What’s Universal Life Insurance and How Does It Work?

Universal life (“UL”) insurance is the most flexible form of life insurance, but you need to actively manage the policy to maintain sufficient funding so it doesn’t lapse and leave you without insurance.

The promise of universal life insurance is a savings element (similar to whole life insurance) which is invested to provide a cash value buildup, along with low-cost life insurance protection (similar to term life insurance).

In a universal life insurance policy, the company credits the premiums to the cash value account, where the money earns interest. Periodically, the company deducts from the cash value account its expenses and the cost of insurance protection, usually described as the mortality deduction charge. The balance of the cash value account continues to earn interest.

If you discuss universal life insurance with an agent who wants to sell you a policy, be aware that there are actually two interest rates you need to pay attention to: One is the minimum rate. The company guarantees you’ll always earn at least the minimum rate, which is typically quite low.

But the financial representative often brushes over the minimum rate, and talks more about the assumptive rate. This is the much higher rate the insurance agent is referring to when he says, “Assume you earn as much as X percent per year. …” But the vast majority of traditional universal life polices issued in recent years have not earned more than the interest rate guaranteed by the insurance company, according to Chip Wittrock, President of Life Audit 101.

If the interest rate paid on your cash value is low, the policy may not generate cash value fast enough to cover the policy’s ongoing expenses. When that happens, you face the alternatives of either increasing how much you pay in premiums or surrendering your policy.

It’s also important to note that traditional universal life insurance premiums are not guaranteed to stay level as you get older. The cost of your policy increases as you get older. This rising cost of a traditional universal life insurance policy may exceed the cash value you have accumulated over the years. If this happens, your policy will lapse if you are not able to come up with the additional money needed to fund your universal life policy.

What Are the Advantages of Universal Life Insurance?

Universal life policies have several features that consumers may find attractive:

• UL policies offer flexible premiums. Particularly in times of high interest rates, when your cash value is growing relatively fast, you may choose to pay less premium out of pocket, with the company drawing on your cash value to make up the difference
• The company may offer you the choice of either a level death benefit or, for a larger premium, a death benefit that increases over time
• Many UL policy owners think of their policies as tax-deferred investment opportunities, because income tax on the growth of the policy’s cash value is deferred until it is drawn out

What Are the Disadvantages of Universal Life Insurance?

The policy’s guaranteed interest rate will always be less than the assumptive rate the agent shows you. According to The Life Insurance Policy Crisis by E. Randolph Whitelaw and Henry Montag, the majority of universal life insurance policies sold in the past need to earn 7-10% interest in order to keep their premiums affordable. But no universal life insurance company is paying anything near that, as of the date of this article.

The New York State Department of Insurance warns about universal life insurance, “Although this type of policy gives you maximum flexibility, you will need to actively manage the policy to maintain sufficient funding, especially because the insurance company can increase mortality and expense charges. You should remember that the mortality charges increase, as you become older.”

Low interest rates have had an overwhelmingly adverse effect on UL insurance policies. Thomas J. Henske, a life insurance agent and partner at Lenox Advisors, tells of a client who bought a policy when he was 40 and was told by the agent he would be paying premiums of $12,000 a year for $4 million of coverage.

At the time, the interest paid on the policy was 6.25%. When Mr. Henske reviewed the policy six years later, the credited interest rate had come down to 4%, and now the client is paying $25,000 per year to keep the policy. “This is problematic,” said Mr. Henske. “He budgeted for $12,000, and now he’s literally paying double that amount to keep it in force.”

How Has the Universal Life Insurance Industry Tried to Offset These Disadvantages?

Many people are concerned that their increasing universal life premiums will eventually be more than they can afford, and they’ll have to give up their policy – perhaps at the time in their life they’re most likely to wish they had it.

For this reason, the universal life industry has introduced “guaranteed” or “no-lapse” policies. Premiums can remain level for life, and interest rate volatility does not affect premium payments.

But the cash value of a “no-lapse” universal life policy is not guaranteed, and these policies may have no cash value at all. Also, if you miss paying a premium or pay it late, this can jeopardize the guaranteed premium feature, resulting in a policy without a guaranteed premium.

How Much Is a Universal Life Policy?

Because the interest rate and expense and mortality charges are not guaranteed for the life of a UL policy, your premium may increase, perhaps by shocking amounts, as we’ve seen. Thus, take the agent’s generalization that “a healthy 35-year-old man might pay about $4,400 a year for a $500,000 universal life policy” with a large – make that a very large – grain of salt. The truth is, the ultimate cost of a universal life is impossible to predict with any accuracy.

Can You Cash in a Universal Life Insurance Policy?

Yes. You will receive the policy’s cash value, less any surrender charges that may be levied when you terminate your policy.

When you surrender your policy, it is cancelled. You cannot reinstate a cancelled policy. If you later want insurance, all you can do is hopefully qualify for a new policy, based on your age, health, lifestyle, income, etc., at the time you apply.

We’ve told you about universal life policies, what they are and how they work. But we also want to make you aware of an alternative that has many advantages and guarantees that universal life does not. Compare universal life to whole life insurance, and you can see why we’re fans of certain types of whole life insurance.

And we’d also be remiss if we didn’t warn you about why you should be wary of indexed universal life insurance policies.

Here’s How to Take the Next Step

If you’d like to discuss the comparative advantages and disadvantages of universal life insurance and Bank On Yourself-type high cash value dividend-paying whole life insurance policies, why not speak with a Bank On Yourself Professional? They’ll talk with you on the phone, and there’s never any cost or obligation. In fact, they’ll be more than happy to prepare for you a free, confidential Personalized Solution, showing exactly what a Bank On Yourself plan could do for you.

And they’ll give you honest answers to your questions. To get the ball rolling, complete an online confidential Analysis Request Form, and we’ll put you in touch with a highly-qualified and experienced financial representative.

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