An Intro To Universal Life Insurance

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UniversalLifeInsuranceIntro

Welcome to an introductory overview on what allied health professionals should know about universal life insurance.

Universal life insurance is one of the major types of life insurance you will be offered when shopping for a policy. As when making any major purchase, it is important to perform your due diligence first. 

When I was offered the opportunity to purchase such a policy, I chose to read up on what universal life insurance is. 

I’m glad I did and I am prepared to share with you what I learned.

Let’s get started.

HOW DID UNIVERSAL LIFE INSURANCE COME ABOUT?

Introduced in 1979, universal life insurance was a revolutionary option due to the high interest rates at the time. Since the rate of return on universal life insurance cash value accounts fluctuates with these interest rates, the gains in policyholders’ cash value accounts could then be used to pay down premiums owed.

However, as interest rates gradually decreased, so did the returns on the cash value accounts. Consequently, a greater amount of premium needed to be paid directly by the policyholder. As this trend continued, universal life insurance policies became more and more expensive. 

Despite interest rates currently sitting at historical lows, universal life insurance policies continue to be advertised and sold by insurance companies. It is for this reason that you should familiarize yourself with what a universal life insurance is.

WHAT TYPE OF INSURANCE IS UNIVERSAL LIFE INSURANCE?

Permanent life insurance and term life insurance are the two major categories of life insurance. 

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As defined by the Insurance Information Institute, universal life insurance is a type of permanent life insurance. Therefore, it has characteristics in common with other types of permanent life insurance policies. 

The other major types of permanent life insurance are whole life insurance and variable life insurance. To learn more about these characteristics, you can read Similarities Between Types of Permanent Life Insurance.

In short, the different types of permanent life insurance mentioned above can last the length of your life and include the opportunity for investing by providing a cash value account. 

However, these major types of permanent life insurance also have important differences. Let’s explore some of the defining characteristics of universal life insurance. 

WHAT ARE THE DEFINING CHARACTERSITICS OF UNIVERSAL LIFE INSURANCE?

When compared to the other major types of permanent life insurance, the flexibility of universal life insurance is unique. Here’s a closer look at how that flexibility is plays a role in each of the policy’s various aspects: 

Premium:

As explained by The Guardian Life Insurance Company of America, the premiums with universal life insurance can vary in a range between a minimum amount and a maximum amount. 

The minimum payment required is determined by the amount needed to fulfill the cost of keeping your policy in force. Any premium amount you pay over this amount goes to your cash value account. However, you can’t pay more than the maximum allowable amount, a value determined by the IRS.

Additionally, be aware that the minimum premium payment will increase over time as your policy becomes more expensive to maintain while you age.

Guardian explains how some policyholders take advantage of the flexibility in premiums with universal life insurance policies by making maximum premium payments early on so that their cash value account increases quickly and then can be used to make their premium payments in the future.

Other policyowners who opt to only make close to the minimum premium payments will find that their cash value accounts will be quite low in future value. 

Rate of Return:

As explained by Protective Life Corporation, the universal life insurance policy’s cash value account increases based on the type of universal life insurance purchased – more on this later. 

When the policy is purchased, a minimum rate is established in the policy’s contract. If the return happens to be poor, the policyholder will at least receive a return according to this minimum rate. 

Unfortunately, the minimum rate is typically not very high. For example, Guardian advertises a minimum rate of return of 2.5%.

Dividends:

When a company decides to share profits with its investors, the money provided is referred to as a dividend.

Universal life insurance policies do not receive dividends

This is because life insurance companies already acknowledge that the rate of return on the cash value account of a universal life insurance policy has the potential to exceed the minimum rate of return if their company portfolio does well.

Death Benefit:

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A death benefit is the amount paid out to the life insurance policy’s beneficiaries upon the death of the insured

With a whole life insurance policy, the death benefit amount paid out to beneficiaries remains fixed, unable to be changed. 

In comparison, the death benefit of a universal life insurance policy can often be changed if desired. This flexibility may be beneficial to a policyholder who needs to decrease their death benefit due to a decrease in income in order to make their premiums more affordable and keep the policy in force. It can also benefit someone who has saved well and no longer needs such a large death benefit. 

In contrast, a policyholder can also increase their death benefit if needed. In this case, though, the life insurance company will likely require that you go through the medical underwriting process again, just as Allstate Corporation mentions as a requirement.

Expenses:

Fees can be a major downside to permanent life insurance policies in general, as there are many of them and they add up quickly. Although not often readily advertised, here you can take a look at the expenses Allianz Life outlines to get a basic overview of the type of expenses involved. Do note that the policyowner must pay several of these expenses every month.  

These expenses can total to as much as 50% of your premium payments, which is why it can take years, even decades, until you break even and then start seeing profit. 

