Universal Life Insurance: Friend or Foe? You Decide.
Universal Life (UL), Variable UL (VUL), Indexed UL (IUL), Equity Indexed UL (EIUL)
First, key points:
- UL, VUL, IUL, EIUL are all risk-inherent and not suitable as a retirement supplement or LTC vehicle if an assurance of financial well-being is important to you.
- Universal Life Insurance (UL) was created in 1978.
- UL was created to take advantage of the tax code, a growing stock market, high interest rates. That environment has changed dramatically since 2000.
- UL, VUL, IUL, EIUL all put the risk of “success” or failure, or cash growth, on the policy owner.
- The “chassis” for all UL’s is based on one-year term policies, and carries an ever-increasing internal cost.
- If the cash growth is not sufficient to cover (or mask) the increasing (underlying) cost, without additional cash infusion, the policy can lapse.
- Projections of cash growth use “straight-line projections” resulting in off-base predictions. Marketing, using these straight-line projections, ignores impact of “arithmetic averages”, volatility, and sequence of returns.
- If, in later years, there is no cash value (a common situation), a missed or forgotten premium will lapse a policy, guarantees notwithstanding.
- UL, VUL, IUL, EIUL are all risk-inherent and not suitable as a retirement supplement or LTC vehicle if an assurance of financial well-being is important to you. (Yes, I’m repeating…)
Over the years, I have met with several people who owned Universal Life (UL) policies; they had been notified by their insurance company that additional premiums were required in order to maintain the policy; the alternative would be a policy “lapse”.
A sampling of real experiences:
In 1986, a young woman bought a UL policy with a $95,000 death benefit. She paid her “target” premium, monthly, for 25 years. In July, 2011, she received a letter from the insurance carrier requesting a check for $83,412, the sum necessary to prevent her policy from lapsing.
In 2014, a retiree (aged 82) received a letter from his insurance company requesting a check (mid-year) for $6,000, an amount above and beyond the $6,000 he paid annually since the policy’s issuance in 1992. When the company was queried as to the amount that would be necessary to ensure the policy’s continuance to age 100, the response was $22,100 per year going forward.
Here’s a hypothetical: an 87 year old man has a universal life policy. There is no longer any cash in the policy, as it has not performed up to expectations. He is now alone in the world; no immediate living relatives. He forgets to pay the premium. POOF! The policy evaporates/lapses! (If there was cash, it might have covered the missed premium).
Now, no life insurance. No one around him knows he had a policy. Is this possible? Yes. Has it happened? Bank on it. Current industry marketing encourages attaching Long-Term Care riders to these universal policies. In this example, both would disappear.
Yes, insurance companies will provide a grace period to re-establish the policy…but someone has to go to bat for the client. Remember, he “forgot”, and he’s alone.
Back in the first half of the 20th Century, life insurance (in a form similar to today’s Whole Life…not universal life) was used as a savings and investment vehicle, as well as a risk management tool. If you, the insured, died, your beneficiary would, of course, receive the proceeds of the death benefit. If you lived, you could use the (cash) value of the policy to provide for your retirement expenses.
That use of “living benefits” continues today and has been going on for well over 100 years.
To be clear, UL and Whole Life Insurance are two very different structures of insurance. Unlike Whole Life, Universal Life shifts the risk from the insurer to the insured.
So, what is UL, and where did UL come from?
It was in the late 1970’s when Jack Barger (at EF Hutton, a Wall Street firm) created universal life. The concept? To take advantage of the tax laws regarding life insurance. The law said that any cash value (CV) increasing inside a policy, did so tax-deferred. Well, those were the days when the stock markets were strengthening after “May Day” (May 1, 1975); the SEC had mandated the deregulation of brokerage commissions.
Another factor in the rise of the stock market was The Revenue Act of 1978; this created the opportunity for 401(k)’s, which went into action in 1980.
