Universal Life: The Inconvenient Truth about the “Other” Permanent Insurance

“The insurance industry has a dirty little secret that threatens the retirement plans of millions of unsuspecting families.
“The problem is buried in the fine print of universal life policies…”
John E. Girouard, Forbes.com,
“Retirement Disaster Looms for Universal Life Policyholders”

No money in the bankIf you are familiar with Partners for Prosperity, Inc., you know that we advocate Whole Life Insurance with PUA (Paid-Up Addition) riders for some of our clients as a good place to store cash, as well as benefit from permanent life insurance. But what about Universal Life? Is that a good place to put your money? And if not, why not?

First of all, let’s look at the history of Universal Life Insurance to understand how it was designed to work, and why it may not work as designed.

Universal Life insurance (or UL) is a type of permanent life insurance that was designed to be more attractive to customers than traditional whole life insurance, with its stiff premiums and reliable-yet-conservative growth of cash value. Whole life had served our parents and grandparents well, but in the 1980’s, UL was widely marketed to be the next generation of permanent insurance, with options for greater affordability as well as gains.

UL was more “flexible” than whole life insurance, with variable options and premiums, flexible death benefits, and some types even replacing the steady growth of traditionally-managed cash value accounts with sexier, more aggressive options for the savings component. Variable Universal Life and Indexed Universal Life Policyholders could put their cash value savings in a money market fund, accounts with earnings that trailed various stock, bond, and financial indexes, or even a range of “investments.”

Attempting to be a hybrid between Wall Street’s promise of gains and the insurance world’s actuarial tables and slow but solid profits, UL has done neither well. But it succeeded in spades in the marketing department, giving consumers what they wanted. (At least, at first….)

Instead of guaranteed level premiums, many policyholders like the idea of being able to modify premiums, death benefits, and investment choices according to their needs or wishes. Need to skip or reduce your payment? No problem, the gains of the market will help to make up the difference. Want to take advantage of higher interest rates or market returns? Now you can!

Appealing on the surface, there were other seeming advantages. The cost of insurance (COI) started lower than in a whole life policy and increased over time, appearing more affordable, at least at the onset. (Essentially, the life insurance component of a Universal Life policy was renewable annual term, bringing the same advantages – and disadvantages – of renewable term insurance into the policy.) And those fees and costs that were essentially buried in the internal costs of a whole life policy? They were now displayed for anyone who wished to read the fine print (though not necessarily a bargain on either the insurance or “investment” side of things.)

Each month the cash value is credited with interest, and the policy is debited with the cost of insurance (COI) along with other policy charges and fees. If the premium paid to an UL policy is greater than the cost of insurance, then the extra is credited to the cash value.  If no premium payment is made that month, or a premium payment that is less than the actual expenses of the policy, then additional amounts are taken from the cash value.

Rather than annually declared dividends, interest rates are declared monthly by the insurer, and typically have a contractual minimum of 2%, less the deduction for policy costs and fees, which are not guaranteed. (If that sounds like a terrible deal, well, it is, but the shiny potential of higher returns – easily earned when interest rates soared in the 80’s) – made for attractive policy illustrations.)

Indexed Universal Life (also referred to as EIUL, short for Equity-Indexed Universal Life) and Variable Universal Life (VUL) took the promise of higher gains even further. “What if you could earn stock market gains with no downside risk?” was the buzz, but unfortunately for policyowners, it wasn’t the reality. The gains were significantly moderated, and in exchange for the no-loss protection, the policyowners found themselves shouldering the risks.

The Universal Life Time Bomb

Fueled by low interest rates, market losses, fine print that protects the companies over policyholders, and premiums that don’t cover actual costs, countless Universal Life policies are imploding or threatening to do so soon. UL policies remain popular, but many who purchased in the 80’s and 90’s are finding themselves in precarious positions. The end of 2012, a Wall Street Journal article lamented, “In the next few years, millions of savers are in for a surprise that could cost them tens of thousands of dollars now—or hundreds of thousands later.”

