Universal Life Insurance: Everything You Need To Know

Universal Life Insurance

Universal life insurance is a complex, flexible premium, life insurance product which combines term life insurance and investing (or proprietary interest crediting methods) as two separate functions within the same contract.

The contract is driven by a variety of assumptions which do not have any explicit guarantee of performance, cost, or outcome. Policyholders share the risk of loss with the life insurance company in exchange for some benefit——no-lapse guarantee death benefits (*terms and conditions apply) or non-guaranteed cash value growth tied to the upward movement of a stock market index or to the stock market directly.

The policyholder can choose to increase or decrease premiums and death benefits at any time.

Likewise, the insurance company can choose to increase or decrease policy charges as well as increase or decrease interest crediting rates at any time. As a result, the insurance company shifts some of the risk of insurance onto the policyholder.

This type of insurance policy may also build a non-guaranteed cash value which can be used while you're alive, for any reason.

Seems simple enough, right?

But… there's a lot more to it.

So, let's dig in…


Why Does This Matter?

Why does universal life insurance matter?

The tl;dr version:

  • Universal life can provide a guaranteed death benefit with potentially guaranteed level (no lapse-guarantee) premiums.
  • Some universal life products build non-guaranteed cash value, and offer potentially attractive growth rates on cash values, which can then be used to supplement your future retirement income.
  • Life insurance companies can change costs and crediting rates. Sometimes, the terms of the contract allow insurers to change these elements at their discretion for any reason. This happens because universal life is driven by current interest rate and mortality assumptions (as opposed to "worst-case scenario", highest guaranteed mortality expenses). If the mortality rates turn out to be higher (more expensive) than originally projected or assumed, the life insurer can increase policy charges to make up for the increased cost. Because of this, universal life insurance is riskier than whole life insurance, since a significant amount of risk (i.e. the risk of rising future policy charges and lower-than-expected interest credits) is shifted back onto the policyholder.

A Brief History Of Universal Life Insurance

Many people are, understandably, confused by universal life.

Some folks erroneously refer to it as "whole life insurance." But… it is its own animal.

Universal life insurance ("UL" for short) is a hybrid life insurance product. Originally, it was designed as a term life insurance policy with a deferred annuity as a technically separate product.

The term life product worked just like any other term insurance policy (see the Term Life Insurance section of this guide for more information about term insurance). The deferred annuity was essentially a long-term savings and retirement account held with a life insurance company which could later be converted into a guaranteed retirement income in the future.

Deferred annuities were meant to be held for many years, and then liquidated during retirement. When the money in them was converted into income, however, it created a tax liability for the policyholder.

No good.

It wasn't until the Life Insurance Company of California, which was later renamed E.F. Hutton Life, combined a term policy with an accumulation fund into one single contract, that a true universal life insurance product was born.

By 1983, nearly every major life insurance company had devised its own universal life insurance product. And… life insurance agents began replacing as many whole life insurance policies as they could.

Why?

During the late 1970s and into the early 1980s, whole life crediting rates were "abysmal," compared to the previous 20 - 30 years. This new universal life product had the benefit of being able to capture current interest rates, and thus it looked way more attractive than the fixed whole life policy contract.

Dividend-paying whole life was popular, but dividend rates were slow to adjust to the sharply-rising interest rates in the 1980s.

A lot of life insurance companies encouraged their agents to replace their own whole life insurance products with the shiny new universal life. And so… the "Great Replacement" began.

Most of the sales in the early 1980s were nothing more than life insurance agents swapping out their clients' whole life products for universal life.

By 1985, the replacement business died down because most of the whole life that was going to be replaced with this business had been replaced.

Business was booming, until… the 1980s ended and interest rates fell.

Because UL contracts were originally designed to work in a high interest rate environment, and often contained high expense loads, they crashed and fell apart under low(er) interest crediting rates.

Today, old school current assumption fixed ULs are almost non-existent, but… there are plenty of iterations left. In general, universal life functions best as supplemental permanent life insurance and should be used in situations where neither term nor whole life insurance are appropriate.

What Is The Purpose Of Universal Life Insurance?

Generally speaking, life insurance exists (ultimately) to create certainty out of uncertainty - the uncertainty of your own death, disability, or chronic illness and also uncertainty about whether you will save up enough money.

No one knows exactly when they will die or if they will become disabled or sick before accomplishing everything they want to accomplish in life. And, that fact has a "trickle down" effect which makes it difficult (and in some cases impossible) to make long-term financial plans - plans you need to make in order to be (and feel) financially secure. In some cases, this uncertainty affects even short-term plans.

Universal life insurance helps remove some of this risk, by providing some certainty about the availability of future income and savings.

Universal life insurance was originally created as a reaction to low interest rates in the 1970s, and is a hybrid product which was (and still is) designed to compete against whole life insurance (primarily as a pseudo investment and cash value driven insurance product). As such, it shares similar purposes:

  • To provide death benefit protection and;
  • To provide a cash value which you can use for any reason while you're alive.

There are many technical differences between whole life and universal life, but the primary practical difference is one of flexibility.

Like whole life insurance, when you own a universal life insurance policy, you may choose essentially between lower premiums or higher cash value accumulation potential. However, unlike whole life insurance, universal life insurance has no base or guaranteed premium. This means you can increase, decrease, stop and restart premiums whenever you want. As long as there is enough cash value to pay for the cost of insurance charges, there is no required premium to keep the policy in force. You can also vary the death benefit such that it remains (mostly) level or you can elect to have it increase over time. The death benefit can be changed after the policy has been issued, allowing you to either increase it or decrease it as needed. Decreasing the death benefit generally requires the policyholder to notify the insurance company of the change, while increasing the death benefit generally requires additional underwriting to prove insurability for a higher insurance amount. Unlike whole life insurance, universal life insurance never endows. Because of this, it is never "paid in full". Instead, it is assumed the cash value of the policy will generate sufficient interest earnings to pay for the insurance for the remainder of the insured's life.

The insurance company, on the other hand, also has some choices. It can adjust internal costs to allow lower out of pocket premiums or force insurance charges higher. It can also raise and lower crediting rates, generally at its discretion.

3 Major Types Of Universal Life Insurance

Current Assumption Universal Life

Current assumption universal life is a universal life insurance policy that pays interest to cash values based on current interest rates. The interest rates can change, though most universal life policies of this type also come with a standard minimum guaranteed rate, which does not change.

Indexed Universal Life

Indexed universal life insurance credits interest based on the movement of a stock market (or other) index. It is not a direct investment in these indices, but rather an interest crediting strategy designed to provide more upside potential than a current assumption universal life policy.

Variable Universal Life

Variable universal life insurance credits or subtracts interest based on the underlying value of subaccounts, which are direct investments in various financial markets - usually, stock markets.

The Annually-Renewable Term Chassis Of Universal Life Insurance

The Term Chassis Of Universal Life Insurance

Embedded within every universal life policy is a term insurance policy.

The term policy gives you one year's worth of death benefit protection for a set premium which does not change for the entire year.

At the end of the year, the term policy automatically renews at a higher rate, but your premium is expected (though not guaranteed) to remain level.

Life insurance companies disclose most (but not all) costs in a UL policy in a cost disclosure section of a universal life insurance policy illustration. The big appeal of a universal life policy is supposed to be the fact that they are completely transparent. However, as you'll see later, we need to do one extra step to understand all of the costs of the policy.

Conceptually, the internal policy charges would look similar to an annual renewable term policy, like this:

However, universal life premiums are generally levelized, meaning they remain flat or level for the life of the policy. In most cases, the level premium is not guaranteed, so while the insurer can assume the premium will remain level, there is no guarantee that the premium will actually remain level forever.

This is because universal life is an assumption-driven product. Assumed costs (which are not guaranteed) and assumed crediting or interest rates (which are also not guaranteed) are what drive the premium rates for universal life.

Of course, universal life does have minimum guaranteed (gross) crediting rates and maximum mortality charges, but policy illustrations run under these minimum and maximum assumptions rarely hold together well. The product is usually designed to run under the non-guaranteed assumptions, not the guaranteed ones.

A Review Of How Level Premium Funding Works

Level premium funding is covered elsewhere in this guide, but I shall provide a review of it here as well.

"Level premium funding" is a premium payment and scheduling scheme which helps keep the premiums for universal life insurance level for a set period of time, potentially lasting for the entire term of the contract (which is usually age 100 or age 121).

If you're a detail-oriented person, or a spreadsheet junkie, then I recommend you check out the book, Actuarial Aspects of Individual Life Insurance and Annuity Contracts, by Albert E. Easton and Timothy F. Harris, where these (and other) insurance concepts are fleshed out in more excruciating detail.

The way this works is… the insurance company collects more than what it actually needs to pay for the death benefit. By doing so, it establishes a cash reserve.

This reserve is, in actuality, a liability that the insurance company needs to pay the future death benefit. There are lots of different ways insurers can establish reserves but… they all basically work the same way.

Whenever a life insurance policy has a level premium, you can be sure the insurer is collecting more premium than it really needs and then investing that money on your behalf.

For all fixed universal life policies, the reserve is invested in the insurance company's General Investment Account (GIA). For variable universal life policies, the money is allocated to one or more separate accounts which function like mutual funds. More on that later.

Death Benefit Options

Options, Options

Most universal life insurance policies offer you a choice of 2 death benefit options: Option A (or Option 1) or Option B (or Option 2).

Sounds kind of like a Chinese restaurant, doesn't it?

Except that here, your options determine how your death benefit and cash value (if any) behaves.

Option A

Under Option A, you specify the amount of insurance (face amount) you want, and the insurance company maintains this insurance amount for you as decreasing term insurance. The death benefit, then, equals the cash value plus any remaining term life insurance in the policy (i.e. any remaining pure insurance).

If you read the whole life insurance section, and this sounds somewhat familiar, it's because it's exactly how whole life insurance death benefits work.

As the cash value grows, the amount of pure insurance in the policy decreases. If cash values approach the face amount before policy maturity (usually age 100 or age 121), then an additional amount of insurance is automatically purchased, which creates something called a "corridor." This corridor is maintained in addition to cash values and the original face amount of insurance.

Option B

With Option B, your death benefit is equal to the face amount of insurance (pure insurance) plus the cash value. In essence, you are buying a level term insurance policy (as opposed to a decreasing term insurance policy) and also building a cash value.

