Universal Life insurance (UL), often called “Flexible Premium Adjustable Life Insurance,” is a flexible type of permanent life insurance offering both the low-cost protection of term life insurance as well as a savings element (like whole life insurance) which is invested to provide a cash value. This type of policy is flexible in the fact that the death benefit, savings element and premiums can be reviewed and altered as a policyholder’s circumstances change. In addition, unlike whole life insurance, Universal Life insurance allows the policyholder to use the funds from the accumulated cash value savings to help pay premiums.
Universal Life insurance features a savings element that grows on a tax-deferred basis. A portion of your premiums are invested by the insurance company and the return on the investments is credited to your policy tax-deferred. A guaranteed minimum interest rate may be applied to the policy. This means no matter how the investments perform, the insurance company guarantees a certain minimum return on your money. If the insurance company does well with its investments, the interest rate return on the accumulated cash value will increase.
A Universal Life insurance policy is established with the insurer where premium payments above the cost of insurance (COI) are credited to the cash value. The cash value is credited each month with interest and the policy is debited each month by a COI charge and any other policy charges and fees which are drawn from the cash value if no premium payment is made that month.
Universal Life insurance is typically defined by three (3) primary characteristics:
Flexibility: Universal Life insurance was created to provide more flexibility than whole life insurance by allowing the policy owner to shift money between the insurance and savings components of the policy.
Transparency: With most life insurance, the policyowner pays a certain, required premium, and never sees what the insurance company does with the money. However, with Universal Life insurance there is no required premium or premium schedule. Instead of requiring scheduled premium payments from the policyowner, the insurance company makes periodic charges against your cash value account. The policyowner will clearly see exactly what expenses are being incurred by the policy.
Affordability: While it is true that Universal Life insurance is not as affordable as term life insurance, it is generally considered much more affordable than whole life insurance. This is simply because Whole life insurance guarantees a fixed rate of cash value growth, a fixed death benefit, and a fixed rate. By reducing policy guarantees, life insurance companies can reduce the cost of the Universal Life insurance product.
Many Universal Life Insurance policies today offer a no-lapse guarantee: as long as you pay the minimum designated premium, the policy will stay in force to age 100 or even to age 120. However, paying the minimum guaranteed premium is rarely sufficient to build up significant cash values.
Universal Life insurance is quite different from the more traditional Whole Life insurance policies. Whole Life is structured with rigid rules under which a policy owner must pay billed premiums no later than the end of the grace period or risk policy lapse. However, a Universal Life insurance policy owner can pay:
- billed premiums
- more than the billed premium
- less than the billed premiums
- no premium at all
Additionally, the policy owner may pay a premium at some time other than when billed. Universal Life insurance provides the policyowner with a great sense of freedom concerning how much premium to pay and when to pay it.
Universal Life insurance represents a significant change from the traditional fixed premium whole life insurance products that preceded it. Earlier life insurance products were characterized by inflexibility in premiums, cash value, and death benefit. If the policyowner wants to reduce the premium for a whole life insurance policy, it is necessary to reduce the face value of the policy through a partial surrender of the policy. Unfortunately, this can result in the release of cash value to the policyowner and possible income tax liability. Universal Life insurance policies unlock the connection between premiums, face amount and cash value.
Despite the premium flexibility offered by Universal Life insurance, there are certain rules that do apply to premium payments. Although a policyowner may choose to pay no premium into the policy on a particular premium-due date, any payments that are made must meet a certain minimum to help the carrier to manage the costs of premium collection and processing.
There are three premiums types typically associated with Universal Life insurance policies:
- Minimum premiums
- Target premiums
- Maximum premiums
Minimum Premium: The amount of premium that, if paid each year, would generally be just enough to keep the policy in force for one more year without the accumulation of any cash value.
Target Premium: This is generally the amount of premium that will keep the policy in force for the insured’s lifetime. There is, however, no guarantee that the Universal Life insurance policy will remain in force for that period if only the target premium is paid. In fact, there is no guarantee that the Universal Life insurance policy will remain in force regardless of the premium level that is maintained by the policy owner.
Maximum Premium: This is the largest permitted premium that will enable the Universal Life insurance policy to maintain its character as life insurance. If you pay additional premiums, then the policy will be considered a “Modified Endowment Contract” or MEC. Modified Endowment Contracts lose much of the tax advantages of life insurance.
No Lapse Guaranteed Universal Life insurance Policies have a defined premium level at which the carrier guarantees that the policy will remain in force even if the cash value should dip below zero and the policy would otherwise lapse.
Death Benefit Options:
Universal Life insurance typically allows you to choose from two death benefit options. Option A pays the death benefit out of the policy’s cash value. Option A is generally more affordable since there is less risk to the insurance company simply because the more cash value accumulated in the policy reduces the overall benefit amounts paid out by the insurance company. Option B pays the face amount stated in the contract, plus any cash values you accumulated over the years. Option B is generally a more expensive option since the insurance company will likely pay out more upon death of the insured.
Universal Life gives you the flexibility to adjust the death benefit as your needs change, as well as the flexibility to pay smaller or larger premiums – depending on your financial circumstances. This is often an important feature for those who may have fluctuations in their ability to pay.
If your premium payments are too small for too long, the policy could lapse, leaving you without insurance protection. Also, if the insurance company does poorly with its investments, the interest return on the cash portion of the policy will decrease (but never below the minimum interest rate guaranteed in the contract). In this case, cash values will probably fall, forcing you to pay more premiums in the later years. Additionally, as the insured ages the cost of insurance can increase dramatically. If there is no increase in premium to adjust for the increase in insurance costs, then the cash value will be used to cover the difference. Once the cash value account is depleted, often the insured is left with large minimum premium amount to keep the policy in effect. If the minimum premium is not paid, the policy will risk lapsing and terminating.