Universal Life Insurance

Universal Life has developed over the years since it was "invented" to the point at which, yes, it does work. This wasn't always so and, as a consequence, it developed a bit of a bad name with some people. For years the writer refused to sell it and, frequently, advised clients and others to drop it in favour of some form of term insurance. Probably quite rightly: indeed sometimes he still recommends dropping universal life since not all makes and models of universal life are suitable. What is universal life anyway?

Best to start with the betterknown and traditional forms of life insurance. One year (annually renewable) term insurance is the basic plan: you pay a premium for one year and you have one year of coverage for the agreed upon amount. If you die during the year you collect and, if you don't, you don't. If you want it again for the next year you do it again but at a higher premium as reflects your attained age. Ten year term is just the same except that the premium stays level for the full ten years instead of just one year. It costs more up front than one year term but usually is cheaper in the longer run due to the levelized premium. Level term to age 65 and other longer term products such as twenty year term are also much the same in that the premium stays level for the period specified and either the plan lapses at the end of the term (ie at age 65), it gets converted to another plan of life insurance, or it renews at a higher premium, if such options are available with the original plan.

Eventually the idea came to folks in the insurance business that they could get more money in the door if they offered a scheme whereby they gave some of it back (other than as a death benefit). So along came plans which had cash values and plans which "participated" in the profits of the insurance company. Respectively, they are called "whole life" and "participating whole life". These plans often provided a way of getting back either some money or some value in the form of paid-for death benefit coverage.

Whole life tends to overlap somewhat with term to 100 in their respective descriptions. Both provide coverage for the whole of one's life, hence the name (it's assumed by actuaries that nobody lives beyond age 100 so term to 100 policies are considered to be fully paid-for, or paid-up, when the insured reaches age 100). For simplicity I tend to call products which have no cash values in them Term to 100 and those which do have cash and other paid-up (the technical term is non-forfeiture) values in them Whole Life.

Whole life has two components: one is the death benefit, or the insurance. The other is the cash value or the savings. The insurance component gradually reduces during the lifetime of the policy as it is replaced by the cash value. Thus, in a typical $100,000 whole life policy twenty years into the plan, there could be $25,000 of cash value and only $75,000 of actual insurance. The cash value is available for loans (at current rates of interest) but is the property of the insurance company: it only becomes the client's property if he or she surrenders the policy.

Many insurance companies encourage people to surrender their policies at or near retirement and use the cash values to supplement their retirement incomes: this is good for the insurer since they only have to pay out the savings element and no longer are on the hook for the entire death benefit. It's even better for the insurance company if they get to pay out the cash values as an income stream since they get to keep some of it even longer. As a rule, whole life costs up to ten times more than ten year term does during the first ten years and rarely does one see much of the other ninety percent building up in the cash value account.

Term to 100 could be construed as a sort of stripped down whole life. The premiums are (or should be) guaranteed to age 100 and the plan is (or should be) guaranteed renewable all the way along. Term to 100 generally costs about two to four times more than ten year term per $1,000 of death benefit. Some term to 100 policies offer "reduced paid-up" options and these can be extremely valuable: they permit the owner (at the owner's option) to stop paying premiums after a given number of years (often twenty) and receive a policy for, say, half of the original face value, fully paid for. Not a bad deal for most people since they can have a larger policy when they need it for various obligations and, assuming the obligations (and their incomes) drop in retirement, they can pay no more and still keep a portion of their coverage.

Ideally, universal life is the best of both worlds with a few other benefits thrown in. Variously described as "unbundled" life insurance, a "dog's breakfast", a "tax shelter", and the "best of all possible worlds", it can be all of the above. It is simple to understand if you can put all your knowledge (or lack of it) about life insurance on the shelf and leave it there; otherwise you may never understand it or why it makes sense for a lot of people who have permanent coverage needs.

Universal Life got a bad name because it was based on projections, as indeed were many term to 100 and whole life products which had variable interest rate and mortality charge factors built into them. Clumped together as "new money life" they laid off the risks associated with interest rates, administration expenses, and (sometimes) the mortality rate to the consumer. The guarantees that have become associated with life insurance simply were not there, other than that the insurer would pay the in-force death benefit when the insured died, whatever that actually was at the point of death. Otherwise, the cost of the coverage, the cash values, and other factors were not contracted for and people got a lot of nasty surprises when interest rates dropped.

Some policies (like some other investments) had been projected to yield 12% to 14% for ever! And they didn't. Since investment return on capital is an important part of the revenue which drives life insurance companies, and the projected revenue just was not there, obviously it had to come from somewhere. People found that policies which were projected to be "paid for" in five to seven years were not paid for and either they had to come up with more money or take a drop in the death benefit amount.