Cash values under this option must be tightly controlled, since IRS regulations prohibit them from growing disproportionately larger than the term insurance death benefit.

This ratio of cash value to death benefit is maintained under one of two definitions of life insurance specified under section 7702 of the Internal Revenue Code. The insurer will either perform a Cash Value Accumulation Test (CVAT) or a Guideline Premium Test (GPT). The policy's premium payments, cash value, and death benefit amounts must pass this test to be considered life insurance (as opposed to an investment product.

How Cash Value In A Universal Life Policy Works

What Cash Value Means In A Universal Life Policy

Unlike whole life insurance, cash value in a universal life insurance policy is simply an accumulation fund or policy value fund. In the industry, we call it the "pot of money."

It's sole purpose, from the perspective of the insurance company, is to pay for the cost of the term insurance.

That's it.

As long as there is money in the cash value to cover policy charges, you're good.

Premiums are, of course, scheduled but policyholders may pay more (up to a certain limit) or less (including $0) than the scheduled amount.

Premiums paid to the insurance company are credited directly to the cash value of the policy. Policy charges, including cost of term insurance, are then deducted from the cash value. After charges have been deducted, interest (if any) is credited back to the cash values.

The actual credited interest depends entirely on what those cash values are invested in.

Bottom line: As long as there is money in the cash value account sufficient to pay for the term insurance, you have an insurance policy. If, at any time, your cash value drops to $0, your universal life insurance policy terminates and you have no more life insurance. The only exception to this is Guaranteed (or "No-Lapse") Universal Life, which generally does not have cash value or has low cash value.

Other than that, the insurance company does not strictly enforce specific premium or cash value levels.

Policyholders may pay premiums up to the policy's premium limit or up to the MEC guidelines (discussed elsewhere in this guide), they may reduce premiums, or a policyholder may stop them entirely  and… a policyholder may also withdraw cash value from the policy at any time for any reason.

Policy Value vs Net Cash Surrender Value

Unlike whole life, universal life cash values are divided into two different values - the policy value and the net cash surrender value.

The policy value is defined as: "The total value in the policy, which consists of premiums paid and credited interest, minus policy charges and partial withdrawals."

However, all universal life policies also have declining surrender charges, which are charges in addition to the basic policy charges, which last for many years. These charges are only paid if you surrender the policy for its cash value during the surrender period. Once the surrender period is over, no surrender charges are paid.

The net cash surrender value is the cash value minus the surrender charges. It is essentially the cash value available to you as a policyholder if you decide to borrow against the policy or surrender it for its cash value.

Sample Universal Life Policy Illustrations

Guaranteed No-Lapse Universal Life Insurance

Guaranteed No-Lapse (sometimes called "Universal Life With Secondary Guarantees" or "GUL") generally does not build much (or any) cash value. Instead, it provides a level death benefit. The insurer charges a guaranteed level premium as long as all premium payments are made on-time and no policy loans are taken.

Guaranteed No-Lapse Universal Life Illustration
YearAgePremium OutlayPolicy ValueCash Surrender ValueDeath Benefit
136$6,261.00$0.00$0.00$1,000,000.00
237$6,261.00$0.00$0.00$1,000,000.00
338$6,261.00$0.00$0.00$1,000,000.00
439$6,261.00$0.00$0.00$1,000,000.00
540$6,261.00$0.00$0.00$1,000,000.00
641$6,261.00$0.00$0.00$1,000,000.00
742$6,261.00$0.00$0.00$1,000,000.00
843$6,261.00$0.00$0.00$1,000,000.00
944$6,261.00$0.00$0.00$1,000,000.00
1045$6,261.00$0.00$0.00$1,000,000.00
1146$6,261.00$0.00$0.00$1,000,000.00
1247$6,261.00$0.00$0.00$1,000,000.00
1348$6,261.00$0.00$0.00$1,000,000.00
1449$6,261.00$0.00$0.00$1,000,000.00
1550$6,261.00$2,443.00$275.00$1,000,000.00
1651$6,261.00$5,501.00$3,694.00$1,000,000.00
1752$6,261.00$8,456.00$7,011.00$1,000,000.00
1853$6,261.00$11,268.00$10,183.00$1,000,000.00
1954$6,261.00$13,893.00$13,170.00$1,000,000.00
2055$6,261.00$16,320.00$16,320.00$1,000,000.00
2156$6,261.00$18,546.00$18,546.00$1,000,000.00
2257$6,261.00$20,586.00$20,586.00$1,000,000.00
2358$6,261.00$22,447.00$22,447.00$1,000,000.00
2459$6,261.00$24,115.00$24,115.00$1,000,000.00
2560$6,261.00$25,547.00$25,547.00$1,000,000.00
2661$6,261.00$26,669.00$26,669.00$1,000,000.00
2762$6,261.00$27,356.00$27,356.00$1,000,000.00
2863$6,261.00$27,491.00$27,491.00$1,000,000.00
2964$6,261.00$26,988.00$26,988.00$1,000,000.00
3065$6,261.00$25,753.00$25,753.00$1,000,000.00
3166$6,261.00$23,702.00$23,702.00$1,000,000.00
3267$6,261.00$20,753.00$20,753.00$1,000,000.00
3368$6,261.00$16,811.00$16,811.00$1,000,000.00
3469$6,261.00$11,741.00$11,741.00$1,000,000.00
3570$6,261.00$5,368.00$5,368.00$1,000,000.00
3671$6,261.00$0.00$0.00$1,000,000.00
3772$6,261.00$0.00$0.00$1,000,000.00
3873$6,261.00$0.00$0.00$1,000,000.00
3974$6,261.00$0.00$0.00$1,000,000.00
4075$6,261.00$0.00$0.00$1,000,000.00
4176$6,261.00$0.00$0.00$1,000,000.00
4277$6,261.00$0.00$0.00$1,000,000.00
4378$6,261.00$0.00$0.00$1,000,000.00
4479$6,261.00$0.00$0.00$1,000,000.00
4580$6,261.00$0.00$0.00$1,000,000.00
4681$6,261.00$0.00$0.00$1,000,000.00
4782$6,261.00$0.00$0.00$1,000,000.00
4883$6,261.00$0.00$0.00$1,000,000.00
4984$6,261.00$0.00$0.00$1,000,000.00
5085$6,261.00$0.00$0.00$1,000,000.00
5186$6,261.00$0.00$0.00$1,000,000.00
5287$6,261.00$0.00$0.00$1,000,000.00
5388$6,261.00$0.00$0.00$1,000,000.00
5489$6,261.00$0.00$0.00$1,000,000.00
5590$6,261.00$0.00$0.00$1,000,000.00
5691$6,261.00$0.00$0.00$1,000,000.00
5792$6,261.00$0.00$0.00$1,000,000.00
5893$6,261.00$0.00$0.00$1,000,000.00
5994$6,261.00$0.00$0.00$1,000,000.00
6095$6,261.00$0.00$0.00$1,000,000.00
6196$6,261.00$0.00$0.00$1,000,000.00
6297$6,261.00$0.00$0.00$1,000,000.00
6398$6,261.00$0.00$0.00$1,000,000.00
6499$6,261.00$0.00$0.00$1,000,000.00
65100$6,261.00$0.00$0.00$1,000,000.00
66101$0.00$0.00$0.00$1,000,000.00
67102$0.00$0.00$0.00$1,000,000.00
68103$0.00$0.00$0.00$1,000,000.00
69104$0.00$0.00$0.00$1,000,000.00
70105$0.00$0.00$0.00$1,000,000.00
71106$0.00$0.00$0.00$1,000,000.00
72107$0.00$0.00$0.00$1,000,000.00
73108$0.00$0.00$0.00$1,000,000.00
74109$0.00$0.00$0.00$1,000,000.00
75110$0.00$0.00$0.00$1,000,000.00
76111$0.00$0.00$0.00$1,000,000.00
77112$0.00$0.00$0.00$1,000,000.00
78113$0.00$0.00$0.00$1,000,000.00
79114$0.00$0.00$0.00$1,000,000.00
80115$0.00$0.00$0.00$1,000,000.00
81116$0.00$0.00$0.00$1,000,000.00
82117$0.00$0.00$0.00$1,000,000.00
83118$0.00$0.00$0.00$1,000,000.00
84119$0.00$0.00$0.00$1,000,000.00
85120$0.00$0.00$0.00$1,000,000.00
86121$0.00$0.00$0.00$1,000,000.00

This policy runs to the insured's age 121 and is taken out on a 35 year-old male, standard, non-smoker. Notice the death benefit remains level for the entire time.

From year 15 to year 35, this policy builds a non-zero amount of cash value. It is never substantial and is not meant to be a permanent cash value. If a premium is ever paid late, and the no-lapse guaranteed minimum premium is not paid, the guarantee disappears and the policy may lapse.

A policyholder can pay more into this policy to build up the policy value, but these policies are generally not designed for high cash value accumulation.

Because substantial premiums are paid into this policy over long-periods of time, it is possible to pay more in premium than you receive as a death benefit. In this case, the cumulative premiums paid over 65 years totaled just $406,965 - a lot of money, but still less than the total face amount of insurance.

When buying GUL, it's a good idea to verify the total premiums paid will never exceed the death benefit amount.

Additionally, GUL is very sensitive to when premiums are paid. Paying early or late can suspend the no-lapse guarantee provisions, or terminate them altogether. This is partially due to the fact that some insurers use a combination of a minimum premium amount plus a guaranteed interest rate to determine whether the no-lapse guarantee will be in effect. Other insurers use a more complex formula to determine whether a special extended no-lapse guarantee rider will be triggered.

Paying premiums early sometimes shunts premium dollars into a "shadow account" or "multi-tiered shadow account", which can earn less than the guaranteed rate in the contract. Premiums paid over and above the minimum premium may be assessed a large premium charge before normal mortality and expense charges are deducted and interest is paid on that premium.

Premiums paid late or "off schedule" can also cause unexpected or poorly disclosed charges to be triggered, suspending or terminating the guarantees in the policy.

These various expense mechanisms are loosely referred to as "trap doors" in the insurance industry, and can either prevent the no-lapse guarantee provisions from being triggered or cause previously-triggered guarantees to terminate unexpectedly.

All this to say that, sometimes, a guarantee isn't what you think it is.

