Understanding the advantages of universal life insurance helps consumers make the most educated decision. Here are the 12 major advantages that should be considered when considering universal life:
- The policyowner has wide discretion or flexibility in selecting the premiums that they pay. Provided that the policy has enough cash value to cover mortality charges, the policyowner may even skip premium payments. In contrast with other types of policies, skipping premiums does not result in the creation of policy loans.
- The policyowner may change the level of death benefits. Insurers permit policyowners to decrease death benefit at virtually any time. However, the tax rules may subject policyowners who reduce death benefits within the first seven years of issue to adverse tax consequences under the Modified Endowment Contract (MEC) rules. Insurers generally permit policyowners to increase the face amount, subject to evidence of insurability. Increases in the death benefit also may subject the policy to a new test period under the MEC rules.
- The policy is transparent. That is, policy illustrations and annual reports break out and report each of the policy elements separately. This unbundling of the policy allows the policyowner to specifically identify and track premiums, death benefits, interest credits, mortality charges, expenses, and cash values and to check projections against actual performance over time.
- Most UL policies offer two death benefit patterns, called option A and option B, or option I and option II and many, if not most, now offer an option C, or option III.
Option A – This option, which is similar to a traditional whole life policy, offers a fixed (level) death benefit. As cash values grow larger, the net amount at risk (or pure insurance) is reduced to keep the total death benefit constant (unless the cash value grows to an amount where the death benefit must be increased to avoid classification as a modified endowment contract).
Option B – This option operates in a manner similar to the death benefit one would receive from a traditional whole life policy with a term insurance rider that is equal to the current cash value. Under option B, the death benefit at any time is equal to a specified level of pure insurance, plus the policy’s cash value at the time of death. Therefore, the death benefit increases as the cash value grows.
Option C – This option provides a Return Of Premium (ROP) feature that increases the death benefit by the cumulative premiums. Some ROP options also provide for an interest factor that will increase the cumulative premiums by a specified interest rate. This option has become more popular as a result of premium financing and the need to maintain a level death benefit for the insured net of the amount that is owed back to a lender.
- Many companies permit policyowners to attach a cost-of-living rider to UL policies that, without evidence of insurability, automatically increases the policy death benefit each year by the increase in the Consumer Price Index (CPI).
- In contrast with most traditional whole life policies, many UL policies use back-end loads, rather than front-end loads. (A load is the charge imposed by an insurer to recover the initial policy expenses. The terms front-end and back-end refer to when the charge is imposed.) Consequently, most or all of the policyowner’s initial premiums go into cash values—subject of course to regular annual expense and mortality charges. Therefore, cash values build more quickly than with traditional whole life policies.
- UL, as a current assumption policy, allows policyowners to directly participate in the favorable investment, mortality, and expense experience of the company. Although a traditional participating whole life insurance policy is essentially a type of interest sensitive current assumption policy—as reflected in dividend payments—the connection is indirect and difficult to measure. The annual UL policy statements explicitly show the amount of credited interest and expense and mortality charges for the year.
- Cash value interest or earnings may accumulate tax-free or tax-deferred, depending on whether gains are distributed at death or during lifetime.
- UL policies have historically paid a higher effective rate of interest on cash values than have tax-free municipal bonds. Rates credited to UL policies have more closely tracked rates paid on high-grade corporate and government bonds and mortgages.
- Although the interest credited to cash values will vary with market rates, the cash values are not subject to the fluctuations in market value characteristic of longer-term municipal bonds and other longer-term fixed income investments when market rates change.
- Policyowners can borrow policy cash values at a low net cost. Although insurers charge interest on policy loans, cash values continue to grow as insurers continue to credit these cash values with at least the minimum guaranteed rate in the policy. Consequently, the actual net borrowing rate is less than the stated policy loan rate.
- In most UL policies, policyowners may withdraw a portion of their cash value without surrendering the policy. However, if policyowners withdraw money, the insurer typically reduces the pure life insurance portion of the death benefit by the amount of the withdrawal. In addition, policyowners may be subject to income tax on part of all of the amounts withdrawn.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM