Monday, January 15, 2007

Universal Life Insurance and Variable Universal Life

Universal life (UL) combines the flexibility of Adjustable Life with the higher earnings potential of Variable Life. Before I break this policy down, lets briefly mention a few of the benefits:
  • UL can imitate any of the traditional insurance products - whole life to term insurance to Endowment at age 95
  • UL is PERMANENT INSURANCE. Even though the protection element of the policy is ALWAYS INCREASING TERM INSURANCE, the contract can provide coverage until death or around age 95
  • As with Adjustable Life, death benefits can be raised (with evidence of insurability) or lowered.
  • As with Variable Whole Life, cash value can grow at a much higher rate of interest, but
  • unlike Variable Whole Life, there is a minimum guaranteed rate of interest.
  • Though policy loans can work just as they do with other cash value policies, it is also possible to make a cash withdrawal (partial surrender) from a UL policy that neither has to be repaid nor requires the payment of interest. Principle comes out first, therefore tax consequences are minimal.
  • Premiums are even more flexible than with Adjustable Life as they can be raised, lower, or even skipped entirely. (known as "Stop and Go" feature).
  • It is possible to structure UL so that the cash value is paid in addition to the death benefit.

This is how UL work. Each time you pay your premiums, your premium is first credited to a fund, which is call the cash value. Soon, the amount of cash value not only reflects how much you paid, but also what the company has earned. In your cash value, there is a guaranteed minimum of interest, which is usually around 4%. There is also a current rate, which reflects what the company is truly earning on the money. These rates will vary with market conditions. Historically, they have range from 5% to 8% in the past few years. As with other cash value policies, cash value grows tax-deferred. From the cash value, the money is taken to pay company expenses such as commission, premium taxes, administrative costs, on a monthly basis. The money is also taken to purchase term insurance, which is always the protection element of a UL policy.

Unlike traditional policies that force what the cash value should be, you can choose how much cash value you want. The more premiums you pay, the greater the cash value will be. The less premiums you pay, the lesser the cash value. When you purchase a UL policy, you are typically quoted two numbers, a minimum premium and a target premium. If you pay the minimum premium, your UL will closely resemble Term insurance. There will be almost no build up of cash value. If you pay the target premium, the policy will function similar to a Whole Life policy. Based upon interest rates guaranteed in the policy, the cash value would equal the face value when you are between the ages of 95 to 100. If you pay more than the target premium, the policy can work similar to an Endowment insurance. Of course, federal laws dictate that cash value cannot build faster than a Seven-Pay Whole Life contract, which means the growth of the cash value cannot be more than what the value of the cash value should be in 7 years. Therefore, you cannot put bunch of money into the policy in attempt to avoid taxes.

As your cash value grows, you may be able to skip your premiums. This doesn't mean you are not paying it directly. Your cash value is used to pay the minimum premium. Depending on how much cash value you have in the policy and the rate at which the money is earning, it is possible to avoid paying the premiums for quite a long time.

You also have death benefit possibilities. You can decrease your coverage anytime and increase your coverage (with proof of insurability). There are two options on how you want your policy to work.

Option 1 or Option A: Your death benefit remains level and the policy can either pay the death benefit or cash value, not both. As time grows, your death benefit remains level, but your cash value grows. As your cash value grows, you are purchasing less and less term insurance to fund your desired death benefit. And this need for less Term insurance comes exactly at the time when Term begins to get expensive. Remember, cash value cannot grow faster than a Seven-Pay Whole Life policy. If you make any cash value withdrawals and you don't pay it back, your death benefit will be reduced. When the cash value nears the value of the face amount, your cash value will raise the death benefit.

Option 2 or Option B: Your death benefit grows as your cash value grows. You don't know how much death benefit you will have at any given time. All you know that the death benefit will be the face amount plus whatever cash value happens to be when you die. The problem with this option is that the cost of Term insurance gets more expensive as you get older. Most policy owners switch from Option 2 to Option 1 because the cost of Term will be simply too expensive.

Unlike whole life insurance, the death benefit and the cash value are kept completely separate. This allows you to see how much you are paying for Term protection and exactly what is earning in your cash value. In many respects, UL was created in response to "buy term and invest the difference." The UL allows the insurance industry to respond, "Okay, buy our Term and invest the difference with us on a tax-deferred basis."


There nothing much to talk about here. It contains almost all the same features of a regular Universal Life except: (1) Your cash value is invested in the market, therefore (2) there is no guarantee interest. Variable Universal Life is considered a security and agents selling this product must have a life license and a securities license.

Here is something you should really take a look at if you have a universal life policy:
Universal life is an increasing term policy where the cost of having insurance increases internally and less premiums goes toward the cash value. For example, lets say you pay initially pay $100/month for a $100,000 coverage. $10 of it goes toward the insurance and $90 goes toward the cash value. Next year, the cost of insurance goes up to $12, and $88 goes toward the cash value. Every year, the cost of the insurance goes up and less premiums goes toward the cash value. Eventually, the cost of insurance will equal to $100 and $0 goes toward the cash value. A year after that, the cost of insurance will be $110 and if you don't pay the extra $10, the $10 will be deducted from the cash value. What if you don't want to pay the new premium? Then $110 will be deducted and premiums will continue to rise.

I had a client who had a universal life policy with $20,000 coverage when the premiums were initially $318/year and 25 years later, it jumped to $383/year. It had about $10,600 in cash value after surrender charges. The policy eventually paid dividends that was enough to cover the premiums. It paid dividends every year for awhile. Eventually, something happened and no dividends were paid out. She didn't pay her premiums, so what happen next is the cash value was automatically used to pay the premiums. When I was about to do a 1035 exchange, I found out that there was a loan balance of around $800. So I had her pay the balance off to avoid taxes and moved the entire $10,600 cash value into a variable annuity. 6 months later, the variable annuity was worth around $11,300 and she didn't make any contributions to it. I'm not going to talk about variable annuities, but the main point is that universal life insurance is not that great as it seems. Don't be fooled when an agent says that policy pays dividends because they are not guaranteed. Plus, the cost of the insurance increases internally. You don't notice it because the premiums remain about the same for awhile. Eventually, your premiums will go up too. If you have a universal life policy, you should check it out yourself.