Current Assumption Universal Life (Option A)

Current assumption UL credits cash values according to current interest rates. In this example, the gross interest rate (before policy charges) is 4.25%. This interest rate can change over time with interest rates in the marketplace, and tend to follow bond interest rates over the long-term.

Because current assumption UL builds cash value, a common question arises: "how much does the insurance cost as versus the cash value?" In a UL, these policy charges can be broken out by month and by year.

First, the total illustration under option A:

YearAgePremium OutlayPolicy ValueCash Surrender ValueDeath Benefit
136$11,693.00$6,835.00$1,390.00$1,000,000.00
237$11,693.00$14,338.00$9,165.00$1,000,000.00
338$11,693.00$22,134.00$17,233.00$1,000,000.00
439$11,693.00$30,214.00$25,586.00$1,000,000.00
540$11,693.00$38,596.00$34,240.00$1,000,000.00
641$11,693.00$48,986.00$44,903.00$1,000,000.00
742$11,693.00$59,758.00$55,947.00$1,000,000.00
843$11,693.00$70,912.00$67,373.00$1,000,000.00
944$11,693.00$82,457.00$79,190.00$1,000,000.00
1045$11,693.00$94,394.00$91,399.00$1,000,000.00
1146$11,693.00$108,481.00$105,759.00$1,000,000.00
1247$11,693.00$123,029.00$120,579.00$1,000,000.00
1348$11,693.00$138,066.00$135,888.00$1,000,000.00
1449$11,693.00$153,626.00$151,720.00$1,000,000.00
1550$11,693.00$169,718.00$168,084.00$1,000,000.00
1651$11,693.00$186,376.00$185,014.00$1,000,000.00
1752$11,693.00$203,583.00$202,494.00$1,000,000.00
1853$11,693.00$221,375.00$220,558.00$1,000,000.00
1954$11,693.00$239,768.00$239,224.00$1,000,000.00
2055$11,693.00$258,793.00$258,793.00$1,000,000.00
2156$11,693.00$278,469.00$278,469.00$1,000,000.00
2257$11,693.00$298,822.00$298,822.00$1,000,000.00
2358$11,693.00$319,843.00$319,843.00$1,000,000.00
2459$11,693.00$341,486.00$341,486.00$1,000,000.00
2560$11,693.00$363,697.00$363,697.00$1,000,000.00
2661$11,693.00$389,005.00$389,005.00$1,000,000.00
2762$11,693.00$415,315.00$415,315.00$1,000,000.00
2863$11,693.00$442,672.00$442,672.00$1,000,000.00
2964$11,693.00$471,048.00$471,048.00$1,000,000.00
3065$11,693.00$500,480.00$500,480.00$1,000,000.00
3166$11,693.00$530,956.00$530,956.00$1,000,000.00
3267$11,693.00$562,654.00$562,654.00$1,025,637.00
3368$11,693.00$595,510.00$595,510.00$1,058,085.00
3469$11,693.00$629,542.00$629,542.00$1,090,722.00
3570$11,693.00$664,737.00$664,737.00$1,123,484.00
3671$11,693.00$701,120.00$701,120.00$1,156,320.00
3772$11,693.00$738,761.00$738,761.00$1,189,470.00
3873$11,693.00$777,644.00$777,644.00$1,222,927.00
3974$11,693.00$817,850.00$817,850.00$1,257,165.00
4075$11,693.00$859,428.00$859,428.00$1,292,185.00
4176$11,693.00$902,288.00$902,288.00$1,327,760.00
4277$11,693.00$946,484.00$946,484.00$1,363,961.00
4378$11,693.00$992,078.00$992,078.00$1,400,854.00
4479$11,693.00$1,039,106.00$1,039,106.00$1,438,628.00
4580$11,693.00$1,087,511.00$1,087,511.00$1,477,394.00
4681$11,693.00$1,137,923.00$1,137,923.00$1,518,183.00
4782$11,693.00$1,190,198.00$1,190,198.00$1,560,779.00
4883$11,693.00$1,244,466.00$1,244,466.00$1,605,509.00
4984$11,693.00$1,300,842.00$1,300,842.00$1,652,339.00
5085$11,693.00$1,359,449.00$1,359,449.00$1,701,363.00
5186$11,693.00$1,420,333.00$1,420,333.00$1,752,682.00
5287$11,693.00$1,483,498.00$1,483,498.00$1,806,404.00
5388$11,693.00$1,549,059.00$1,549,059.00$1,862,773.00
5489$11,693.00$1,617,244.00$1,617,244.00$1,922,114.00
5590$11,693.00$1,688,073.00$1,688,073.00$1,984,420.00
5691$11,693.00$1,761,747.00$1,761,747.00$2,049,817.00
5792$11,693.00$1,838,407.00$1,838,407.00$2,118,267.00
5893$11,693.00$1,918,344.00$1,918,344.00$2,189,248.00
5994$11,693.00$2,001,845.00$2,001,845.00$2,262,546.00
6095$11,693.00$2,089,341.00$2,089,341.00$2,337,921.00
6196$11,693.00$2,181,352.00$2,181,352.00$2,414,858.00
6297$11,693.00$2,277,253.00$2,277,253.00$2,490,948.00
6398$11,693.00$2,377,734.00$2,377,734.00$2,563,638.00
6499$11,693.00$2,483,713.00$2,483,713.00$2,629,694.00
65100$11,693.00$2,596,542.00$2,596,542.00$2,683,944.00
66101$0.00$2,702,268.00$2,702,268.00$2,793,229.00
67102$0.00$2,811,985.00$2,811,985.00$2,906,639.00
68103$0.00$2,925,859.00$2,925,859.00$3,024,347.00
69104$0.00$3,044,082.00$3,044,082.00$3,146,549.00
70105$0.00$3,166,854.00$3,166,854.00$3,273,454.00
71106$0.00$3,294,371.00$3,294,371.00$3,405,263.00
72107$0.00$3,426,645.00$3,426,645.00$3,541,989.00
73108$0.00$3,563,841.00$3,563,841.00$3,683,803.00
74109$0.00$3,706,214.00$3,706,214.00$3,830,969.00
75110$0.00$3,853,966.00$3,853,966.00$3,983,694.00
76111$0.00$4,007,310.00$4,007,310.00$4,142,201.00
77112$0.00$4,166,519.00$4,166,519.00$4,306,768.00
78113$0.00$4,331,806.00$4,331,806.00$4,477,619.00
79114$0.00$4,503,394.00$4,503,394.00$4,654,983.00
80115$0.00$4,681,511.00$4,681,511.00$4,839,096.00
81116$0.00$4,866,396.00$4,866,396.00$5,030,204.00
82117$0.00$5,058,585.00$5,058,585.00$5,228,862.00
83118$0.00$5,258,366.00$5,258,366.00$5,435,368.00
84119$0.00$5,466,040.00$5,466,040.00$5,650,032.00
85120$0.00$5,681,917.00$5,681,917.00$5,873,177.00
86121$0.00$5,906,324.00$5,906,324.00$6,105,137.00

In this illustration, premiums of $11,693 are paid in the first year, which generates a policy value of $6,835, and a net cash surrender value of $1,390.

How much goes towards cost of insurance? It might be intuitive to say $4,858, since this is the difference between the premium paid and the policy value, or… maybe $10,303, since this is the difference between the premium and the net cash value.

But, universal life insurance is an "unbundled" insurance product, meaning you can "see inside" of the policy and break out most of the internal charges.

Like this:

YearMonthTotal PremiumPremium ChargesPer Policy ChargesCost Per $1,000 Base ChargeBase Cost Of Insurance ChargeInterest Credited Back To Policy
11$974.00$78.00$9.00$276.00$54.00$2.00
12$974.00$78.00$9.00$276.00$54.00$4.00
13$974.00$78.00$9.00$276.00$54.00$6.00
14$974.00$78.00$9.00$276.00$54.00$8.00
15$974.00$78.00$9.00$276.00$54.00$10.00
16$974.00$78.00$9.00$276.00$54.00$12.00
17$974.00$78.00$9.00$276.00$54.00$14.00
18$974.00$78.00$9.00$276.00$54.00$16.00
19$974.00$78.00$9.00$276.00$54.00$18.00
110$974.00$78.00$9.00$276.00$54.00$20.00
111$974.00$78.00$9.00$276.00$54.00$22.00
112$974.00$78.00$9.00$276.00$54.00$24.00
21$974.00$49.00$5.00$276.00$57.00$26.00
22$974.00$49.00$5.00$276.00$57.00$28.00
23$974.00$49.00$5.00$276.00$57.00$30.00
24$974.00$49.00$5.00$276.00$57.00$32.00
25$974.00$49.00$5.00$276.00$57.00$34.00
26$974.00$49.00$5.00$276.00$57.00$37.00
27$974.00$49.00$5.00$276.00$57.00$39.00
28$974.00$49.00$5.00$276.00$57.00$41.00
29$974.00$49.00$5.00$276.00$57.00$43.00
210$974.00$49.00$5.00$276.00$57.00$45.00
211$974.00$49.00$5.00$276.00$57.00$47.00
212$974.00$49.00$5.00$276.00$57.00$50.00

These charges are broken out monthly, so you can get very granular with this. Of course, you can also see charges annually:

YearPremium ChargesPer Policy ChargesCost Per $1,000 Base ChargeBase Cost Of Insurance ChargeInterest Credited Back To Policy
1$935.00$108.00$3,317.00$650.00$153.00
2$585.00$60.00$3,317.00$681.00$452.00
3$585.00$60.00$3,317.00$705.00$770.00
4$585.00$60.00$3,317.00$752.00$1,100.00
5$585.00$60.00$3,317.00$792.00$1,443.00
6$585.00$60.00$1,658.00$836.00$1,836.00
7$585.00$60.00$1,658.00$894.00$2,276.00
8$585.00$60.00$1,658.00$968.00$2,732.00
9$585.00$60.00$1,658.00$1,050.00$3,204.00
10$585.00$60.00$1,658.00$1,146.00$3,693.00
11$585.00$60.00$0.00$1,198.00$4,237.00
12$585.00$60.00$0.00$1,333.00$4,833.00
13$585.00$60.00$0.00$1,460.00$5,448.00
14$585.00$60.00$0.00$1,573.00$6,084.00
15$585.00$60.00$0.00$1,699.00$6,743.00
16$585.00$60.00$0.00$1,815.00$7,424.00
17$585.00$60.00$0.00$1,969.00$8,128.00
18$585.00$60.00$0.00$2,113.00$8,857.00
19$585.00$60.00$0.00$2,264.00$9,609.00
20$585.00$60.00$0.00$2,412.00$10,388.00
21$585.00$60.00$0.00$2,565.00$11,193.00
22$585.00$60.00$0.00$2,720.00$12,025.00
23$585.00$60.00$0.00$2,913.00$12,886.00
24$585.00$60.00$0.00$3,179.00$13,773.00
25$585.00$60.00$0.00$3,522.00$14,685.00
26$585.00$60.00$0.00$1,418.00$15,677.00
27$585.00$60.00$0.00$1,489.00$16,751.00
28$585.00$60.00$0.00$1,559.00$17,868.00
29$585.00$60.00$0.00$1,700.00$19,027.00
30$585.00$60.00$0.00$1,846.00$20,230.00
31$585.00$60.00$0.00$2,048.00$21,476.00
32$585.00$60.00$0.00$2,120.00$22,770.00
33$585.00$60.00$0.00$2,305.00$24,113.00
34$585.00$60.00$0.00$2,521.00$25,505.00
35$585.00$60.00$0.00$2,798.00$26,945.00
36$585.00$60.00$0.00$3,099.00$28,434.00
37$585.00$60.00$0.00$3,381.00$29,974.00
38$585.00$60.00$0.00$3,731.00$31,565.00
39$585.00$60.00$0.00$4,054.00$33,211.00
40$585.00$60.00$0.00$4,382.00$34,912.00
41$585.00$60.00$0.00$4,856.00$36,668.00
42$585.00$60.00$0.00$5,331.00$38,479.00
43$585.00$60.00$0.00$5,801.00$40,347.00
44$585.00$60.00$0.00$6,294.00$42,273.00
45$585.00$60.00$0.00$6,901.00$44,258.00
46$585.00$60.00$0.00$6,950.00$46,314.00
47$585.00$60.00$0.00$7,224.00$48,450.00
48$585.00$60.00$0.00$7,447.00$50,667.00
49$585.00$60.00$0.00$7,642.00$52,969.00
50$585.00$60.00$0.00$7,803.00$55,361.00
51$585.00$60.00$0.00$8,011.00$57,847.00
52$585.00$60.00$0.00$8,312.00$60,428.00
53$585.00$60.00$0.00$8,593.00$63,106.00
54$585.00$60.00$0.00$8,752.00$65,889.00
55$585.00$60.00$0.00$9,001.00$68,781.00
56$585.00$60.00$0.00$9,162.00$71,788.00
57$585.00$60.00$0.00$9,304.00$74,916.00
58$585.00$60.00$0.00$9,285.00$78,174.00
59$585.00$60.00$0.00$9,123.00$81,575.00
60$585.00$60.00$0.00$8,686.00$85,134.00
61$585.00$60.00$0.00$7,907.00$88,870.00
62$585.00$60.00$0.00$7,927.00$92,780.00
63$585.00$60.00$0.00$7,434.00$96,867.00
64$585.00$60.00$0.00$6,235.00$101,165.00
65$585.00$60.00$0.00$3,941.00$105,721.00
66$0.00$60.00$0.00$4,464.00$110,250.00
67$0.00$60.00$0.00$4,955.00$114,732.00
68$0.00$60.00$0.00$5,450.00$119,384.00
69$0.00$60.00$0.00$5,930.00$124,213.00
70$0.00$60.00$0.00$6,394.00$129,227.00
71$0.00$60.00$0.00$6,857.00$134,434.00
72$0.00$60.00$0.00$7,505.00$139,839.00
73$0.00$60.00$0.00$8,189.00$145,445.00
74$0.00$60.00$0.00$8,828.00$151,261.00
75$0.00$60.00$0.00$9,485.00$157,297.00
76$0.00$60.00$0.00$10,157.00$163,561.00
77$0.00$60.00$0.00$10,795.00$170,064.00
78$0.00$60.00$0.00$11,468.00$176,815.00
79$0.00$60.00$0.00$12,176.00$183,824.00
80$0.00$60.00$0.00$12,922.00$191,099.00
81$0.00$60.00$0.00$13,707.00$198,651.00
82$0.00$60.00$0.00$14,248.00$206,496.00
83$0.00$60.00$0.00$14,811.00$214,652.00
84$0.00$60.00$0.00$15,395.00$223,129.00
85$0.00$60.00$0.00$16,003.00$231,941.00
86$0.00$60.00$0.00$16,636.00$241,102.00

Policy charges never seem to end, do they?

In reality, various charges drop off over time in this particular illustration. Those costs are designed to help pay for various benefits within the policy and, when they have sufficiently covered the cost of the benefit, they drop off. For example, the per $1,000 charges stop in year 10.

However, not all policy charges are disclosed in the illustration. This policy's advertised gross interest crediting rate is 4.25%. But, if you start in the first year of this policy, subtract all itemized costs, and then add back in the interest, you will see it is not a 4.25% net rate.

No problem, as the insurer does tell us it's the gross interest rate. So, take the premium, add 4.25% interest, then subtract all the costs.

Uh oh!

The difference between the gross crediting rate and net rate credited to the policy is between $100 and $300 "off."

To get at the real cost of the policy, you must "reverse engineer" the policy. This is relatively straightforward since:

Net cash surrender value = (Premium - Expenses) + interest crediting

So, subtract out the gross crediting rate of 4.25% (interest earnings) and then subtract the premium from the remaining cash value. Whatever is left is not premium, and it is not interest earnings. It is therefore, by definition, the cost of the policy. You must do this each and every year (remembering to add the previous year's cash value and subtracting the total net cash value at the end of the year) to get at the true annual cost for the policy.

When you do, you end up with these as your total policy costs:

YEARNET ANNUAL PREMIUMNET CASH VALUETOTAL NET DEATH BENEFITTRUE CALCULATED ANNUAL POLICY COSTS
1$11,693.00$1,390.00$1,000,000.00$10,385.87
2$11,693.00$9,165.00$1,000,000.00$4,464.42
3$11,693.00$17,233.00$1,000,000.00$4,652.43
4$11,693.00$25,586.00$1,000,000.00$4,865.44
5$11,693.00$34,240.00$1,000,000.00$5,080.39
6$11,693.00$44,903.00$1,000,000.00$3,707.12
7$11,693.00$55,947.00$1,000,000.00$3,984.56
8$11,693.00$67,373.00$1,000,000.00$4,283.78
9$11,693.00$79,190.00$1,000,000.00$4,597.31
10$11,693.00$91,399.00$1,000,000.00$4,933.22
11$11,693.00$105,759.00$1,000,000.00$3,638.36
12$11,693.00$120,579.00$1,000,000.00$4,061.93
13$11,693.00$135,888.00$1,000,000.00$4,485.65
14$11,693.00$151,720.00$1,000,000.00$4,906.56
15$11,693.00$168,084.00$1,000,000.00$5,350.18
16$11,693.00$185,014.00$1,000,000.00$5,793.55
17$11,693.00$202,494.00$1,000,000.00$6,285.71
18$11,693.00$220,558.00$1,000,000.00$6,778.69
19$11,693.00$239,224.00$1,000,000.00$7,289.56
20$11,693.00$258,793.00$1,000,000.00$7,553.26
21$11,693.00$278,469.00$1,000,000.00$8,619.35
22$11,693.00$298,822.00$1,000,000.00$9,155.79
23$11,693.00$319,843.00$1,000,000.00$9,741.07
24$11,693.00$341,486.00$1,000,000.00$10,409.42
25$11,693.00$363,697.00$1,000,000.00$11,165.65
26$11,693.00$389,005.00$1,000,000.00$9,577.51
27$11,693.00$415,315.00$1,000,000.00$10,144.12
28$11,693.00$442,672.00$1,000,000.00$10,728.14
29$11,693.00$471,048.00$1,000,000.00$11,400.92
30$11,693.00$500,480.00$1,000,000.00$12,099.66
31$11,693.00$530,956.00$1,000,000.00$12,872.64
32$11,693.00$562,654.00$1,025,637.00$13,540.48
33$11,693.00$595,510.00$1,058,085.00$14,341.36
34$11,693.00$629,542.00$1,090,722.00$15,194.35
35$11,693.00$664,737.00$1,123,484.00$16,129.68
36$11,693.00$701,120.00$1,156,320.00$17,110.84
37$11,693.00$738,761.00$1,189,470.00$18,096.99
38$11,693.00$777,644.00$1,222,927.00$19,173.20
39$11,693.00$817,850.00$1,257,165.00$20,247.29
40$11,693.00$859,428.00$1,292,185.00$21,354.17
41$11,693.00$902,288.00$1,327,760.00$22,627.49
42$11,693.00$946,484.00$1,363,961.00$23,926.46
43$11,693.00$992,078.00$1,400,854.00$25,246.78
44$11,693.00$1,039,106.00$1,438,628.00$26,616.59
45$11,693.00$1,087,511.00$1,477,394.00$28,125.50
46$11,693.00$1,137,923.00$1,518,183.00$29,124.07
47$11,693.00$1,190,198.00$1,560,779.00$30,377.71
48$11,693.00$1,244,466.00$1,605,509.00$31,620.17
49$11,693.00$1,300,842.00$1,652,339.00$32,873.31
50$11,693.00$1,359,449.00$1,701,363.00$34,136.47
51$11,693.00$1,420,333.00$1,752,682.00$35,489.38
52$11,693.00$1,483,498.00$1,806,404.00$36,974.28
53$11,693.00$1,549,059.00$1,862,773.00$38,487.03
54$11,693.00$1,617,244.00$1,922,114.00$39,928.23
55$11,693.00$1,688,073.00$1,984,420.00$41,507.06
56$11,693.00$1,761,747.00$2,049,817.00$43,054.51
57$11,693.00$1,838,407.00$2,118,267.00$44,638.98
58$11,693.00$1,918,344.00$2,189,248.00$46,127.84
59$11,693.00$2,001,845.00$2,262,546.00$47,542.17
60$11,693.00$2,089,341.00$2,337,921.00$48,763.69
61$11,693.00$2,181,352.00$2,414,858.00$49,734.39
62$11,693.00$2,277,253.00$2,490,948.00$51,562.02
63$11,693.00$2,377,734.00$2,563,638.00$52,972.71
64$11,693.00$2,483,713.00$2,629,694.00$53,793.18
65$11,693.00$2,596,542.00$2,683,944.00$53,670.06
66$0.00$2,702,268.00$2,793,229.00$55,383.45
67$0.00$2,811,985.00$2,906,639.00$57,933.79
68$0.00$2,925,859.00$3,024,347.00$60,565.97
69$0.00$3,044,082.00$3,146,549.00$63,265.43
70$0.00$3,166,854.00$3,273,454.00$66,036.11
71$0.00$3,294,371.00$3,405,263.00$68,893.68
72$0.00$3,426,645.00$3,541,989.00$72,022.87
73$0.00$3,563,841.00$3,683,803.00$75,280.51
74$0.00$3,706,214.00$3,830,969.00$78,591.80
75$0.00$3,853,966.00$3,983,694.00$82,021.79
76$0.00$4,007,310.00$4,142,201.00$85,572.17
77$0.00$4,166,519.00$4,306,768.00$89,199.22
78$0.00$4,331,806.00$4,477,619.00$92,975.65
79$0.00$4,503,394.00$4,654,983.00$96,904.74
80$0.00$4,681,511.00$4,839,096.00$100,995.09
81$0.00$4,866,396.00$5,030,204.00$105,249.95
82$0.00$5,058,585.00$5,228,862.00$109,404.28
83$0.00$5,258,366.00$5,435,368.00$113,723.24
84$0.00$5,466,040.00$5,650,032.00$118,211.78
85$0.00$5,681,917.00$5,873,177.00$122,879.38
86$0.00$5,906,324.00$6,105,137.00$127,728.55