Cost of Purchasing a Policy:

As explained by Mutual of Omaha Insurance Company, the cost of purchasing a permanent life insurance policy depends on factors including your age, your health, how much life insurance coverage you are looking to purchase, and the type of permanent life insurance policy you’re are looking to purchase.

A universal life insurance policy is often less expensive than a whole life insurance policy because there are less guarantees with universal life insurance. However, don’t discount the cost of a universal life insurance policy. Guardian provides an estimated range of $8,000-$10,000 per year for the cost of a universal life insurance $1,000,000 policy for a healthy 40-year-old.

WHAT ARE THE DIFFERENT TYPES OF UNIVERSAL LIFE INSURANCE?

There are a few different types of universal life insurance that exist. Each of these types incorporates slightly different policy characteristics.

Here’s a closer look:

Guaranteed Universal Life Insurance:

Guaranteed universal life insurance is also referred to as a no-lapse guarantee universal life insurance. This is because it was developed to be the least risky type of universal life insurance option on the market. 

Guaranteed universal life insurance aims to fix the problem of policyholders relying on the returns from their less predictable cash-value accounts to pay for their premiums. To remedy this, guaranteed universal life insurance provides a fixed interest rate for cash value account returns along with fixed premium payments.

The result is that the policy is to have more predictable amounts in the cash value account and more predictable premiums needing to be paid. As long as policyholders make these more predictable premium payments using the more predictable growth from their cash value accounts, the policy will always stay in force.

There are a few downsides to consider here, though. 

First, if the market rate increases, it can cause the policyholder’s cash value account to miss out on better returns. Insurance companies argue that while the fixed but low interest rate of a guaranteed universal life insurance policy allows the cash value account to grow minimally, this slow cash value growth is why guaranteed universal life insurance is the least expensive universal life insurance policy on the market.

Another downside to guaranteed universal life insurance is that if a policy is surrendered, having a small amount of cash value would leave a policyholder with little money. Many insurance companies realize this and therefore offer a return of premium rider. This provides the policyholder with the option to surrender their policy at designated times. However, these selected times are usually only after the policyholder has already had the policy for many years. 

Overall, guaranteed universal life insurance is marketed as a permanent life insurance version of term life insurance, but a cheaper option than whole life insurance. 

This is because, like term life insurance, guaranteed universal life insurance provides a death benefit. However, the death benefit for a guaranteed universal life insurance policy can last the life of the policyholder while the death benefit of a term life insurance policy typically only lasts a few decades

When compared to whole life insurance, guaranteed universal life insurance may not be the preferred option since whole life insurance can offer higher cash value returns. However, providing a lifelong death benefit while giving up the higher cash value returns allows guaranteed universal life insurance to be the more affordable permanent life insurance option.

Indexed Universal Life Insurance:

Indexed universal life insurance offers more potential for greater investment returns than guaranteed universal life insurance. However, with more potential reward comes more potential risk. 

The cash value account of an indexed universal life policy is linked to one or multiple stock market indexes such as the S&P 500 or Dow Jones Industrial Average. This means that your cash value account is not directly invested in the index. Rather, the performance of the index is just used as a measure to determine what return your cash value should receive.

While your cash value account will increase if the index it is tied to has a positive return, your return may be limited by a participation rate and by a cap.

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The participation rate dictates how much of the index’s gain your cash value account will actually get. For example, if your participation rate is 50% and the index your cash value account is tied to went up 20%, then your cash value account would get a 10% gain.

The cap restricts on how much return your cash value account can gain. For example, if your cap is 10%, then even though the index gained 20% your cash value account will only increase by the 10% cap.

Not only is your return being limited by a participation rate and cap, a portion of whatever return your cash value account does get will always go to paying for the cost of your insurance policy.

On the other hand, if the index your cash value account follows has a very low or even negative return, indexed universal life insurance policies can have a set minimum rate to prevent your cash value from losing money. Despite this, you will still have to pay the costs mentioned earlier that required to keep your policy in force even though you didn’t earn much money. Overall, this could still lead to a potentially negative, or at least a very low return.

Variable Universal Life Insurance: 

Variable universal life insurance is sometimes classified as its own category of life insurance, as a subtype of universal life insurance, or as a subtype of variable life insurance. 

It will be more closely examined in the upcoming article on variable life insurance.

FINAL THOUGHTS. . .

I hope this article provided you with a basic understanding on what universal life insurance has to offer. 

If you haven’t done so already, be sure to educate yourself on the other types of life insurance by reading each of the following:

  • Variable life insurance

We will tackle variable life insurance in a future article. 

Do you have any additional information to share on variable life insurance policies? Any questions on aspects that may not have been covered? Before moving on, please help make the Money Mobilizer a supportive and welcoming community for our current and future colleagues by leaving a question or sharing your knowledge below!  

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