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Universal Life

Universal Life Insurance is the Best Life Insurance?

is a complex product — it always has been, from the time it was first created in the 1970s as a way for insurance companies to attract money away from bank deposits in a time of extreme inflation in America. With the potential to pay higher rates of “current interest” than traditional cash value (“Whole Life”) insurance policies, UL policies “unbundle” the cost components and display them once a year on the policy-owner’s annual statement.  But this does nothing for most policy-owners other than confuse them.

UL . . . IUL/EIUL . . . GUL . . . SGUL . . . VUL — it’s more than alphabet soup!

Universal life, indexed/equity indexed universal life, guaranteed universal life, secondary guarantee universal life, variable universal life.  They are all the same, yet each is different from the other, and policies with similar sounding names from different insurance companies are not the same at all.  But the are all the same.  Like human beings, they have essentially the same “DNA”, but the assembly of the “genes” is different in each policy.

Universal life insurance has become even more complex today, with the plethora of no-lapse guarantees and riders that attempt to overcome the inherent and common design flaws in all UL products that can, and do, lead to their collapse long before the insured dies.  When this happens, the policy-owner is forced to pay considerably higher premiums or terminate the coverage and lose every penny paid in premiums, sometimes amounting to tens or hundreds of thousands of dollars.  This outcome is preventable, but not all policy-owners have the financial ability to do so.

Most folks can ill afford such costly mistakes.  Would you play a game if you did not know the rules?  And if you played a game without knowing the rules, wouldn’t you expect to make some mistakes that could cause you to lose the game?  Think of life insurance along those same lines.  Your policy contains all the rules — it’s a contract between you and the insurance company.  Agents frequently fail to understand some or most (or even all) of the most important “rules”, and they sometimes describe the policy as doing something it does not, or is not designed to do the way the agent explains it.  And one of the most important rules is that the insurance company or its policy may not be obligated to do what the agent says unless it also says so in the contract.

In my role as a licensed Life & Disability Insurance Analyst, I take a very close look at the language of the contract, the performance of the contract as revealed in the annual policy-owner statements, and do the math needed to show how the policy is actually performing now and how it may perform in the future.  The insurance companies do not make this obvious to their clients, and the vast majority of agents do not have the skills or abilities to perform such an analysis.  Indeed, there are less than 30 licensed Life & Disability Insurance Analysts in the entire State of California.

In the vast majority of cases, analysis reveals that the premium being paid for an individual policy is wholly insufficient to maintain the policy to its maturity — despite the fact that it’s the same premium the agent told the client he or she would pay at the time the policy was issued, and the client has paid that premium every month since they purchased the policy.  Many of  my clients say things to me such as, “So how can this be wrong?  It must be a mistake, right?”

Wrong!  It’s a failure to know and understand the “rules” of UL policies.

Older life insurance policies mature or “endow” at the insured’s age 100.  All policies issued in California since January 1, 2009 must now mature at age 120 or 121., although some of these policies will not require any additional premium payments after age 100.  A traditional type of cash value policy, called “Whole Life Insurance” (sometimes referred to as “Ordinary” insurance), is designed with a level premium that does not change from the day it is issued to the day it endows.  If all the premiums are paid on time, if no money has been borrowed from the cash accumulation, and if the insured has not died by the endowment age, the policy cash value will equal the face amount of insurance at the endowment date, and the contract terminates by paying the face amount to the policy-owner.  The fundamental rule in a whole life policy is rather simple:  “You pay, you die, we pay.”  Policies like this have been sold in America since the 1840s.

Even though Universal Life Insurance is referred to as whole life insurance, The Rules of Universal Life are very different than those of a traditional Whole Life policy.  There is nothing in the contract that promises there will be as little as $1 of cash value remaining in the policy at the endowment date — even after having paid tens or hundreds of thousands . . . or even millions . . . of dollars in total premiums over 20, 30, 50. 80 years or more..

