Universal Life
Universal life is also a permanent type of life insurance policy. Universal policy is generally a combination of term and whole life into one policy. They are similar to whole life in that they have a permanent death benefit and cash value. They are different from whole life in that the premiums can be flexible and the policy can expire if not paid properly because of the term like component.
A universal life insurance option provides more flexibility than whole life insurance. Policyholders can adjust their premiums and death benefits. Universal insurance premiums consist of two components: a cost of insurance amount and a saving component, known as the cash value.
The cost of insurance (COI) is the minimum amount of a premium payment required to keep the policy active. It consists of several items rolled together into one payment. COI includes the charges for mortality, policy administration, and other directly associated expenses to keeping the policy in force. COI will vary by policy based on the policyholder’s age, insurability, and the insured risk amount.
Collected premiums in excess of the cost of universal life insurance accumulate within the cash value of the policy. Over time the cost of insurance will increase as the insured ages, because that portion of the policy premium is a annual renewal term. The goal is to get the accumulated cash value to cover the increases in the COI.
There are three main types of universal life insurance policies, guaranteed universal, index universal and variable universal. Universal life policies can you make wealthy when done properly but they can expire if done improperly.
Guaranteed universal life (GUL)
A guaranteed universal life policy is basically a term policy with guarantees. Depending on the company there are two guarantees that are offered with GULs.
- The policy is guaranteed for a lifetime
- The premium is guaranteed
One quality of GULs are they are more expensive than term policies. Another characteristic is they are less expensive that whole life insurance. GULs accumulate little to no cash value. Some GULs offer return of premium clauses, which means the policyholder can agree to terminate the policy and receive 50% to 100% of the premiums the have paid in after a specific period of time as said in the policy.
Index Universal Life (IUL)
Indexed universal life insurance allows policyholders to decide how to assign the cash value to either a fixed account or an equity-indexed account. IUL insurance policies offer a number of well-known indexes, such as the S&P 500 or the Nasdaq-100.
Indexed universal line insurance policies are more volatile than guaranteed universal life policies, but they are less risky than variable universal life insurance policies, because no money is actually invested in equity positions.
When a premium is paid, a portion pays the cost of insurance based on the life of the insured. Any fees are paid, and the rest is added to the cash value. The total amount of cash value is credited with interest based on increases in an equity index (but it is not directly invested in the stock market).
Some policies allow the policyholder to select multiple indexes. IULs usually offer a guaranteed minimum fixed interest rate and a choice of indexes. Policyholders can decide the percentage allocated to the fixed and indexed accounts.
The value of the selected index is recorded at the beginning of the month and compared with the value at the end of the month. If the index increases during the month, the interest is added to the cash value. The index gains are credited back to the policy either on a monthly or an annual basis.
Variable Universal Life (VUL)
Variable universal life is a type of permanent life insurance policy with a built-in savings component that allows for the investment of the cash value into the stock market. The premium is flexible. Variable universal life insurance policies typically have both a maximum cap and minimum floor on the investment return associated with the savings component.
Variable universal life insurance has investment subaccounts that allow for the investment of the cash value. The function of the subaccounts is similar to a mutual fund. Exposure to market fluctuations can generate significant returns, but may also result in substantial losses. This insurance gets its name from the varying results of investment in the ever-fluctuating market.
VUL insurance can offer increased flexibility and growth potential over a traditional cash value or a whole life insurance policy, but policyholders should carefully assess the risks before purchasing them.
The separate subaccount is structured like a family of mutual funds. Each has an array of stock and bond accounts, along with a money market option. Some policies restrict the number of transfers into and out of the funds. If a policyholder has exceeded the number of transfers in a year and the account in which funds are invested performs poorly, they may need to pay a higher premium to cover the cost of insurance.
The growth of the VUL insurance policy’s cash value is tax-deferred. Policyholders may access their cash value by taking a withdrawal or borrowing funds. However, if the cash value falls below a specific level, additional premium payments must be made to prevent the policy from lapsing.
