and a great option for those who need permanent coverage and don’t care about building cash value but want a lower, fixed “term like” premium and a no stress policy with a no lapse guarantee.
Cheap life insurance quotes are going to be something you will see (and hear for that matter) with a term life insurance policy.
Well, it is temporary, rented life insurance protection that “terminates” in a certain number of years you elect during application. The insurance company has lower risk because they are only on the hook for a limited time, unlike a permanent policy such as Universal life insurance.
Disadvantages of Universal Life Insurance
Universal life is confusing for many people. It simply is a complex policy compared to others on the market. It is a policy that requires significant owner attention as to how it is performing and to adjust premium payments if necessary.
Coverage such as IUL, VUL and traditional, interest sensitive UL may be an option for those willing to keep tabs on how the policy is performing rather than stick it in the fire safe and call it good.
Traditional Universal Life insurance is a very interest sensitive product. That in and of itself can be problematic if interest rates plummet. Premiums are based on a set of assumed interest rates.
It can perform nicely during higher interest years but often require higher than normal premiums when the interest rates decline if you want to maintain the full contract value. Being an interest sensitive product, trouble can ensue with these policies if not funded aggressively during the low interest periods.
Of course an IUL policy will depend upon the performance of the stock market. For some, that is still a bit of a rocky road if cash value is decreasing while paying the yearly increase in the cost of insurance.
With the exception of Guaranteed Universal Life (GUL), we do not recommend the other universal life products for the typical life insurance consumer. While we are warming up to the newer, Indexed Universal life insurance that is still for the type of policy owner that understands the stock market.
With VUL and Traditional UL, the risk of policy lapse has reared its ugly head. These policies of the 80’s left many policy owners in rough shape due to and under performing investments and low interest rates. With policies going south like that, the requirements of the policy owner to double down on monthly premiums caused a lot of people to surrender or lapse their policy.
That is a big problem to have you premiums go bonkers 25 years down the road and become unaffordable where you have to drop it, right?
To restate our position…only a GUL policy is appropriate for most life insurance consumers outside of term and whole life insurance. This is all respective of your needs and goals.
While we are warming up to Indexed Universal life policies, they are best suited for someone who already has a stock market mentality.
Understand that life insurance companies make huge profits on all life insurance products that are dropped prior to expiration.
Never, ever buy a policy that you are not going to keep hell or high water. The insurance company will win and you may not achieve what you set out accomplish by taking out the coverage in the first place.
While some folks buy life insurance to protect their loved ones or business from financial harm, still others desire to leave a legacy behind charitable.
Ultimately, life insurance is purchased for various reasons.
Your snapshot of the needs of the policy beneficiary or loved ones should dictate what “kind” of coverage is truly needed.
A 29 year old man or woman starting a family would likely be fine with 20 or 30 year term. The need for insuring their income for their family during those vunerable years of raising children, car, house payments and possible college funding is fairly predictable. Now a 50 year old consumer should be thinking about guaranteed universal life insurance as a option to protect their family into the future. Health and age related issues are very real at this point. It is not predictable how long we are likely to live. Certain people will become statistics and not make it to 60 while others could easily live past 80.
There is no type of life insurance that is ideal for everyone!!
Yes, you heard that here.
There is some bogus information circulated by financial gurus, pundits, and bloggers many of whom do not even have a life insurance education and license and/or extensive industry experience.
There are also insurance salespeople who consistently push “cheap term life insurance.” Many of these individuals think they doing you a great favor by selling you low cost term life insurance. Problem is, they have not been around the block long enough to see term policies expire and leave people uninsured in their final years of life, stuck with poor health and without life insurance they can afford.
Most of these representatives have a lot to learn about life insurance consumers before pushing their blanket opinions.
Be leary of recommendations based on cost, hearsay and limited case experience. It is important to save money, but not at the expense of having the wrong kind of life insurance.
Remember, a life insurance policy is a legal, binding contract. It is enforceable in a Court of Law.
Unlike a homeowners or auto policy, there are no grey areas. The life insurance company must pay according to the terms specified in the policy. You are responsible to understand the terms of your policy in addition to being honest thru the process of obtaining the coverage.
Take the time and always review any policy you intend to purchase. Make sure your independent agent or broker has shopped the market for the type of life insurance best for you. Verify it will meet your expectations. After apply and obtaining the actual policy, you have a good 30 days to make sure you have a policy you can count on. If not, request a refund. State law has you covered.
I hope this article has answered your questions on universal life insurance.
Is Guaranteed Universal life insurance for you? Let us know.
Feel free to comment below if you would like to. Give us a call if you need some specific advice or have an unanswered question. We’re here to help. 800-598-6445
Special Risk Life is a veteran independent life insurance agency that specializes in guiding people with even the toughest health conditions thru the life insurance process. We are very passionate about helping people get the financial protection they want while delivering affordable coverage people can absolutely count on.