The reason? In a UL policy, no amount of cash value is guaranteed, and as the renewable term COI increases along with the policyowner’s age, the policies can drain the cash value and then require much larger premiums to remain in force. Sold on the premise that market gains would cover future rising insurance costs, policy owners are waking up to realize the insurance company covered those costs from the cash value they thought was their safety net. Even worse, the draining of their cash value now threatens their death benefit as well.

The WSJ.com article, “Draining Away,” continues, “If interest rates stay low, many policyholders will face the unhappy choice of kicking in more money, accepting a lower death benefit or walking away, possibly sacrificing years of premiums they already paid.” According to Kenneth Himmler of Integrated Asset Management, as much as 70% of the client policies he reviews are not generating sufficient interest to cover costs.

When interest rates change and performance falls short of projections, policies end up under-funded, even after the insurer thought the funding portion was over. In This is Not Your Parents’ Retirement, Patrick Astre shares a story of a grandfather, “Mr. W.,” who purchased a Universal Life policy with the intent of leaving the $135,000 death benefit as a final gift to children and grandchildren. The premiums were $4,065 per year, and he could afford it. And if he lived to a ripe old age (as he did), the projections showed the policy would remain in force, well-funded and making money.

However, on the 20th anniversary of the policy, Mr. W. received notification from the company (a major insurer) that “the next premium payment would be an astounding $14,078 to keep the policy in force for just one more year.” (Subsequent premiums would be that much and more.) With no guaranteed premiums, his UL policy had become a time-bomb with out-of-control costs. Over $80,000 had been put into the policy, and yet, now at age 83 and still in good health, Mr. W. realized he should never have been sold the policy.

In the following video, financial software developer and trainer Todd Langford of TruthConcepts.com explains the importance of guarantees in a permanent policy, including some key issues with Universal Life, such as the fact that policies do not endow and the key guarantees they lack:

YouTube Preview Image

Echoing an observation in the video, if indeed a UL policy is simply a renewable term life policy bundled with a savings or investment account, why do we classify it as “permanent insurance”?

Do you already have a Universal Life Policy? If so, we recommend that you keep yourself regularly apprised of where your policy stands so that you don’t have any unpleasant surprises when you are counting on the cash value or death benefit most. Make sure you review your policy at least every other year with your agent or advisor. Policyholders who are unsure of their current benefits should request an “in-force” illustrations from the company showing the state of the benefits at the current premium, and an illustration showing the cost to keep their current policy in force to age 100.

Depending on age and insurability, universal life policyholders may have some alternatives. Often reducing the death benefit can keep a policy in force at the current premium. And if the policy was purchased after 2008 when rates plummeted, there may be little problem. If you wish for additional insurance as a place to store cash as well as to provide additional death benefit, the policyholder may be able to qualify for purchase a whole life policy if they are still under age 85. (See our article, “Too Old for Life Insurance? The Surprising Truth about Seniors and Life Insurance.”)If the policyholder has a greater need for insurance than they can afford with their current UL or  a new whole life policy, the solution may be to combine permanent whole life with term insurance. When whole life premiums are not doable for the entire desired death benefit amount, adding term yourself is a much more efficient option than purchasing a bundled “permanent” UL policy with few guarantees.

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13 Responses to Universal Life: The Inconvenient Truth about the “Other” Permanent Insurance

  1. Pete Finney says:

    Kim,

    I am a relatively new agent starting this career just 4 years ago but at 60 young years of age I’m finding I have little patience for differing of opinions with regards to this issue. Although many of the IMO’s pushing only IUL’s seem sleazy and out for the commission, I have recently come across a couple who seem very credible, stating IUL’s as the best thing to come along in years. Do you at least say that there may be a place for them for clients whose income is not as consistent as it needs to be for a WL policy? Or is it yours & Todds position that we should stay completely away from them? Any thoughts will be greatly appreciated…pf

  2. Kate4Kim@P4P says:

    Great question, Pete. Inconsistent income is often a reason given to go the UL route, but if people understand the flexibility of whole life, that is not typically a problem. (Regular payments don’t stop people from buying homes or cars, but there is much less flexibility in those, as you can never leverage or withdraw payments already made.) See Live Your Life Insurance for ideas about how flexible WL can be. If the death benefit is important and premiums are an issue, then a small WL policy with term on top is a better solution than a larger UL policy.

