This article is meant to bring some very important information to the reader that has a Universal Life (UL) Insurance policy. We are genuinely concerned that most of these policies will have problems either currently or in the near future. I hope this article makes you think about your situation and you take the time to have your policy reviewed by a professional that knows how these policies really work. The main message here is you need to review your UL policy and understand what is happening in your situation. This article goes pretty in depth on how mechanically UL policies work. If you get bored or confused, give us a call and we can work with you firsthand on your policy. We also use many examples in this article, that for the article purposes are only hypothetical illustrations of how these policies work. Whenever we are using numbers to show Cost Of Insurance (COI) or rates for policies, these were taken from realistic illustrations but by no means are we quoting any life insurance rates here and all readers should know COI for them is specific to their own age and risks.

1. Universal Life Insurance is NOT Whole Life Insurance

The fact is universal life insurance is not whole life insurance. Over the years many people have been tricked into thinking UL is more flexible than whole life insurance and hence a better product for the consumer. To talk about UL insurance and how it works, we need to go into the other types of policies.

Whole life (WL) insurance has been around for ages and is a product that uses the cash value to offset the cost of insurance and provides a guaranteed death benefit as long as the customer pays the periodic premium that was established when the policy was taken out. Almost all whole life polices have a static premium required. That means that in the beginning of the policy the premium is determined by calculating the appropriate risk of coverage to the mortality age (age you are suspected to die based on actuarial data) of the customer. Based on that premium, the math used, will equal the guaranteed benefit at death. The premium amount is set in the contract and can not change without changing the contract. This makes WL pretty much bulletproof for a death benefit if you pay your scheduled premium.

In 1982, after the passing of the Tax Equity and Fiscal Responsibility Act (TEFRA), many banks and insurance companies became more interest sensitive. Consumers weighed the benefits of purchasing whole life insurance against investing in the stock market, where annualized return rates for the S&P 500 were, adjusted for inflation, 14.76% in 1982 and 17.27% in 1983. Most consumers began investing in the stock market and buying cheaper term life insurance, rather than whole life insurance. Term insurance is cheaper because it is pure insurance with no cash value. Every year the consumer pays the premium that has been determined by risk calculations of your mortality and the length of the policy’s term (10yrs, 20yrs etc). At the end of that term your coverage usually goes away and then you buy another term for a different cost going forward. This shift in consumer purchasing, left the insurance companies with very little equity in the products they sold. Imagine your business just went from having products you hold that have a real dollar value, (money in the bank) to products you sell having no dollar value. It gave the insurance companies less assets and that set the scene for the insurance companies to come up with a new product called Universal Life Insurance.

Universal life (UL) insurance is sold as flexible, permanent life insurance with an investment savings element and low premiums that are similar to the cost of term life insurance. The investment portion of UL gave the insurance companies tangible assets that they could invest similarly as they did with the WL products. But the major difference in the UL product is they buy term insurance, which in turn makes UL insurance cheaper than whole life insurance. To really understand about UL insurance, you need to know more about term insurance.

Here is what we know about term insurance. Most insurance companies buy what is called re-insurance. This is a process where the company goes to a much bigger insurance company called a re-insurer and purchases a policy to cover the risk of you dying during your policy. If the risk is low, then they will purchase that insurance rather cheaply and you will benefit because your cost of insurance will be cheap. As you get older and less healthy, the cost of that reinsurance goes up. It goes up because the companies are taking more risk. You pay a higher premium when they have more risk. Essentially the older and unhealthier you get, the more you will pay for that term insurance because it is inevitable that the insurance company will have to pay the death benefit sooner than later. Term insurance is not usually affordable for the consumer after age 65. The risks get too high and the COI is not feasible for most to pay. Here is an example, a healthy 35 yr old male can get a $100,000.00, 10yr term policy for around $116 per year. That same policy as you get older will cost

Do you get the point? As we get older term insurance rates skyrocket because your risk skyrockets.

Universal Life (UL) insurance is made up of 2 parts. Cost of Insurance (COI) and a cash value account that is very similar to a savings account. The cost of insurance portion is basically how we described the term insurance cost in the previous section, except it can change each year based on the insureds age. The COI is not to be confused with the premium payments. COI is the minimum amount of payment required to keep the policy active. On a UL policy, the premium you pay must be at least the COI but usually has extra money involved. That extra money you pay over the COI piles up in the savings account portion of the policy. Over time it accumulates and earns interest paid by the insurance company to your savings account.

2. You need to understand the term “Potential Lapse Date “

Let’s say at age 35 you start your UL policy, your agreed premium for the policy is $50 per month and the COI at that age is 9.40 per month, The other 40.60 per month goes into your policy savings account. Over many years of you paying your premiums, the money in your savings portion can become quite significant. Now maybe at age 55 you have accumulated about 10,000 in cash value but the COI is not just 9.60 anymore but now 47.00 per month and the 3 dollars you are paying extra is still going into the savings portion but you are not gaining like you used to. At age 65 you are still paying 50/mo. premium, the COI is 117/mo. and now instead of money going into your savings portion, it is coming out of your savings portion to cover the COI. Eventually the savings portion will be completely depleted and that is what we call the Potential Lapse Date of the policy. When you no longer have money in your savings account to cover the rising COI. When you run out of money in your savings account your only option is to pay 100% of the coast of insurance to keep your policy active. This in lies the problem, at older ages (>65) most people are not planning or able to pay higher insurance costs. Especially ones that are over 28x the original premium. The reason this has happened is what we call underfunding the policy. Underfunding happens when the premium amounts paid over the years fail to cover the cost of insurance throughout the life of the insured (mortality age).

