Guide to Understanding Universal Life Insurance Policies

For many people, the world of insurance is something you have little incentive to understand in great depth—once you have your chosen policies in place, it’s easy to file them away and pay them little mind beyond paying your annual premiums.

Individuals with universal life insurance policies, however, should review their policies, assess how their investments are performing, and check their premiums.

Realizing you don’t fully understand how your policy works? Here is a quick primer on universal life insurance to get you started.

What is universal life insurance?

Most universal life insurance policies last for the policyholder’s life, or to an advanced age, providing a death benefit along with a tax-advantaged savings component that accrues value over time. It is a type of “permanent” life insurance policy that, according to The Wall Street Journal, has accounted for at least a quarter of all new individual life-insurance sales since the 1980s, and more than a third in the last decade.

How is it different from term insurance?

“Term” insurance is the most basic type of insurance. It covers a specific period of time—anywhere from 10 to 30 years—during which time, buyers pay a fixed premium in exchange for a payout if they die within the range of the policy. If the policyholder lives longer than that time range, he or she receives no benefit. This type of policy typically does not include a savings component.

Is it the same as whole life insurance?

No. Whole life is another form of permanent life insurance.  Like universal life, it combines a death benefit with a tax-advantaged savings component. In a whole-life policy, the insurer pays an annual dividend of a guaranteed minimum amount into the cash-value account—minus insurance costs and other expenses. The difference is that whole life insurance contracts have a fixed premium, which is calculated to steadily increase the cash value to meet the guaranteed death benefit by age 100 (or sometimes now 120).  Universal life contracts, on the other hand, have flexible premiums.

How does universal life insurance work?

Under a universal life contract, the buyer generally deposits money—in the form of a monthly, quarterly, or annual premium—into the policy, tax deferred. The insurer then takes a regular deduction for administrative fees and expenses, including the cost of the death benefit (called the “cost of insurance”), and the rest of the money remains in a cash-value account. That money is supposed to earn interest to help pay some, or all, of the future costs of the policy.

As long as there is a positive balance in the cash account, the policy stays in force. But the annual cost of the death benefit typically rises as the holder ages, to reflect higher chances of death. If the cash-value account isn’t earning enough interest to cover the rising cost of insurance, the insurer may increase the premium payment required by the policyholder to keep the policy in good standing.

What is the “cost of insurance”?

The cost of insurance is the actual premium—determined using current mortality rates—for insuring a policyholder at their present age.

What is the “monthly deduction rate”?

This is the amount an insurer takes from a policyholder’s account to cover the premium, the cost of the policy’s death benefit, and other expenses and fees.

What affects the potential growth of my savings component?

A universal life policy accrues value based on its ability to earn interest and cash in on investments (traditionally in stocks and bonds) made using the payments policyholders deposit into the policy. It loses value based on the amount the insurer deducts from the account to cover expenses and fees and the cost of insurance. As the cost of insurance rises, the cash value of the account decreases.

Why might some insurers be imposing dramatic premium increases?

Universal life policies were designed to take advantage of high interest rates in order to reduce premiums and provide built-in savings. But for many years, interest rates have been at historic lows, while the financial world has endured two stock market collapses, the housing bust, and economic downturns. This means the financial theory upon which universal life policies were created has not been playing out in reality. What’s happened instead is that insurers have been forced to meet guaranteed minimum interest rates provided when policies were written—rates that might be higher than the interest they are actually earning on the cash portions of the policies.

As the cost of insurance today continues to rise for aging policyholders, some universal life policies use the cash reserves to cover those premium increases, which can deplete savings until they are exhausted. The insurer then passes the remaining premium costs on to the policyholders, who must pay if they want to keep their death benefits in force. In many cases, the savings component of the policy no longer exists.

Still have questions about your policy or recent communication from your insurance provider? Consult a legal advisor to get to the bottom of your insurance concerns.

Vinas & Deluca is currently working with Rivero Mestre in regards to  cost of insurance increases against Principal Life Insurance Company. You can find a copy of the complaint here. If you or someone you love has a policy with Principal, and has seen their cost of insurance rates increase dramatically,please give us a call.

Read more about “Why Some Policyholders Are Suing Their Universal Life Insurers.”

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