As you can see, the annual policy costs grow quite large. Based on the policy's illustration, you'd think they shrink over time.

This is not true, and we know from looking at term life insurance policy costs that term costs only grow over time. In fact, annually-renewable term costs are guaranteed to grow each and every year. And, all universal life policies are built on a 1-year annually-renewable term policy chassis.

So, it doesn't make sense that they would decrease over time.

And… we see that they don't. In year 86 alone, the total costs for the policy are $127,728 for a little over $6.1 million of death benefit. Total cumulative costs for this policy are roughly $3.2 million.

Current Assumption Universal Life (Option B)

Option B of this same policy allows the policyholder to increase the death benefit each year by adding cash value on top of a level death benefit.

Like so:

YearAgePremium OutlayPolicy ValueCash Surrender ValueDeath Benefit
136$11,435.00$6,796.00$1,351.00$1,006,796.00
237$11,435.00$14,251.00$9,079.00$1,014,251.00
338$11,435.00$21,993.00$17,092.00$1,021,993.00
439$11,435.00$30,008.00$25,380.00$1,030,008.00
540$11,435.00$38,315.00$33,959.00$1,038,315.00
641$11,435.00$48,616.00$44,532.00$1,048,616.00
742$11,435.00$59,281.00$55,470.00$1,059,281.00
843$11,435.00$70,308.00$66,769.00$1,070,308.00
944$11,435.00$81,700.00$78,433.00$1,081,700.00
1045$11,435.00$93,453.00$90,458.00$1,093,453.00
1146$11,435.00$107,324.00$104,602.00$1,107,324.00
1247$11,435.00$121,607.00$119,156.00$1,121,607.00
1348$11,435.00$136,321.00$134,143.00$1,136,321.00
1449$11,435.00$151,494.00$149,588.00$1,151,494.00
1550$11,435.00$167,122.00$165,488.00$1,167,122.00
1651$11,435.00$183,229.00$181,868.00$1,183,229.00
1752$11,435.00$199,777.00$198,688.00$1,199,777.00
1853$11,435.00$216,786.00$215,969.00$1,216,786.00
1954$11,435.00$234,252.00$233,707.00$1,234,252.00
2055$11,435.00$252,185.00$252,185.00$1,252,185.00
2156$11,435.00$270,578.00$270,578.00$1,270,578.00
2257$11,435.00$289,429.00$289,429.00$1,289,429.00
2358$11,435.00$308,679.00$308,679.00$1,308,679.00
2459$11,435.00$328,202.00$328,202.00$1,328,202.00
2560$11,435.00$347,848.00$347,848.00$1,347,848.00
2661$11,435.00$371,570.00$371,570.00$1,371,570.00
2762$11,435.00$396,078.00$396,078.00$1,396,078.00
2863$11,435.00$421,381.00$421,381.00$1,421,381.00
2964$11,435.00$447,353.00$447,353.00$1,447,353.00
3065$11,435.00$473,956.00$473,956.00$1,473,956.00
3166$11,435.00$501,037.00$501,037.00$1,501,037.00
3267$11,435.00$528,865.00$528,865.00$1,528,865.00
3368$11,435.00$557,352.00$557,352.00$1,557,352.00
3469$11,435.00$586,543.00$586,543.00$1,586,543.00
3570$11,435.00$616,310.00$616,310.00$1,616,310.00
3671$11,435.00$646,599.00$646,599.00$1,646,599.00
3772$11,435.00$677,448.00$677,448.00$1,677,448.00
3873$11,435.00$708,689.00$708,689.00$1,708,689.00
3974$11,435.00$740,367.00$740,367.00$1,740,367.00
4075$11,435.00$772,448.00$772,448.00$1,772,448.00
4176$11,435.00$804,543.00$804,543.00$1,804,543.00
4277$11,435.00$836,577.00$836,577.00$1,836,577.00
4378$11,435.00$868,482.00$868,482.00$1,868,482.00
4479$11,435.00$900,103.00$900,103.00$1,900,103.00
4580$11,435.00$931,024.00$931,024.00$1,931,024.00
4681$11,435.00$962,650.00$962,650.00$1,962,650.00
4782$11,435.00$994,339.00$994,339.00$1,994,339.00
4883$11,435.00$1,026,179.00$1,026,179.00$2,026,179.00
4984$11,435.00$1,058,197.00$1,058,197.00$2,058,197.00
5085$11,435.00$1,090,431.00$1,090,431.00$2,090,431.00
5186$11,435.00$1,122,677.00$1,122,677.00$2,122,677.00
5287$11,435.00$1,154,561.00$1,154,561.00$2,154,561.00
5388$11,435.00$1,186,053.00$1,186,053.00$2,186,053.00
5489$11,435.00$1,217,481.00$1,217,481.00$2,217,481.00
5590$11,435.00$1,248,476.00$1,248,476.00$2,248,476.00
5691$11,435.00$1,279,259.00$1,279,259.00$2,279,259.00
5792$11,435.00$1,309,806.00$1,309,806.00$2,309,806.00
5893$11,435.00$1,340,536.00$1,340,536.00$2,340,536.00
5994$11,435.00$1,371,776.00$1,371,776.00$2,371,776.00
6095$11,435.00$1,404,350.00$1,404,350.00$2,404,350.00
6196$11,435.00$1,439,392.00$1,439,392.00$2,439,392.00
6297$11,435.00$1,472,410.00$1,472,410.00$2,472,410.00
6398$11,435.00$1,503,602.00$1,503,602.00$2,503,602.00
6499$11,435.00$1,532,884.00$1,532,884.00$2,532,884.00
65100$11,435.00$1,559,766.00$1,559,766.00$2,559,766.00
66101$0.00$1,572,191.00$1,572,191.00$2,572,191.00
67102$0.00$1,581,565.00$1,581,565.00$2,581,565.00
68103$0.00$1,588,068.00$1,588,068.00$2,588,068.00
69104$0.00$1,592,066.00$1,592,066.00$2,592,066.00
70105$0.00$1,593,929.00$1,593,929.00$2,593,929.00
71106$0.00$1,593,842.00$1,593,842.00$2,593,842.00
72107$0.00$1,590,212.00$1,590,212.00$2,590,212.00
73108$0.00$1,582,933.00$1,582,933.00$2,582,933.00
74109$0.00$1,572,603.00$1,572,603.00$2,572,603.00
75110$0.00$1,559,261.00$1,559,261.00$2,559,261.00
76111$0.00$1,542,964.00$1,542,964.00$2,542,964.00
77112$0.00$1,524,138.00$1,524,138.00$2,524,138.00
78113$0.00$1,502,677.00$1,502,677.00$2,502,677.00
79114$0.00$1,478,466.00$1,478,466.00$2,478,466.00
80115$0.00$1,451,388.00$1,451,388.00$2,451,388.00
81116$0.00$1,421,322.00$1,421,322.00$2,421,322.00
82117$0.00$1,389,974.00$1,389,974.00$2,389,974.00
83118$0.00$1,357,288.00$1,357,288.00$2,357,288.00
84119$0.00$1,323,208.00$1,323,208.00$2,323,208.00
85120$0.00$1,287,675.00$1,287,675.00$2,287,675.00
86121$0.00$1,250,626.00$1,250,626.00$2,250,626.00

The face amount of insurance is $1 million, just as the previous option, but this time cash value is added to the death benefit amount, which allows it to grow over time.

