When to Use Universal Life Insurance as an Alternative to Adjustable Life Insurance

Universal life is the principal alternative to adjustable life (AL). When the insurance industry introduced AL, the industry promoted it as the perfect policy for virtually everyone. It could be adjusted to meet anyone’s changing insurance needs throughout life. However, with the introduction of universal life, the popularity of adjustable life has waned for several reasons:

1. AL provides somewhat less flexibility to adjust premiums and death benefits than UL policies. Generally, UL policyowners may vary their premiums at will or skip premium payments altogether if the policy has sufficient cash values to cover mortality and expense charges. In contrast, unless an AL policyowner officially requests a change in the premium payment plan, skipping premium payments will either cause the policy to lapse or trigger policy loans under the automatic premium loan provision. In addition to the inconvenience of having to make requests in advance regarding a change in the premium payment plan or face amount or duration of coverage, the insurance company may limit or restrict such requests to specific dates or intervals.
2. AL policy elements are bundled whereas UL policy elements are unbundled. The annual statements for UL policies report mortality and expense charges and interest credits to cash values separately. This allows policyowners to easily monitor actual versus projected performance. The insurance company also issues new cash value schedules and schedules of projected dividends for AL policies when the policyowner requests a change in the plan of insurance, but there is no regular and separate accounting for mortality and expense charges and interest credits. (Note, however, that some AL policies are unbundled.) Although higher than projected dividend payments or lower current mortality and interest charges may reflect favorable company experience, most companies do not regularly report how dividends actually paid compare with those projected. This makes it more difficult for policyowners to monitor actual versus projected performance as compared to unbundled UL policies.
3. AL has more restrictive withdrawal rules than UL. In general, insurance companies permit withdrawals from AL policies only when accompanied by reductions in the face amount of coverage. Many UL policies permit withdrawals of up to 10 percent of the cash value, and sometimes more, without reductions in the face amount of coverage.
4. UL offers two death benefit options: option I – level total death benefit, and option II – level insurance benefit plus cash value) whereas AL offers only the traditional level total death benefit. Note, however, that a policyowner can reconfigure an AL to resemble the UL option II program with the purchase of a term rider or by using dividends to purchase paid-up additions. With over a dozen dividend options, this type of AL policy can return benefits to a client by reducing premiums, strengthening the plan of insurance or growing cash value.

Despite these relative disadvantages, some people may prefer AL to UL for several reasons:

1. AL offers more certainty regarding cash value accumulations than UL. Like ordinary level premium whole life policies, the insurance company guarantees an AL policy’s cash value schedule for as long as the policyowner maintains the selected plan of insurance. When a policyowner arranges a new premium payment plan or a new face amount, the insurer produces a new guaranteed cash value schedule. In contrast, illustrations of UL policy cash values are just that—projected nonguaranteed illustrations.
2. AL dividends give the policyowner more options as to how to use or apply the favorable investment experience of the company than UL policies. UL policies reflect favorable investment performance directly in the amounts credited to cash values. In virtually all AL policies, the level of dividends the insurer pays reflects the insurer’s favorable investment performance. The policyowner may use these dividends in several ways. Policyowners can have the insurer pay the dividends in cash, use them to reduce premiums, accumulate them at interest, use them to purchase additional term insurance (with a rider), or add them to policy cash values.
3. The requirement to pay scheduled premiums under the selected plan of insurance with AL provides a forced saving feature that is absent with UL. AL policyowners have a strong incentive to continue scheduled premiums because failure to do so will often have adverse consequences. If an AL policyowner fails to pay scheduled premiums under the selected plan of insurance without requesting a change in the plan, the policy may lapse and be put on either the extended term or the paid-up nonforfeiture option, depending on the default option under the contract. AL policies typically have very liberal reinstatement provisions, but they do normally require evidence of insurability. Policyowners can avoid lapses with the automatic premium loan provision, but then each failure to pay premiums will incur a loan against the policy.

Preprogrammed Combinations of Differing Life Insurance Policies

To the extent a person can anticipate future life insurance needs and premium paying ability, a program combining various cash value and term insurance products may meet an insured’s needs. However, most people cannot anticipate all the ways their insurance needs may change over time. Therefore, they must rely on the possibility of buying new insurance and their rights to lapse, change, or surrender old policies, to keep their programs up-to-date. The Code section 1035 exchange provisions provide some flexibility to change the plan of insurance. Also, some companies include change provisions that permit limited changes to the face amount of coverage. To some extent policyowners can assure the right to buy additional insurance with guaranteed purchase options, but the amounts guaranteed may turn out to be insufficient. Policy loan provisions, the dividend options on participating policies, and the renewable and convertible features of term insurance all give policyowners some flexibility in their overall plan of insurance. Although these features and provisions are useful for limited adjustments in the plan of insurance, insureds may find it difficult to arrange major changes within these somewhat constrained options.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM