As you may know, there are two general types of life insurance plans and they are as follows:
- Permanent Life Insurance, and
- Term Life Insurance
Universal Life Insurance or UL is a form of permanent life insurance which by the way is widely misunderstood.
Widely misunderstood because Universal life insurance can also act as a term life insurance when it’s not properly funded.
A Universal life insurance policy is an insurance policy with an investment component.
This means that your premiums or life insurance contributions are invested first into market portfolios, GICs or simply the money market before your cost of insurance and other expenses are deducted.
The remaining amount then will form part of your account and/or cash surrender values.
In lay man’s term, the easiest way to understand a Universal life insurance policy is that it is:
- A cash value insurance policy, and a
- Life insurance with an investment component.
For easier understanding, most advisors explain Universal life insurance as a life insurance policy
But what really happens is that when your premium goes into the account, it is first invested before your insurance costs are deducted then whatever is left is deposited into your investment bucket.
Keep in mind, however, that a Universal life insurance policy should NEVER be bought or sold as an investment product or an investment contract as it is, first and foremost a Life insurance policy and NOT an investment account.
If an agent or a financial security advisor claims that it is an investment and NOT an insurance policy, run fast toward the opposite direction as he or she may not be working toward your interest as a client.
If you are to strip off the technicalities, Universal life insurance is simply life insurance with flexible premiums and asset growth potential.
The basic premiums can be as low as a term life insurance but keep in mind that if you’re only contributing the minimum premiums, your policy may not last you a lifetime and may lapse at some point in time.
For Universal life insurance to stay enforced as a permanent life insurance policy, over-funding is the key. Meaning, it has to have enough account values inside the policy to make it last a lifetime.
Think of the “buy term and invest the difference concept”; you’re technically buying term and investing the difference from within the Universal life insurance policy.
If you’re investing the difference from within the insurance policy; you have the option to keep the money inside the policy if you
Universal Life Insurance – Costing
There are costs associated with any life insurance policies and Universal life insurance isn’t an exception.
When acquiring a Universal life insurance policy, you have the option of going with the “yearly renewable term” cost of insurance (COI) or the “level” cost of insurance.
Yearly Renewable Term COI
The yearly renewable term is a cost of insurance option where the insurance costs start at it’s lowest or the bare minimum but increase over time.
The level cost of insurance, on the other hand, calculates your lifetime cost of insurance and levels it throughout your payment period.
In effect, your cost of insurance remains “level” and does not increase over-time; hence, the term “level cost” or “level COI”.
YRT vs Level
There are a lot of different schools of thought when it comes to life insurance planning. You have the buy term, invest the difference, you have the UL YRT only, you have UL Level only and of course, you have the whole life all the way to avoid any forms of risks.
So within the realm of Universal life insurance alone, there are a group of advisors who prefers one over the other; there are those who only recommend Universal life with level cost of insurance for fear of policy lapses and there are those who only recommends Universal life YRT due to low initial cost of insurance thereby giving the client(s) the opportunity for higher cash values
As for myself, I’m not a proponent of any single-type of insurance policy as it will all depend on client preference. What I usually do is discuss and illustrate these different scenarios and let you decide whichever type of insurance or insurance costing you’re most comfortable with.
What I suggest to my clients is that they should have permanent coverage to cover their permanent financial obligations and a term life coverage to cover their temporary obligations.
This can be done in one life insurance policy.
For a lot of people, their most permanent financial needs are their final expenses which oftentimes come in the form of:
- Funeral Costs, and
- Final Taxes.
Their permanent life insurance policy can come in the form of whole life insurance or universal life insurance and their term life insurance policy vary in length of coverage depending on their current age and how long their temporary financial needs like income protection are.
Universal Life Insurance – Flexibility
One of the key factors of a Universal life insurance policy is premium flexibility as it allows a person to afford an otherwise more expensive life insurance coverage when purchased through a whole life policy.
This flexibility, however, is where the misconception lies…
A lot of Universal life insurance policies are sold and purchased at minimum or near-minimum funding which of course, isn’t a bad thing but calling it a permanent policy gives the policyholders the wrong expectations.
You see, when you purchase a Universal life insurance policy and you’re only contributing the minimum premium doesn’t necessarily buy you a lifetime coverage.
It gets you in but if you’re only paying the minimum premiums, you can’t expect that the policy will cover you for the rest of your life that’s why you have to make it a point that your Universal life insurance policy is well-funded.
You can actually pay off Universal life insurance as soon or as long as you want!
Meaning, if you want to pay a lump sum for lifetime coverage, you may… or you can pay it off in 20, 30 years or up to age 65… or you can have it designed as a life-pay policy where you keep on contributing premiums as long as you live.
This is how flexible Universal life insurance is.
The worse scenario is when you don’t pay enough premiums into your policy; making the minimum premiums doesn’t mean that you have permanent life insurance in your hands, at least one that will last you a lifetime.
Understanding A Universal Life Insurance Illustration
Some insurance agents believe that a Universal life insurance policy is only a life policy for the wealthy but that entirely depends on policy design.
As mentioned earlier, a Universal life insurance policy is a flexible type of permanent insurance, not just in terms of insurance costing but with coverage as well.
In essence, a Universal life insurance policy can be both permanent insurance or a term policy depending on funding.
Universal life insurance coverage can be topped-off with a term life insurance as a rider to effectively manage costs and the assumed rates of return to compute the monthly premiums should be as conservative and realistic as possible.
When considering a Universal life insurance policy, always ask to see the actual illustration for your specific policy and make it a point that your illustration doesn’t indicate a lapse scenario even when it’s computed at a 3% rate of return.
Of course, you can ask for a more favorable rate(s) of return of between 5% and 6% which are realistic expectations but always make sure that your policy illustration still works even at a low rate of return scenarios like 3% and 4%.
What to Avoid in a Universal Life Insurance Illustrations
If you encounter someone illustrating a Universal life insurance projection at rates of between 8% and 12%, you should avoid this at all costs because even though the cash surrender values look promising at these presumed scenarios, this is not necessarily good for you as a policy owner.
Not only does these type of illustrations give you the wrong expectation(s), these actually jeopardize your policy.
While it’s good to have a positive outlook in life, over-estimating future rates of return is a formula for disaster because if your policy fails to achieve such rates of returns, your policy lapses.
Conservative projection and making sure that your Universal life insurance is well-funded is the key to making a Universal life insurance policy work. If it performs better than the conservative assumptions, then that’s a bonus.