Here's how that affects the total costs of the policy:

YEARNET ANNUAL PREMIUMNET CASH VALUETOTAL NET DEATH BENEFITTRUE CALCULATED ANNUAL POLICY COSTS
1$11,693.00$1,351.00$1,006,796.00$10,422.55
2$11,693.00$9,079.00$1,014,251.00$4,506.29
3$11,693.00$17,092.00$1,021,993.00$4,699.03
4$11,693.00$25,380.00$1,030,008.00$4,918.16
5$11,693.00$33,959.00$1,038,315.00$5,138.64
6$11,693.00$44,532.00$1,048,616.00$3,775.00
7$11,693.00$55,470.00$1,059,281.00$4,062.13
8$11,693.00$66,769.00$1,070,308.00$4,374.77
9$11,693.00$78,433.00$1,081,700.00$4,705.18
10$11,693.00$90,458.00$1,093,453.00$5,061.11
11$11,693.00$104,602.00$1,107,324.00$3,785.38
12$11,693.00$119,156.00$1,121,607.00$4,243.09
13$11,693.00$134,143.00$1,136,321.00$4,703.62
14$11,693.00$149,588.00$1,151,494.00$5,166.45
15$11,693.00$165,488.00$1,167,122.00$5,659.41
16$11,693.00$181,868.00$1,183,229.00$6,155.99
17$11,693.00$198,688.00$1,199,777.00$6,718.80
18$11,693.00$215,969.00$1,216,786.00$7,288.09
19$11,693.00$233,707.00$1,234,252.00$7,888.63
20$11,693.00$252,185.00$1,252,185.00$8,250.29
21$11,693.00$270,578.00$1,270,578.00$9,431.88
22$11,693.00$289,429.00$1,289,429.00$10,097.78
23$11,693.00$308,679.00$1,308,679.00$10,846.47
24$11,693.00$328,202.00$1,328,202.00$11,737.43
25$11,693.00$347,848.00$1,347,848.00$12,785.73
26$11,693.00$371,570.00$1,371,570.00$10,124.04
27$11,693.00$396,078.00$1,396,078.00$10,799.20
28$11,693.00$421,381.00$1,421,381.00$11,512.77
29$11,693.00$447,353.00$1,447,353.00$12,392.22
30$11,693.00$473,956.00$1,473,956.00$13,347.30
31$11,693.00$501,037.00$1,501,037.00$14,483.87
32$11,693.00$528,865.00$1,528,865.00$15,395.98
33$11,693.00$557,352.00$1,557,352.00$16,435.37
34$11,693.00$586,543.00$1,586,543.00$17,471.74
35$11,693.00$616,310.00$1,616,310.00$18,670.46
36$11,693.00$646,599.00$1,646,599.00$19,954.29
37$11,693.00$677,448.00$1,677,448.00$21,233.51
38$11,693.00$708,689.00$1,708,689.00$22,704.10
39$11,693.00$740,367.00$1,740,367.00$24,155.74
40$11,693.00$772,448.00$1,772,448.00$25,665.42
41$11,693.00$804,543.00$1,804,543.00$27,564.92
42$11,693.00$836,577.00$1,836,577.00$29,535.79
43$11,693.00$868,482.00$1,868,482.00$31,566.97
44$11,693.00$900,103.00$1,900,103.00$33,736.22
45$11,693.00$931,024.00$1,931,024.00$36,279.73
46$11,693.00$962,650.00$1,962,650.00$37,460.28
47$11,693.00$994,339.00$1,994,339.00$39,286.58
48$11,693.00$1,026,179.00$2,026,179.00$41,033.88
49$11,693.00$1,058,197.00$2,058,197.00$42,764.80
50$11,693.00$1,090,431.00$2,090,431.00$44,470.59
51$11,693.00$1,122,677.00$2,122,677.00$46,381.10
52$11,693.00$1,154,561.00$2,154,561.00$48,644.03
53$11,693.00$1,186,053.00$2,186,053.00$50,913.58
54$11,693.00$1,217,481.00$2,217,481.00$52,851.32
55$11,693.00$1,248,476.00$2,248,476.00$55,132.25
56$11,693.00$1,279,259.00$2,279,259.00$57,179.53
57$11,693.00$1,309,806.00$2,309,806.00$59,236.75
58$11,693.00$1,340,536.00$2,340,536.00$60,885.87
59$11,693.00$1,371,776.00$2,371,776.00$62,238.40
60$11,693.00$1,404,350.00$2,404,350.00$62,846.47
61$11,693.00$1,439,392.00$2,439,392.00$62,467.68
62$11,693.00$1,472,410.00$2,472,410.00$66,460.21
63$11,693.00$1,503,602.00$2,503,602.00$70,145.88
64$11,693.00$1,532,884.00$2,532,884.00$73,801.68
65$11,693.00$1,559,766.00$2,559,766.00$77,804.38
66$0.00$1,572,191.00$2,572,191.00$81,309.16
67$0.00$1,581,565.00$2,581,565.00$84,919.04
68$0.00$1,588,068.00$2,588,068.00$88,177.75
69$0.00$1,592,066.00$2,592,066.00$90,921.11
70$0.00$1,593,929.00$2,593,929.00$93,167.18
71$0.00$1,593,842.00$2,593,842.00$95,112.00
72$0.00$1,590,212.00$2,590,212.00$98,438.58
73$0.00$1,582,933.00$2,582,933.00$101,653.60
74$0.00$1,572,603.00$2,572,603.00$104,088.73
75$0.00$1,559,261.00$2,559,261.00$106,305.28
76$0.00$1,542,964.00$2,542,964.00$108,288.65
77$0.00$1,524,138.00$2,524,138.00$109,695.24
78$0.00$1,502,677.00$2,502,677.00$111,050.73
79$0.00$1,478,466.00$2,478,466.00$112,357.27
80$0.00$1,451,388.00$2,451,388.00$113,609.88
81$0.00$1,421,322.00$2,421,322.00$114,805.34
82$0.00$1,389,974.00$2,389,974.00$114,218.37
83$0.00$1,357,288.00$2,357,288.00$113,607.63
84$0.00$1,323,208.00$2,323,208.00$112,969.78
85$0.00$1,287,675.00$2,287,675.00$112,304.29
86$0.00$1,250,626.00$2,250,626.00$111,611.43

Because the cash value is being added to the face amount instead of helping to replace it, the cost of maintaining the insurance increases. This also results in a lower total net cash value, lower total death benefit, and total cumulative internal charges of about $3.8 million.

In general, trying to have both insurance and savings/cash value is more expensive than using the cash value to replace the pure insurance amount (as is done in Option A and also in whole life insurance).

Equity-Indexed Universal Life (Option A)

Equity-indexed universal life is an equity-linked universal life insurance product. It is not a direct investment in the stock market. More on that in a moment.

This is the hottest universal life product on the market right now, and it doesn't show signs of stopping. The product itself is driven by a precise mix of bonds and index options contracts (which is explained in more detail in the Crediting Rates And Options In Universal Life section below).

When illustrating these products, life insurance agents tend to be a little too… how shall I say this… "optimistic." Most indexed universal life insurance illustrations need to take a "chill pill" and bring those illustrated rates back to reality.

Here's what I mean:

When you see indexed life products being illustrated, usually you see agents use 6%, 7%, or even 8% or more as the illustrated rate.

This is way too high.

How do we know it's too high?

Because… in general, life insurance companies are not earning quite that much (overall) on their indexed universal life portfolio.

Bobby Samuelson, former MetLife (now Brighthouse) Senior Vice President and head of product development and pricing for life and annuity contracts, has extensive experience in the indexed life marketplace. He is also an independent consultant for major life insurers in the indexed UL space, guiding insurers on product design and pricing.

The reason I bring this up is because he has said, on numerous occasions, that when illustrating indexed life insurance, keep expectations in line with what the product actually is.

His recommendation? Illustrate indexed universal life at 1% over current assumption rates. His reasoning is pretty straightforward. At its core, indexed universal life insurance is a fixed life insurance product (or, in industry jargon, a "general account product."). As such, it functions more like a current assumption or fixed universal life than it does a variable universal life or an index fund (or some other equity product).

According to Samuelson, these products may perform between 25 and 50 basis points (0.25% to 0.50%) over a current assumption universal life product.

Even with high cap rates over 13%, Samuelson's recommendation is to illustrate at 1% over current assumption UL (which would set the illustrated rate at 5.25%), which is what I did here:

YearAgePremium OutlayPolicy ValueCash Surrender ValueDeath Benefit
136$11,435.00$6,030.00$0.00$1,000,000.00
237$11,435.00$12,788.00$4,137.00$1,000,000.00
338$11,435.00$19,900.00$12,318.00$1,000,000.00
439$11,435.00$27,365.00$20,853.00$1,000,000.00
540$11,435.00$35,209.00$29,766.00$1,000,000.00
641$11,435.00$45,497.00$41,123.00$1,000,000.00
742$11,435.00$56,294.00$52,989.00$1,000,000.00
843$11,435.00$67,624.00$65,388.00$1,000,000.00
944$11,435.00$79,507.00$78,341.00$1,000,000.00
1045$11,435.00$91,960.00$91,960.00$1,000,000.00
1146$11,435.00$107,045.00$107,045.00$1,000,000.00
1247$11,435.00$122,888.00$122,888.00$1,000,000.00
1348$11,435.00$139,538.00$139,538.00$1,000,000.00
1449$11,435.00$157,102.00$157,102.00$1,000,000.00
1550$11,435.00$175,630.00$175,630.00$1,000,000.00
1651$11,435.00$195,710.00$195,710.00$1,000,000.00
1752$11,435.00$216,909.00$216,909.00$1,000,000.00
1853$11,435.00$239,257.00$239,257.00$1,000,000.00
1954$11,435.00$262,824.00$262,824.00$1,000,000.00
2055$11,435.00$287,644.00$287,644.00$1,000,000.00
2156$11,435.00$313,761.00$313,761.00$1,000,000.00
2257$11,435.00$341,273.00$341,273.00$1,000,000.00
2358$11,435.00$370,272.00$370,272.00$1,000,000.00
2459$11,435.00$400,923.00$400,923.00$1,000,000.00
2560$11,435.00$433,322.00$433,322.00$1,000,000.00
2661$11,435.00$467,562.00$467,562.00$1,000,000.00
2762$11,435.00$503,812.00$503,812.00$1,000,000.00
2863$11,435.00$542,187.00$542,187.00$1,000,000.00
2964$11,435.00$582,849.00$582,849.00$1,000,000.00
3065$11,435.00$625,995.00$625,995.00$1,000,000.00
3166$11,435.00$671,856.00$671,856.00$1,000,000.00
3267$11,435.00$720,677.00$720,677.00$1,000,000.00
3368$11,435.00$772,753.00$772,753.00$1,000,000.00
3469$11,435.00$828,408.00$828,408.00$1,000,000.00
3570$11,435.00$887,927.00$887,927.00$1,029,995.00
3671$11,435.00$951,042.00$951,042.00$1,093,698.00
3772$11,435.00$1,017,949.00$1,017,949.00$1,150,282.00
3873$11,435.00$1,088,918.00$1,088,918.00$1,208,699.00
3974$11,435.00$1,164,262.00$1,164,262.00$1,269,046.00
4075$11,435.00$1,244,348.00$1,244,348.00$1,331,452.00
4176$11,435.00$1,329,642.00$1,329,642.00$1,396,125.00
4277$11,435.00$1,419,831.00$1,419,831.00$1,490,822.00
4378$11,435.00$1,515,168.00$1,515,168.00$1,590,926.00
4479$11,435.00$1,615,912.00$1,615,912.00$1,696,708.00
4580$11,435.00$1,722,319.00$1,722,319.00$1,808,435.00
4681$11,435.00$1,834,643.00$1,834,643.00$1,926,375.00
4782$11,435.00$1,953,108.00$1,953,108.00$2,050,764.00
4883$11,435.00$2,077,969.00$2,077,969.00$2,181,867.00
4984$11,435.00$2,209,459.00$2,209,459.00$2,319,932.00
5085$11,435.00$2,347,787.00$2,347,787.00$2,465,176.00
5186$11,435.00$2,493,310.00$2,493,310.00$2,617,976.00
5287$11,435.00$2,646,003.00$2,646,003.00$2,778,303.00
5388$11,435.00$2,805,977.00$2,805,977.00$2,946,275.00
5489$11,435.00$2,973,312.00$2,973,312.00$3,121,977.00
5590$11,435.00$3,148,121.00$3,148,121.00$3,305,528.00
5691$11,435.00$3,330,530.00$3,330,530.00$3,497,056.00
5792$11,435.00$3,525,643.00$3,525,643.00$3,666,668.00
5893$11,435.00$3,735,381.00$3,735,381.00$3,847,443.00
5994$11,435.00$3,961,952.00$3,961,952.00$4,041,191.00
6095$11,435.00$4,207,843.00$4,207,843.00$4,249,922.00
6196$11,435.00$4,467,963.00$4,467,963.00$4,512,643.00
6297$11,435.00$4,750,920.00$4,750,920.00$4,755,671.00
6398$11,435.00$5,051,035.00$5,051,035.00$5,056,086.00
6499$11,435.00$5,369,392.00$5,369,392.00$5,374,761.00
65100$11,435.00$5,707,098.00$5,707,098.00$5,712,805.00
66101$0.00$6,054,131.00$6,054,131.00$6,060,185.00
67102$0.00$6,422,248.00$6,422,248.00$6,428,670.00
68103$0.00$6,812,727.00$6,812,727.00$6,819,540.00
69104$0.00$7,226,926.00$7,226,926.00$7,234,153.00
70105$0.00$7,666,284.00$7,666,284.00$7,673,950.00
71106$0.00$8,132,328.00$8,132,328.00$8,140,460.00
72107$0.00$8,626,679.00$8,626,679.00$8,635,305.00
73108$0.00$9,151,055.00$9,151,055.00$9,160,206.00
74109$0.00$9,707,281.00$9,707,281.00$9,716,988.00
75110$0.00$10,297,294.00$10,297,294.00$10,307,591.00
76111$0.00$10,923,147.00$10,923,147.00$10,934,070.00
77112$0.00$11,587,014.00$11,587,014.00$11,598,601.00
78113$0.00$12,291,209.00$12,291,209.00$12,303,500.00
79114$0.00$13,038,186.00$13,038,186.00$13,051,224.00
80115$0.00$13,830,544.00$13,830,544.00$13,844,375.00
81116$0.00$14,671,039.00$14,671,039.00$14,685,710.00
82117$0.00$15,562,601.00$15,562,601.00$15,578,164.00
83118$0.00$16,508,347.00$16,508,347.00$16,524,856.00
84119$0.00$17,511,570.00$17,511,570.00$17,529,082.00
85120$0.00$18,575,764.00$18,575,764.00$18,594,340.00
86121$0.00$19,969,309.00$19,969,309.00$19,989,278.00

As you can see, the product performs slightly better than a current assumption universal life policy under these hypothetical crediting rates, which… is exactly what it's supposed to do. Anything over 6% in this current interest rate environment is probably unrealistic.

Now… why do these UL policies perform the way they do?

A lot of that has to do with the way the interest crediting works on these things.

Crediting Rates And Options In Universal Life

How Interest Gets Credited To A Universal Life Policy

The Interest Sensitive Rate (AKA "Current Assumption") -

The one. The only. The crediting rate that started it all.

Interest sensitive universal life credits interest to cash values, in part, by pegging cash value performance to current market interest rates. As these rates fluctuate, the universal life policy's cash value may be credited with more or less interest.

This method worked out great in the 1980s because interest rates were absolutely amazing. But… it's not nearly as popular as it once was because of the fact that interest rates have fallen for the past 37 years and have remained too low to make this type of policy attractive to buyers.

So… insurance companies put their focus elsewhere.

Today, interest sensitive policies have been relegated to no-lapse guaranteed products, where the insurance company will guarantee the death benefit payment, regardless of cash values, as long as all scheduled no-lapse guarantee premiums are paid on time and the no-lapse guarantee provision is active or in place.

This is the only exception to the rule that a $0 cash value balance will cause a policy lapse. You can literally have no cash value, and the insurer will keep your policy in force forever as long as the policy's no-lapse guarantee provision is still active on the policy. Again, you must pay the insurer's required no-lapse guarantee premium amount and maintain the no-lapse rider and comply with the rules regarding policy loans and withdrawals to get this deal.

The Variable Interest Rate

Universal life may also be credited with interest tied to the performance of subaccounts, which are similar - almost identical to - mutual funds.

The insurer may allow part or all of the premium to be invested directly into the stock market through these subaccounts. You can choose which accounts you want to invest in, and usually you are able to change your accounts and perform fairly intricate asset allocation within the policy whenever you want with minimal or no additional fees.

But… take heed.

The separate account is different from the insurer's general investment account and is not guaranteed against loss. Because of this, variable interest earnings in universal life can cause cash values to fluctuate both up and down and may put you at risk of losing some or all of your cash value and death benefit.

If you want to know more about investing and how rates of return work, check out The Truth About Investment Returns section of this guide.

The Equity-Indexed Rate -

This is probably the single most-popular type of universal life insurance on the market today.

An equity-indexed strategy requires the insurer to take full control over the investment strategy. You are paid based only on the upward movement of a stock market index. All market losses are ignored.

Some insurance companies also offer indices that let you capture gains based on market downturns, incorporate volatility control in an attempt to smooth out crediting rates to cash values, and other more complex crediting strategies which affect cash value growth in different ways.

The insurer is able to do all this by using a very precise mix of bonds and index call options. With an equity-indexing strategy, you are not credited with dividends on the underlying index. Instead, the insurer pays interest based on a proprietary or non-proprietary crediting formula.

If the underlying index options are profitable, they will credit your policy with interest based on their profit, up to a cap (which is specified in the contract). Insurers can also limit interest credited using participation rates, which limit your participation in the underlying stock market index.

If this sounds like a complicated method of crediting interest to your cash values, it's because it is.

Very complex.

So complex that almost no life insurer actually retains the risk themselves. Instead, they buy stock options that make this strategy possible and push the equity risk onto an investment bank.

Since there are only a handful of major investment banks in the world capable of servicing a life insurance company and the massive amounts of premium dollars flowing through their accounts, every insurer is essentially doing business with the same investment banks and counterparties when they do these deals.

To understand how equity indexing works, it's helpful to get a handle on some of the "lingo" used by agents and insurance companies.

The Index

An index represents a number used to measure the general behavior of stock prices by measuring the current price behavior of a representative group of stocks in relation to a base value. The Dow Jones, for example, measures 30 of the largest and most established companies in America; often referred to as "blue chip" companies. It consists of companies like Walt Disney, Wal-Mart, and Microsoft. The S&P 500, on the other hand, measures 500 large cap companies, most of which are American.

To make an equity indexed contract work, there needs to be two components: bonds (or bond-like instruments) and index call options.

A bond is a debt instrument - a loan if you will - made by the Government or a corporation to another party, usually an institution like a bank or a life insurance company. These pay a fixed rate of return. If the bond is going to pay (i.e. if the debtor - the Government or the corporation - does not default on the bond) it will pay the stated interest rate. There is no variance in what it pays.

Next is the call option.

The Call (or Put) Option

An index call option is a stock option. A stock option is the right - but not the obligation - to buy or sell stock for a preset price (which is set when the option is purchased).

There are two types of options: put options and call options.

A put option is the right to sell stock at a preset price, and a call option is the right to buy stock at a preset price. So, for example, if you thought that a company's stock was set to gain value, but you weren't 100% sure that it would, you could buy a call option for much less than buying the actual stock.

Conversely, if you thought a company's stock was set to plummet, then you might buy a put option.

Why buy stock options?

Simple.

With options, you are able to control a large amount of stock with very little money up front. You don't actually own the stock and you don't ever have to buy the stock, which is what gives you protection if the stock doesn't do as well as you expected.

However, there is an expiration date for every option. And, the longer the expiration date, the more expensive the option will cost (i.e. a 3 month call option may cost $500, but a 1 year call option may cost $750).

An index call option is a call option on a stock index - usually the S&P500 stock index. But, it could be on any stock index.

Some insurance companies use call options on the S&P, the Dow, and even international indices. And, sometimes, an insurance company will buy put options if they want to offer policyholders the opportunity to gain from a downward movement in an index.

Insurance companies are able to use a very precise mix of bonds (to guarantee the contract owner's principal plus a small amount of appreciation) and index call (or put) options (to capture the upside potential of the stock market) to produce a new type of contract that gives the contract owner the upside potential of the stock market, without any of the downside risks associated with a direct investment in the stock market.

The insurance company purchases the index call options through counterparties to ensure that all of the obligations of the index contract can be fulfilled. This is known as "hedging".

When an insurer hedges its risk, they are essentially moving that money out of their own general account and pushing the risk onto another company to fulfill the promises of their contract.

While equity indexed contracts do provide a guaranteed minimum interest rate, the guaranteed rate is usually weaker than in traditional 'declared rate' contracts, like fixed universal life or whole life, but this is because the focus is on the upside potential of the contract and not the guaranteed rates.

If fixed rates are higher or comparable to indexed returns and you would like to take advantage of fixed rates inside of an indexed UL, some contracts provide the option to switch to fixed rate returns that mirror current interest rates.

Life insurance agents love to tout the benefits of equity indexing because it feels like investing in the stock market without actually investing.

The reality is there is no free lunch.

Insurers aren't dummies. And, they will not lose money on these non-guaranteed products.

They price these contracts with caps and participation rates to control their risk.