ALL UL policies, including IUL, SGUL, and VUL, are designed with an annually increasing “Cost of Insurance” (“COI”,:or rate factor), based on the age of the insured, and their underwriting classification (Preferred, Standard, Substandard, Non-Tobacco or Tobacco User).  This is equivalent to a type of term life insurance called Annually Renewable Term, or “ART”.  The rate for life insurance is based on $1,000 “units”.  You multiply the number of units by the rate factor to determine what the premium is.  On top of the premium in a UL contract may be a sales charge, and various monthly administration or expense charges, plus the cost of any riders added to the contract.

Premiums paid . . . adds current interest . . . deducts expenses   . . . equals cash value

Premiums for UL policies, after any deductions for sales charges (or “loads”) have been taken, are deposited into the “Cash Accumulation Fund” of the policy.  And from that cash accumulation is taken all the other monthly expenses of the policy — administration fees, the cost of riders, and the monthly Cost of Insurance based on something called the Net Amount at Risk (“NAR”).  A “formula” in the contract — another one of the rules — describes how the monthly COI deduction is calculated.  It will look something like this:

The formula is

1. multiplied by the difference between 2. and 3., divided by $1,000, where

1. is the cost of insurance rate,

2. is the insured’s death benefit divided by 1.0020598, and

3. is the policy fund after deducting the expense amount and the rider charge.

Sound confusing?  It confuses your insurance agent, too. Care to do the math?  It’s nearly impossible because the insurance company will not tell you what the COI rate is.  Not even in the policy-owner’s annual statement.  From the statement, the COI rate can be “reverse engineered” to figure it out.

Nothing in the contract tells you what the actual COI factor will be in any year — you are only shown the most it could be at any age.  In almost all UL policies, the COI will easily increase by 100,000% or more from the first day of the policy to the last day a premium could be paid, when the policy endows at age 121 (or age 100, if stated in the contract).

Agents sometimes sell parents of a newborn child a UL policy on the life of the child . . . “There are so many diseases these days, you don’t know what could happen to your child.  By purchasing life insurance now, you guarantee your child’s future insurability, even if they develop a disease five or ten or twenty years from now.”

Have you been told this?  It’s not a lie, but it’s also intended to instill fear.  Those are the words sometime spoken by agents . . . and the maximum COI for a child age 3 to 10, might only be $0.02 per $1,000 of insurance per month (for a newborn or younger child it will be higher due to infant and toddler mortality statistics).  A $100,000 UL policy for a 2-year-old might only cost $10 – $12 dollars per month.  But at age 120, the last year of the policy, the COI could be as much as $83.33 per $1,000 of insurance per month, an increase of 416,550% compared to the first day’s COI of just $0.02 per $1,000.  And beyond age 15, $10 – $12 per month in premiums is highly unlikely to sustain a traditional UL policy beyond age 21.

However, agents rarely describe the cost of insurance in those terms to a prospective client.  |f you knew this information, how likely would you be to buy that kind of life insurance policy for your child?

Or for yourself?  At age 25, your COI might only be $0.06 per $1,000.  At age 120, the $83.33 maximum monthly cost is a mere 138,783% increase, a relative bargain compared to the child’s policy.

There is a mitigating factor in the application of this “rule”.  It is the cash accumulation.  Each dollar of cash accumulation reduces the Net Amount at Risk — the difference between the full death benefit (the “Specified Amount”) and the accumulated cash value that will be paid as part of the death benefit (reducing the amount of insurance company money that needs to be paid out — its Net Amount at Risk). Ideally, the NAR will decrease as rapidly as the cost of insurance is increasing due to age.  But this rarely happens on its own.

For any Universal Life Insurance policy to work best, there must be a very rapid and large cash accumulation in the earliest years of the policy. The design of every UL policy permits the policyowner to pay as little as $0 each month or nearly as much as he or she can afford to pay.

The Internal Revenue Code sets a limit on the amount of cash accumulation than is permissible in the first seven years of the policy, which limits the amount of premium that can be paid.  Still, even coming close to that number cannot guarantee that the policy will survive to age 121, but it’s a fair bet that the policy will endure for a very long time. 

