Universal life is a relatively new type of policy, introduced in the 1970s. It has been referred to as an “unbundled” policy, as most of its components are relatively transparent. In the late 1990s, guaranteed universal life was introduced. In this essay, I refer to them as current assumption (CAUL) and guaranteed (GUL). While each has distinct characteristics, the same concepts apply to both unless otherwise noted.
After premium loads, expenses, and cost of insurance are deducted, the balance of each premium earns the current rate of interest.
This structure makes the universal life policy very flexible, because as long as there is sufficient funds in the policy account to pay the expenses and mortality charges, no premium payment is necessary. Additionally, within limits and subject to underwriting for increases, the face amount may be changed. Cash values can be accessed via policy loan or a direct withdrawal.
But similar to the whole life policy, the premium in the early years must exceed the expenses and COI if a level premium is desired. The cost of insurance increases annually, so the policy account must be built up in the early years so that in later years, the premium, interest and even some of the cash value can be used to paying the increasing cost of insurance.
Just as the policy cannot be funded too thinly without the risk of a lapse or increased premiums, it also cannot be funded too aggressively without running afoul of IRS rules regarding the definition of life insurance
Internal Revenue Code Section 7702
In return for a potentially more efficient policy, the insurance company transfers some risk to the policyholder. Unlike a whole life policy that cannot lapse if the entire specified premium is paid each year, a CAUL policy could lapse even if all scheduled premium payments are made. That cannot happen with a GUL policy, because paying the guaranteed premium each year prevents the policy from ever lapsing, even if there is no money in the policy account.
The risk the policyholder assumes with a GUL policy is that a rise in interest rates will have little impact on their account value.
As stated in the
article, whole life is the most conservative policy with the strongest guarantees. Universal life, in my opinion, is most appropriate for older individuals, where a shortened life expectancy makes it unlikely that the increased whole life premiums can ever be re-couped. But often times it just comes down to personal preferences.
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