6 Disadvantages of Universal Life Insurance

Understanding the disadvantages of universal life (UL) insurance helps consumers make the most educated decision. Here are the 6 major disadvantages that should be considered when considering universal life:

  1. The flexibility associated with premium payments can be a disadvantage because policyowners can too easily allow their policies to lapse. There is no forced savings feature, because UL policies do not require premium payments as long as the cash value is sufficient to carry the policy. To reduce the likelihood of lapse, most companies have a voluntary provision where the policyowner agrees to let the insurer bill for a target premium set by the policyowner. (As is discussed in the section titled “Guaranteed No-Lapse Universal Life,” the insurance market has evolved and many insurers now offer UL policies with provisions and guarantees which are designed to ensure that cash values do not fall below levels necessary to keep the policies in force (i.e., do not lapse as long as the requirements to maintain the guarantee are satisfied).
  2. Although traditional participating whole life policies are indirectly interest sensitive, insurers guarantee the mortality and expense charges. In contrast, current assumption policies, including UL, only guarantee that mortality charges and expense rates will not exceed certain maximums. Consequently, policyowners bear more of the risk of adverse trends in mortality or expenses than if they owned traditional whole life policies. The converse is also true. If the trend of mortality costs and expenses improves, UL policyowners may participate in the improvement through lower charges.
  3. Although most new UL policies do not use a two-tiered interest crediting approach, some new (and most older) policies do. The two-tiered method credits interest on the first $1,000 or so of cash value at the minimum rate guaranteed in the contract. The insurer credits cash value amounts in excess of $1,000 with the current rate. Consequently, on policies that credit interest in this manner policyowners do not earn the current rate on the entire cash value.
  4. Some UL policies, similar to many traditional whole life policies, use what is called the direct recognition method to determine the amounts the insurer will credit to cash values that are subject to policy loans. Under this method, insurers credit the current rate to only that portion of the cash value that is not used to secure a loan. Insurers credit amounts backing loans with the minimum guaranteed rate or a rate usually 1 to 2 percentage points lower than the loan rate. Insurers most commonly use the direct recognition method in policies that have fixed loan rates. Typically, policies with variable loan rates, and some others with fixed loan rates, do not employ the direct recognition method and instead credit current rates on the entire cash value without regard to loans.
  5. Surrender of the policy within the first five to ten years may result in considerable loss because surrender values reflect the insurance company’s recovery of sales commissions and initial policy expenses. In addition, most UL policies now assess surrender charges rather than up-front fees or loads. These surrender charges generally decline each year the owner holds the policy. Typically, after about seven to fifteen years insurers assess no explicit charges if the owner surrenders the policy.
  6. The flexibility with respect to premium payments and death benefits permits policyowners to change the policy in such a way that it inadvertently may become a modified endowment contract (MEC) with adverse tax consequences.
Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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