Agents are very reluctant to discuss this because the amount of money maximum funding requires is considerably higher than most folks are willing to commit.  Instead, by using hypothetical accounting — a straight-line interest rate that never changes, and other “current costs” that remain the same in all future years as they are today, on Day 1 — the agent will present an “Illustration” of what the policy might  look like if all these factors worked exactly that way.  They will not.

In the nearly 40 years of Universal Life Insurance history . . . remember, the life insurance industry in American is about 170 years of age, so UL is still a “toddler” by comparison . . . those unchanging current factors have never remained constant like that — not once!

In the late 1970s, UL policies offered “current interest” in the range of 14% to 16% — far more than banks were offering at 10% to 13% on CDs (at least one insurance company offered more than 20%).  But as soon as the inflation rate in America dropped back into the single digits in the early 1980s, so too did the “current interest” rates of life insurance companies (today’s “current interest” rates in nearly all UL policies are at the minimum guaranteed rates of 1% to 4%).

If your policy were built in 1978 on a never-changing rate of 15%, but in 1988 was receiving only an 8% rate, it would mean having to pay almost twice as much in premiums to grow the cash accumulation on track.  But no insurance company will tell a policy-owner to do this;  the policy-owner is left to figure it out for himself.  In fact, many of those 1970s and 1980s policies were sold on the basis of “vanishing premiums” — an illustration that showed how the interest alone would pay the policy’s premiums. (These “vanishing premium” illustrations are now unlawful in almost all states, yet it continues to happen even in the 2010s!)

In the 1990s, many of the earliest UL policies began to collapse under the weight of increasing COI, decreased interest crediting, and disappearing cash accumulation value due to low or no premium payments, and the lawsuits began.  Over the next ten years, the life insurance industry paid billions of dollars in fines, penalties, and restitution to policy-owners.

And they began to create “guarantees” to try to make the policies work a little longer, and perhaps reduce the number of lawsuits.  But the guarantees are not perfect. The earliest of these simply state that paying a certain minimum premium every month will prevent the policy from lapsing — even when there is no remaining cash accumulation — during the first five, ten, or twenty years.  They still forced the policy-owner to pay premiums over an extended period of time, despite the fact that the policy only requires one premium payment — the first — all the others after that, essentially, are optional.  However, if a policy-owner does not have enough cash accumulation to cover all the monthly expenses in any month, the policy will fail.  So paying only one premium is unrealistic.

The cost to keep any UL policy in force when all the cash accumulation has been depleted is enormous.  And that’s why there are the “secondary guarantees” being offered today have some value.  Instead of only promising a limited period of protection against a lapse, these newer guarantees simply extend to the endowment date.  Pay your minimum premium every month, every year, and even if the cash value declined to $0 long ago — which would have ended the policy — the company pays the death benefit to a beneficiary.  But, this too requires the constant payment of premiums.  In many policies, missing just one premium could mean the loss of the policy — after having paid premiums for 40, 50, 60 years or longer.  That’s not a great guarantee.  But it is a guarantee.

The SGUL policies may be a very good choice for estate planning purposes — to leave a large amount of life insurance money, income tax-fee, to pay the 40% estate tax that some estates will be subject to beginning this year, 2013. With a plan to pay premiums without fail, minimum premiums can assure the estate will be protected for the intended beneficiaries instead of nearly half of its value being turned over to the IRS.  A policy like this will have little cash accumulation over its lifetime (none at all in later years), which is the reason premiums MUST BE PAID WITHOUT FAIL.

Before you make a decision to purchase a Universal Life Insurance policy of any kind, be sure you know the rules.  The rules of the insurance game are written by the insurance companies.  They have to operate within the rules established by the state,.  When you play the insurance game, you have to play by the rules.  Those who do not know the rules often fall victim to them.  Occasionally, we discover that the insurance company failed to play by its own rules or those of the state.  When that happens, we may be able to help you recover some or all of your losses.

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Mario Pinzon

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