    I HAVE used UL at rare times when qualifying was an issue. UL is a bit easier to qualify for because the company typically takes less risk, due to the structuring of the policy.

    However, I NEVER use (or recommend someone else to use) IUL (indexed universal life for other readers). One reason is my belief that insurance needs to be the “steady” piece of someone’s portfolio. When the market/economy is down, IUL substantially underperforms WL. The guarantees are limited and meaningless, and we have seen these policies become worthless even when premiums are paid. But that is just the tip of the iceberg… please read two very detailed articles about IUL that Todd and I put together for the Truth Concepts blog. It’s very detailed, written for advisors/agents who want to do the right thing, but don’t fully understand the risks and problems with UL/IUL:

    “The Top 10 Reasons Not to Buy Equity Indexed Universal Life”
    http://truthconcepts.com/blog/2012/04/17/the-top-10-reasons-not-to-buy-equity-indexed-universal-life/

    “The Whole Truth About Equity Indexed Universal Life”
    http://truthconcepts.com/blog/2013/01/10/the-whole-truth-about-equity-indexed-universal-life-part-ii/
    Kim

  3. Pete Finney says:

    Thanks so much Kate for this answer. I just now remembered to check on this and so glad I did. …pf

  4. Kate4Kim@P4P says:

    Oops, maybe I needed to email you, wasn’t sure if wordpress would notify you! KP

  5. Michael G says:

    It is absolutely true that whole life offers guarantees that no form of universal life offers. It’s also true that the guaranteed interest credited to whole life policies is about one third to one half the interest normally credited to indexed universal life policies, which are tied to the growth of a stock market index, but are not actually invested in that index.

    This article uses the sleazy tactic of lumping the securities product (variable universal life) with the insurance product (indexed universal life or IUL) and tries to paint them both with the same slimey brush. Indexed universal life is not affected by low interest rates because the crediting depends on the performance of the index chosen, and these types of policies have not been around for a full 20 years, so the example of “Mr. W” does not involve an IUL. However, the indexes available to IUL owners HAVE been around for a long time and it’s easy to compare how an IUL would have done if it had been available. We can calculate that the average crediting rate for an IUL with a cap of 14.5% over the last 30 years would have been 8.6%, and the rate HAS BEEN 9.1% over the last 10 years.

    This article is slanted and dishonest because it compares their own whole life product (which they are actively promoting) to a “worst-case scenario” of another product, but don’t disclose this fact, nor do they make a comparison until normal conditions. They say, “whole life has guaranteed performance, so we’re ONLY going to compare it to the minimum guarantees of other products, not the normal performance.” The only guarantee with an IUL is that if the indexed performance shows less than 3% growth over a period of time (say 8 years), less the maximized costs allowable, the carrier will increase the cash value to that level. Basically, they are comparing the guaranteed performance of SOME whole life policies (the ones they promote) to the minimum guranteed performance of indexed universal life instead of the normal performance, and using fear-mongering to make the reader believe there is impending doom (which there is not).

    Does it matter that they quote from articles in major publications that are just as inaccurate and dishonest? Not to me. Over the last 15 years, IUL’s have been wiping the floor with whole life policies and the only way this won’t continue is if the stock market collapses and there is no growth for many years, resulting in the collapse of the U.S. economy. Think the guarantees of whole life will mean much then?