Flexible premium means you can adjust your premium if it meets a few rules of the policy contract.

The rules are complicated but in essence, come to this, you need to pay at least the COI each year to keep the policy in force. There is also a maximum premium that you can pay into a UL policy. This maximum is called the IRS maximum. It is a particular dollar amount determined by tax law that keeps your premiums from overloading the policy and allowing you to defeat the taxation guidelines set on life policies. You see death benefits are 100% tax free to the beneficiary of a life policy. The IRS does not want people to abuse or take advantage of this and so they put a limit based on cash value and total death benefit provided. What you really need to understand about the IRS maximum is that you cannot exceed that amount without severe penalties and most life companies will not even let you get close.

This flexible premium of UL is sold as an attraction for people who may want to change their premiums or policy values as years go by. Maybe they need to change for a few years while they have financial struggles. Maybe they want to increase their premium when they have extra, good years of income. But what it really comes down to is that the consumer needs to be aware of the pitfalls of the premium’s flexibility. Let us throw in another premium amount that we have not talked about yet for UL. The Target Premium, this is the most important premium for a UL policy holder. The target premium is the premium that will be required to carry the UL policy through the insureds mortality age. The target premium is in between the min premium (COI) and the IRS maximum premium. It is specifically calculated to make sure the policy stays in effect based on policy guarantees. The problem with having these flexible premiums Min, Max and everything in between, is that too many unqualified people take the adjustments into their own hands. It usually starts with the eager salesman. He wants to sell you a policy so he can get paid. He comes to visit with you about your life insurance needs and asks you a simple question.  “How much life insurance do you need or want to buy?” Maybe you answer with $100,000.00. He runs the numbers on some fancy calculator provided by the company and comes up with the target premium of $1200.00 per year or $100 per month. At this time, he is telling you what dollar amount is required to keep the policy in force to age 95 or even age 121 (all policies now a days go to age 121). You tell him, “we cannot afford $100 per month at our young age and limited income”, He says “what can you afford”, because he still wants to get paid. You say, “I could probably do $75 a month but that is max”. He looks at his handy tool and sees that the $75 you can pay is over the min premium and says, “we can make that work, this policy has a flexible premium and you can increase your payments later when you want”. Essentially what he has done in this case is underfunded your policy. The normal consumer will not realize this until the policy is in trouble at age 65 or later. That same agent has probably retired years ago or even dead now. I am not saying all agents are deceptive, maybe he himself does not understand how the policy actually works or maybe he was trained to sell it that way, either way, he is involved in the underfunded policy.

There are other ways a policy can become underfunded. Remember when we talked about the savings portion of the UL policy? That savings portion receives interest credited over the years. The company’s ability to pay that interest goes up and down. The interest rates fluctuate depending on how well the company does with its investments and a lot has to do with financial stability of the economy. As interest rates change so does the value of the interest going into your savings portion. Over many years of lower interest rates your money in the savings portion can be considerably less then expected when the policy was taken out. Remember earlier when we discussed what the interest rates were in the mid 80’s? If UL policies were sold taking those high interest rates into consideration for the calculations of the target premiums, what do you think happened when the interest rates did not stay at 15 and 17%? The fact is, those projected high rates did not work out and the money we were counting on to be there later was never credited to your savings portion. The rates today for these policies have been well under 5% for over 20 years. The low interest rates over the years have impacted your cash value and caused this policy to be underfunded.

3. You need to have good representation or be knowledgeable yourself

As you can see the flexibility of this policy type can cause a lot of issues with the policy lasting. With flexibility you also have a need for important oversight as to how this policy preforms over the years. It requires someone that knows what they are doing and when to say you should adjust the policy premiums to make the policy last to your mortality age. Here in lies the 3^rd pitfall with UL policies. Who is going to keep a trained eye on this policy? Most consumers do not take the time to understand the complexities of life insurance. Of course not, why would they? Most consumers would not even choose this type of policy if they knew how many moving parts it had or that they needed to be a mathematician to maintain it. Most consumers would say that is what the agent is for.

Let’s talk about that agent. The one from 25 years ago that sold you the policy. Where is he or she today? I can tell you this, most people I talk to haven’t seen that agent since they bought the policy. If they have, almost all of those agents have retired or went on to do other things by now. UL polices need to be looked at approximately every five years by a professional agent that understands the mechanics of the policy. Just paying the premium is not enough, just getting your statement and filing them into wherever you file things is not going to work. The fact is UL polices are complex and need to be reviewed. Consumers need to get knowledgeable on these polices or find and agent you trust to help them out.

Let’s review the things we learned today about the three pitfalls of Universal Life Insurance.

1. Universal Life Insurance is not Whole Life insurance.
2. You need to understand the term “Potential Lapse Dates” and how it may impact your policy.
3. You need to have knowledgeable representation when owning a Universal Life Insurance Policy and review that policy at least every 5 years.

We see these pitfalls daily here at I-Review. In fact, we started our review business because we know this is a true epidemic for policy holders. First thing you need to do is to get a qualified professional agent to look at your policy. Get a full review and understand how your policy may be affected by the above situations. Not every policy that we see is broken, just about 80% of them. Contact us today for your free review.