Universal life policies were designed to take advantage of the tax code, a growing and strengthening stock market, and reasonably high interest rates. With UL, the insurance company was able to invest a part of premiums paid and provide a “crediting rate” (interest on the policy’s cash value) as an inducement to purchase policies. This structure was the original and is still sold.
In (or about) 1986, variable universal policies (VUL) were getting started. Here, the part of premium that was to be applied to growth was positioned to invest in “sub-accounts” (similar to mutual funds) and thereby directly tied to the markets. Your success (or failure) was market related.
It was around 2000 when indexed universal life (IUL or EIUL) reared its ugly head. These were structured to benefit from (what seemed to be) the ever-climbing stock indexes.
The period 1980 – 2000, “The Roaring Twenty”, saw the stock markets grow like never before in our financial history. The UL’s were designed for that environment. That dynamic growth has all but disappeared.
Unfortunately, in 2000, the “Tech Bubble” burst. The stock markets went down in 2000 and 2001. Subsequent years have seen enormous volatility in the stock markets. The performance of the policies largely suffered as a result. Volatility continues to be a real concern.
Is there an additional key point here? Yes…underlying cost.
Universal life is sold with the idea that the policy’s cash value will grow with the markets, and the CV growth will be tax-deferred. And flexible premiums! Who wouldn’t like that?
Here’s the problem: Back in 1978, Jack created these with a “chassis” consisting of annually-renewable term insurance.
Consider that a premium payment covers two requirements: 1) cost of insurance (death benefit) and 2) cash infusion for growth.
In order to cover the company’s risk and cost of death claim, with UL, the company builds-in a string of one-year term policies; this is what the first portion of the premium covers.
We know that term insurance gets more expensive as we age. The chassis for universal life has an ever-increasing-cost chassis. And? Well, as the insured ages, a growing portion of that premium is required to cover that growing cost of insurance, and less of that premium will go toward CV growth.
So, if the cash growth is not sufficient (long-term) to cover or mask the increasing (underlying) cost, the insurance carrier can (and, in today’s volatile marketplace often does) call for additional premiums to maintain the policy, or the policy can “evaporate”!
Jack’s structure was acceptable during the “The Roaring Twenty”, when the policies grew with the markets. Since 2000, not so much.
So, why does an “illustration” of these policies look so attractive?
Today, (variable and indexed) universal life policies are marketed as very attractive due to the potential for stock market participation, in the form of cash value (CV). But, that is only the revenue (or cash-growth) side:
Again, if the cash value (CV) does not grow sufficiently to overwhelm the increasing cost of the policy, the policy can lapse or require increasing premium payments to insure continuity of the policy.
But the numbers look good! Why?
The marketing of these policies is typically done using “straight-line projections”, without explanation of “Arithmetic Averages”, volatility, and sequence of returns. The results? Projections can be (and usually are) wildly off-base.
A full explanation can be viewed following the link below, but, in summary, the actual “ups and downs” of the stock market will change results from projections; “straight-line projections” ignores those changes.
The phrase “real returns” is extremely important, but generally ignored. Any time there is performance related to a securities market, “real returns” are essential to determining reality of projections and results.
Remember, VUL and IUL policies’ cash-growth performance is related to the stock markets; this carries and relies on inherent volatility.
One more point: the concept of “loans” from the policy before or in retirement can also jeopardize the longevity of these UL policies as the policies are likely already (and increasingly) cash-thin.
The marketing of these policies often neglects a full explanation of the underlying cost of insurance (remember the annually-renewable term chassis?). It might also neglect the fact that due to the frequent lack of real cash accumulation, if you miss a premium, you could lose the policy, “guaranteed” death benefit notwithstanding.
Clearly this is a complicated topic. That does not, however, excuse the consumer from doing his/her homework. The potential negative results can be devastating to a family’s financial well-being. UL owners are strongly urged to get an “in-force illustration” from their insurance company to determine the level of performance to date, and to see how long their policy is likely to last. Oh, and this should be done annually.