    In the normal world (the one that you and I live in), whole life is a good, conservative tool. For those that can stomach a LITTLE more risk, an indexed universal life policy is a better option. There WILL be some years when the whole life policies outperform the IUL’s but, in MOST years, IUL’s will greatly outperform whole life, and this will make a HUGE difference in your retirement years.

  6. Kate4Kim@P4P says:

    Michael, thank-you for taking the time to leave an extended comment, even if you make some false assumptions in it.

    First of all, we do not have “our own whole life product,” nor or we trying to knock down what we don’t sell, as you imagine. We don’t recommend the types of policies that we sell, rather, we SELL the policies we RECOMMEND – the same kind we purchase for ourselves and our own family members.

    We can sell ANY type of life insurance policy we want, therefore, we wish to educate clients on WHY we choose to sell (mostly) whole life. In our work with many hundreds of clients (as well as other advisors) we have seen how various policies actually perform (often, policies purchased before working with us), and we continue to believe that whole life is a superior place to store cash. (Of course, we also recommend term insurance for many clients, and there are even occasions in which we have recommended UL for clients when they could not qualify for whole life.)

    You are correct that the cash value of IUL policies often out-performs the whole life dividend rate in years when the market climbs, though you seem to quoting gross rates of potential gains, not net after fees and cost of insurance (which is often structured to increase over time.) You are also correct that IUL policies will underperform whole life when the market tumbles. Therefore, if insurance savings are used as a hedge against the stock market, IUL is a poor choice. And there are additional issues, such as when the cash value is credited and available to the policyowner, how the policies are structured, what the guarantees are, etc.

    We admit that we did not take the time to separate out all of the many differences between UL, VUL, IUL, etc. in this article. You are correct that they are not synonymous, with notable differences. As you can tell, we have a “main message” which is, in our recommendation, NOT to tie your life insurance policy savings to the performance of various financial markets, nor to subject your life insurance savings to risks. If someone DOES wish to participate in potential gains of stock market and has a strategy for doing so relatively safely, we would not recommend a life insurance policy as the most efficient way to do that.

    Finally, we believe in saving first, then investing. And although we believe that whole life cash value is a VERY good place to store cash, we do NOT recommend that clients treat life insurance as an “investment” (see our recent post – Is Whole Life Insurance a Good Investment?) but to think of it as a “place to store cash” safely and securely.

    If you are looking for an investment for retirement and are okay with money being “locked up” for a period of time, there are other places where you can earn (typically) double-digit returns with little if any risk of principle. (And this is where a solid, conservative whole life policy gets really interesting… when it can be leveraged to expand a client’s asset base and help them earn much more than their policy returns alone.) But we don’t recommend that a client “invest” in anything before they have ample savings.

    As far as “impending doom” goes, anyone observing stock market cycles might conclude that now would be a bad time to purchase stocks, mutual funds, or any product linked to stock market performance.

  7. Michael G says:

    Thanks for the response and for not deleting my expression of a difference of opinion. I understand the basis of what you’re doing; emphasizing the security of the guarantees in whole life, knowing from the outset how much cash will be available at any point in time and knowing that the premiums will never change. These are great features.

    But they are not a valid excuse to confuse the features of an IUL in 2014 with the features of universal life that was written 20 or 30 years ago, which is what the WSJ and Forbes articles you reference are talking about. It is true that the original universal life policies, which were created specifically as vehicles for tax-advantaged cash growth, suffered from overly optimistic projections about interest rates and underperformed. It’s also true that variable universal life policies, in which the cash value is invested directly into securities, suffers from high costs, volatility, and risk of loss; although carriers of these policies have been making positive changes in recent years to combat the negative image of the product.

    But IUL’s in 2014 are incredible financial tools that combine the protection of term insurance with legitimate cash growth, access at any age or time without penalties or income taxes, with a floor that guarantees the owner cannot lose money due to market forces. The difference is that the amount of cash growth in any particular year is not going to be guaranteed because it will depend on the actions of the index to which the account is tied.

