What is Universal Life Insurance and How Does it Work?

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What is Universal Life Insurance?

Universal life insurance is a type of permanent coverage originally created in the 80’s to be a lower cost, more flexible alternative to whole life insurance.

As opposed to whole life, in universal life, premium payments are variable.  You can pay when you want, as long as there is sufficient cash value to pay for policy fees and cost of insurance.

How Does it Work?

If the policy performs well and policy costs stay low, it’s very possible that over the lifetime of a universal life contract, that substantially less premium may be paid into the contract than in the case of whole life.

Remember with whole life, they have to guarantee the coverage will stay in force for life, so that guarantee comes “at a premium”, if you’ll pardon the expression.

Not all universal life contracts have this sort of guarantee.  Your policy’s ability to stay in force will be based on several variables including the cost of insurance and interest rates, which are both variable, and the premiums you pay.

Since these are unknowns at the time of policy issue, you can run illustrations, or projections, showing how long the policy is estimated to stay in good standing.  But that’s only a preliminary estimate.

Universal Life Insurance Quotes

The quotes below assume excellent health, for a male, non tobacco user.  They are guaranteed universal life contracts to age 121, and build little to no cash value.  For a policy with cash value build up, you’ll need to call us for an illustration.

Age $100,000 $250,000
Male Age 30 $336 $841  PER YEAR
Male Age 40 $559 $1,291
Male Age 50 $809 $2,015
Male Age 60 $1,430 $3,530
Male Age 70 $2,600 $6,382
Male Age 80 $5,162 $12,689

 

Quotes are as of 2/28/2012 and are subject to change.

Universal Life Annual Statements

Your annual statement should give you two important dates.  One is the date your policy is estimated to lapse if you continue paying the scheduled premiums.  The other is the date it is projected to lapse if you stop paying premiums.

If you plan to make a change to your annual premium or withdraw or borrow from your cash, you should always request a new illustration.  You will want to request a new illustration at least once every year or two anyway, to compare it to your original illustration to see how it’s performing.

Universal Life Pros and Cons

The pros are premium flexibility and the possibility of paying less into the contract than in the alternative, a whole life policy.

Flexibility – Say you buy a UL and pay $500 per year into the policy for a few years and then get laid off from your job.  If you can only afford $200 that year, or nothing at all, your policy may still stay in force if it has enough cash value to support the costs.  Then the following year, you might pay double the premium to get the cash value back up to where it should be.

You might also have some unique interest crediting strategies, as is the case with indexed universal life, which allows your gains to track a major equity index, such as the S&P 500.  Some very attractive gains can be made in these policies.

Tax Advantages – You may also be able to borrow from your cash value account, accessing the cash tax free.  Some people stuff their UL full of cash, since the funds grow tax deferred.

Some disadvantages of UL would be expenses and surrender penalties, and the headache of maintaining them.

In most contracts, there are penalties to withdraw funds during the first 15 years.  Just yesterday, a client of mine came into the office to review his Aviva UL annual statement.  At 33 years old with only a $140,000 death benefit, he was charged $406 in expense charges, $46 for base cost of insurance, and a premium expense charge of $100.  So they charged him to pay a premium!

Again, most UL policies don’t have guaranteed riders, so they require constant vigilance and maintenance to be sure sufficient cash values are maintained to keep the policy in good standing.

Guaranteed Universal Life

As previously stated, some UL policies have no lapse riders that provide guaranteed coverage for a certain period of time, such as to age 100 or to age 120.  In these policies, you don’t usually get much cash build up, but at least you have a guaranteed death benefit for life and guaranteed premiums for life as long as you pay your premium on time.

The problem, of course, would arise when someone can’t pay their premium on time.  Once the “no lapse” benefit is breached, you would have the opportunity to backpay the premiums you missed, usually with additional premiums required to put the no lapse guarantee back in good standing.  But if you can’t do that, your policy will revert to the way a UL normally works.  The problem it will probably be in danger of lapsing, because again, cash value is usually sparse in these guaranteed policies.

Term UL Hybrid Policies

Some companies offer a universal life policy short “no lapse guarantee” duration riders, such as for 10, 15, or 20 years.  During this time, the premiums and face value are guaranteed to stay level, even if there is little or even no cash value.  So it acts like a term policy, but is actually built on a universal life platform.  After the initial term, the policy automatically converts back to acting life a universal life policy.

For more information about the types of life insurance including, term and whole life, see our “Types of Life Insurance” tab above.

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