    But IUL’s are similar to whole life in that the growth credited to the cash value will come after the cost of insurance and any other fees. This math is built in to the whole life policy and will vary from year to year for the owner of an IUL. But here’s something you may not have considered – since the cost of insurance throughout the life of the policy does not change, owners of whole life policies are greatly overpaying for the insurance during the early years. This is based on the fact that the probability of dying is greater as one gets older, yet the cost of insurance in the whole life policy for a 60 year old is the same as when that policyholder was 30. So, the young policyholder is therefore subsidizing the older one. In an IUL, the cost of insurance actually goes DOWN starting in the mid-70’s because the growth of the cash value grows close to the amount of the death benefit, reducing the out of pocket exposure for the carrier. Take a look at any IUL Illustration and you’ll see what I mean. Since the reduction in costs is due to the lower exposure, you cannot say the older owner is being subsidized.

    Does all this mean that I ONLY recommend IUL’s for my clients? No, it doesn’t. But my clients that do buy IUL’s don’t worry about “impending doom” from the next stock market crash because they are protected. Crashes and corrections are going to happen. What’s important is not to be hurt by them and to be able to take advantage when things change and the market goes up. My clients earn 0 to 14.5% on the cash value in their accounts. Period.

    To summarize (because I’ve been long-winded again), I don’t blame anyone for railing against the universal life policies written in the 80’s or the variable UL written soon after. They were not good policies. But the complaints and problems with those policies do not apply to IUL’s in 2014. A properly-written IUL with the right carrier can do things that most financial tools, including whole life, cannot do.

  8. Kate4Kim@P4P says:

    Michael, thanks again for your comment. We did edit out one long paragraph because 1) It was sounding a bit too much like a solicitation, even if unintentional, and 2) We would NEVER try to predict what an infant will be earning at age 67 based on assumptions of past market performance!

    THIS is exactly one of our big problems with “typical financial planning” – it gives people a false sense of security. We don’t believe the stock market today is the same as it was decades ago, with high speed traders, “mark to market” accounting, CEOs earning multiple millions, etc. Our clients tend to be wary of putting all (or sometimes any) of their eggs in that basket, which is often a reason why they work with us. Our philosophy is Prosperity Economics, and whole life is an important piece of that as the safe-savings vehicle. Prosperity Economics works for us and our clients, and it is a true alternative to the long-term market speculation that is prevalent in financial planning today.

    We have found that certain types of policies don’t perform as illustrated over time, whether costs are not properly considered, costs of insurance rise, or whether indexes don’t perform as hoped. (We see the same issues with mutual fund illustrations, which is one reason I stopped selling securities and searched for what DID work.) And if you are illustrating decreasing costs of insurance in someone’s later years, there will be a trade-off somewhere else… perhaps the death benefit will not rise to allow for a policyholder to get their cash value plus their original death benefit for heirs.

    We agree that UL and IUL policies HAVE improved, but the “inconvenient truth” to which our article urgently refers is that some of the older policies ARE melting down. We sent this article to our entire client/ subscriber list because some HAVE this kind of policy, they need to be AWARE of potential problems and they need to be having in-force illustrations run and consulting with us or another advisor. In some cases, we see policies decreasing in value, even down to 0 (exactly as described in article), costs eating up cash value, and they have tough decisions to make. These are not scare tactics, this is critical client education.

    We prefer whole life for many reasons. We like that it tends to perform well when stocks don’t, especially as many people have existing 401(k)s, IRAs etc. and are already in the market. We like the stability/guarantees for IBC/ borrowing strategies as well as “opportunity” strategies, which can multiply the returns of whole life cash value alone. We even like how it encourages clients to save MORE rather than less, as all premiums add to cash value (in time), and we believe that saving as little as possible and chasing higher (non-guaranteed) returns is not a solid foundation for prosperity.

    We definitely recognize that UL/IUL policies are not all “bad” and we rarely recommend one to be replaced, but we definitely want older “non-whole life” policies monitored. (Even with whole life, we’ll want clients maximizing existing policies by using PUAs when possible.) And we recommend whole life as the best place to safely store cash, and look to other investments to maximize returns with greater predictability than the stock market can provide. I appreciate that you have a different philosophy.

  9. Michael Goodman says:

    I do have a different philosophy; I don’t want my clients to leave hundreds of thousands of dollars on the table! You continue to lump IUL’s with universal life. They are not just different cats, they are as different as lions and alligators and nobody should ever refer to “UL/IUL” in a sentence. I agreed that the original UL and the later variants of variable UL have problems; but I strongly disagree with what is now a common strategy of denigrating IUL’s by implying the problems of UL and VUL still exist in IUL’s. Your stategies to improve the returns within whole life are probably available to the owner of an IUL policy, aren’t they? So that’s no advantage when comparing IUL’s to whole life, and that is the limit of my disagreement with you. I challenge you to show me a situation where whole life provides a superior rate of return over time when compared to an IUL! Whole life does have an advantage over IUL’s but the rate of return over time will ALWAYS be a disadvantage of whole life. The advantage of whole life lies in the contractual guarantees and the fact that there are terms in an IUL contract that can change over time. That is the added risk in an IUL agreement, and the client must decide if it’s worth the risk to gain the superior rate of return. But that is the ONLY area where whole life is better than an IUL. If you think differently, then SHOW ME THE MATH!

  10. Kate4Kim@P4P says:

    Michael, I’m going to try to keep this short because 1) It’s a poor use of my time and energy to argue 2) You’re not listening anyway 3) It’s tacky and bad karma to use another financial advisor’s website to market your opinion and website, and 4) I’m more inclined to simply delete comments with insults rather than edit out the most rude or inappropriate parts, as I’ve had to do with yours.

    But you asked me for “MATH!” and challenged me to show you “a situation where whole life provides a superior rate of return over time when compared to an IUL!” And here it is:

    According to your first comment, “We can calculate that the average crediting rate for an IUL with a cap of 14.5% over the last 30 years would have been 8.6%.”

    That’s a VERY attractive return for tax-free growth, absolutely nothing to sneeze at. However, it’s slightly LESS than what whole life actually DID return. One of our favorite carriers paid out dividends that averaged 8.98% from 1983 to 2012. Another paid out 9.1%! I actually couldn’t find 30-year figures for whole life that weren’t above 8.6%. All that and guarantees, too.

    (Of course, those returns are before policy costs, as are your figures. And we do not suggest that ANYONE use past performance to speculate how much money they might have many decades down the road; it’s misleading, it’s only guesswork, and it tends to have a negative effect on investor behavior.)

    As mentioned, we rarely replace IUL policies and typically advise clients to complete funding them. But for numerous reasons, we choose not to sell them and recommend whole life as the best place to store cash, particularly when that cash might be used for financing or investment opportunities.

    There is much more I could say, but I’m not going to convert you to Prosperity Economics any more than you’re going to convert us to your way of thinking. So I’ll simply thank-you for commenting and wish you well.

  11. Those are better returns that I would expect, which raises the question of how much of those returns were guaranteed and what is the source? You said they were dividends, which implies they were not guaranteed, but were granted by the carrier. I ask because the main selling point of whole life seems to be the guarantees. Here’s my final question for you – Are you now saying the long term performance of the policy is going to depend on non-guaranteed dividends?

  12. Kate4Kim@P4P says:

    Yes, we think with dividends being paid every single year for more than 100 years – including through the Great Depression and every stock market crash – we can rely on dividends to continue, although we run illustrations that show both the guaranteed cash value and the current dividend rate.

    (I wonder if you show illustrations of your minimum guarantees?)

    Source was a PowerPoint from Guardian comparing the dividend performance of four major mutual insurance companies.

  13. Of course I show the guaranteed values. They are right on the same page with the average performance, and a third chart showing 2% lower performance. I don’t think I’ve seen seen an IUL illustration that didn’t have all three.

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