Caps And Participation Rates

A cap is exactly what it sounds like. If an insurer sets an annual cap at 12%, it means you can never earn more than 12% per year in that policy. So, if the market delivers 15% returns, and your policy's annual cap is 12%, you earn… 12%.

That's it. Where does the rest go? It goes nowhere.

The call option only pays out the underlying index's return in excess of the strike price. If the price of the underlying index doesn't increase beyond the stock option's strike price, then the insurer absorbs the loss. But, the insurer hedges their risk by using some of the policyholder's cash value to buy a 1-year call option on the underlying stock index which is struck at the minimum return.

If the minimum guaranteed return in the insurance policy is 2%, then the insurer buys a 1-year call option struck at that minimum return. They then sell a similar stock option struck at the maximum return. So… if the cap on the policy is 12%, then the insurer buys an options contract struck at 12%.

Caps are usually designed with a minimum and a maximum. In some cases, the insurer will not set a maximum but instead will charge a spread. A spread is similar to a fee charged against any gains you make in the contract. So, if the equity-indexed crediting option generates a 12% return, but there is a 2% spread, then the net return credited to the policy's cash value is 10%.

Minimum annual caps (the lowest the insurer can set the cap) is usually between 3% and 5%. So, an insurance company could lower your cap from 12% to 7% or 5% if it wanted to. Insurers can also set monthly caps, which cap out your monthly earnings.

In addition to this, insurance companies set participation rates. A participation rate determines how much of the gain you receive from the call options.

A 100% participation rate is typical, meaning you get the full benefit of the options contract, but some insurers have minimum participation rates of 75% or less.

Is it too good to be true?

There is no magic, only magicians, as they say.

Once again, insurance companies all fish from the same basic investment pool. They all buy their call options from the same counterparties. Meaning, no one can offer an unusually high cap or participation rate.

And… if an agent does show you a "stellar" policy performance, there are a few reasons why this might happen.

First, agents can manipulate the crediting rate in the illustration software, showing minimum and maximum interest rates. Sometimes, the maximum interest rate is - how shall I say this - unrealistic.

Illustration software for these types of policies use "backtesting," meaning they look back over historical returns of the stock market to determine what crediting rate will be applied to current policy illustrations.

This is no bueno.

Historical returns are not a good way to assess the current market environment because… a lot of things change over time. For example, in the 1980s, interest rates were very high. This had a profound effect on bonds and stocks.

Today's relatively low interest rate environment has a completely different effect on the stock and bond market and thus… those past returns of the 1980s cannot be used with any sort of accuracy in determining hypothetical current or future returns.

At best, historical returns can be used to devise probability scenarios for future market returns and thus potential future crediting rates, or the potential for future interest crediting.

Another factor that affects the returns possible with an equity-indexed universal life (and indexed annuity) policy is the cost of the options themselves. As equity indexed universal life becomes more popular (it is currently the most popular type of permanent life insurance and gaining in popularity), the cost of the underlying stock options which drive the product become more expensive due to the increased demand for those particular kinds of stock options.

Cost are also affected by interest rates. As insurers costs for financing the cost of buying the stock options increases, the total cost for implementing the equity-indexing strategy increases. Those costs ultimately get passed on to policyholders, either through lower caps and participation rates or higher internal policy charges.

And yet, most every insurance company's illustration software still uses backtesting as a hypothetical return assumption.

Other times, life insurance companies will show high cap and participation rates - higher than market averages - because they are charging higher internal policy charges. In effect, the insurer is subsidizing the higher cap and participation rate with higher policy charges.

This is the most obvious way life insurers can show higher crediting rates. If your policy charges are 2% higher than a fixed interest account, the insurer may be able to show a 1.5% or maybe even 1.75% higher potential crediting rate.

As a general rule, life insurers assume a high profit margin on their index options to make these policies work. In some cases, a profit assumption of 50% is used.

With Actuarial Guideline 49 (AG49), insurers are somewhat limited as to how high they (and agents) can illustrate cash value growth, but some insurers have a workaround: index crediting bonuses and multipliers.

A multiplier or bonus allows insurers to show higher crediting rates by multiplying the final index crediting by a "multiplier". For example, if an insurer might normally credit cash values with 6% interest, it can use a 125% multiplier to show a 7.5% interest crediting rate, exceeding the AG49 industry standard because multipliers and bonuses are not restricted by the actuarial guidelines.

These higher index credits are usually funded by some sort of fee or expense charge embedded in the policy. The net effect might be that you get a higher net cash value but it might also not have any effect or cause lower crediting than what you otherwise might get from an indexed UL policy without multipliers or bonuses.

The Bottom Line On Indexed UL Interest Crediting

So… what should you reasonably expect out of an indexed crediting strategy?

Indexed crediting strategies can reasonably earn up to 50 basis points (0.50%) over a fixed-interest account (currently between 3% and 4%). They could, of course, earn more than that, but most insurers - on average - are not showing above-average earnings rates on their indexed crediting strategies.

This is unfortunate because most - if not all - of the indexed universal life insurance being sold today functions best when it can earn between 6% and 8% interest from the equity indexing crediting strategy. But, the probability of staying in this rate of return range over the long-term is low.

Because this strategy is highly dependent on index options, it creates significant dependency on stock market growth rates, options pricing, interest rates, carrier hedging strategies, and carrier administration.

Accessing Cash Value In A Universal Life Policy

Options For Accessing Your Cash Value

As mentioned earlier, you may withdraw money from your cash value directly.

But, you can also borrow against the value of your policy at interest.

Because surrenders or withdrawals are permanent changes to the policy, most policyholders use policy loans prior to retirement. Policy loans are tax-free as long as the policy remains in-force and it does not result in a permanent reduction in the death benefit or cash values.

What is a policy loan?

Good question.

Instead of reducing policy values, a policy loan is a secured or collateralized loan against the value of the life insurance policy. You may take as many loans as you want, up to the full loan value of your cash value, which is typically between 80% and 90% of the net cash surrender value (the value you would get if you completely surrendered your policy for cash).

Each loan is automatically consolidated with previous loans, making policy loans -in effect - one single loan. You can, of course, keep each loan segregated in your own personal accounting or budgeting system but the insurance company will not do this for you.

Because it's a loan, the insurance company charges interest.

The interest method used, however, differs from what most conventional lenders use. Instead of a daily compounding interest calculation, interest accrues daily against the outstanding balance of the loan and functions very similarly to a revolving line of credit.

The only exception to this is if you choose to not repay the loan (which is also an option) in which case the interest is either payable out of pocket or gets added to the loan principal at the end of the year and starts to compound over time if you continue to not repay outstanding policy loans (not a great idea but also not detrimental in most cases).

If you make regular loan payments, it effectively reduces the total interest you pay over the course of the loan and lowers your net effective APR.

For example, if you take out a $10,000 policy loan at an APR of 5%, but repay the loan over 12 months, half the principal amount is paid after 6 months, reducing the amount of interest paid to the insurer. Ordinarily, you would pay $500 in interest at an APR of 5%, but in this scenario, you may only pay $250.

This increases borrowing efficiency, making it difficult to get a better deal elsewhere. It also allows you to schedule retail or market-rate loan repayments to your insurance company and add excess interest payments to your policy's cash value. More on that in a moment.

Interest rates vary, but are usually well below market rates. Policies with preferred loan options typically have a gross loan interest rate of between 5% and 8% but insurers usually try to match the loan rate to the dividend rate (or partially offset the policy loan rate with the dividend rate), either through direct or non-direct recognition, thus creating a net loan cost which is less than 2% and sometimes 0%.

Unlike market-rate loans, there is no credit check (and no "dinging" of your credit) with a life insurance policy loan. It will not show up on your credit report and does not affect any other credit-based or credit-dependent product or service, like auto insurance or credit card APRs. Policy loans are guaranteed issue loans, meaning you cannot be turned down so long as you have cash value available to secure the loan.

And, they do not need to be repaid on a set schedule.

Fixed Rate, Indexed, Variable Rate, Or Net Zero Cost Policy Loans

Universal life policies usually offer either a fixed or a variable rate, with indexed universal life offering the much-vaunted indexed loan rate.

The Fixed Rate

A fixed rate is exactly what it sounds like. It's a fixed interest rate, which remains fixed for the life of the policy.

The Variable Rate

The variable rate can change (though it doesn't always) and is usually tied to a bond index, like Moody's. As the current interest rates in the market change, the insurer has the option, but not the obligation, to change its policy loan rate.

Some contracts stipulate the insurer must change the loan rate, while other contracts specify the option to change the loan rate by specified interest rate steps or "jumps."

The Indexed Rate

The indexed rate allows the insurance company to charge a higher interest rate on loans than a fixed rate loan. In exchange for this, the insurer agrees to keep paying the equity-indexed crediting rate while the policyowner has an outstanding loan. If the equity-indexed crediting rate is higher than the loan rate, then the loan has an effective negative cost.

However, if the indexed rate is lower than the interest rate on the loan, the loan may cost much more than a fixed loan option.

The Net Zero Cost Loan

Preferred loans or "net zero cost" loans give policyholders the assurance that the insurer will credit interest equal to the loan interest they're being charged on the loan. The net effect is all money that is on loan stops earning a net positive interest rate, but it also doesn't cost the policyholder any money.

Control Of Repayment Schedules

Like whole life insurance, you have complete control over the repayment of your policy loans.

You can pay nothing, just the interest on the loan at the end of the year, $50 per month, $72 per month, some other arbitrary dollar amount per month toward just the loan principal, or create a fully amortized repayment schedule similar to what you'd get from a bank or credit union with the difference being your insurer will prioritize repayment of the loan principal over the interest payments.

You can schedule repayments similar to a fixed payment loan, a credit card, or some other revolving line of credit.

It's up to you.

At the end of the year, you will be billed for any interest. You can add it to your current policy loan and not pay it, add it to the current outstanding loan and pay it off, or pay the loan interest out of pocket.

Drawing Retirement Income From The Policy

A lot of indexed universal life policy illustrations are designed with basically one thing in mind: retirement income.

When drawing retirement income from these policies, a sustainable withdrawal and loan rate will depend entirely on the crediting rate and the policy loan rate.

A 2%-3% withdrawal and loan rate may be sustainable for most well-designed UL policies, but this ultimately depends on various factors including the policy's annual interest credits, the loan interest rate, and policy charges. Another option is to convert the policy's cash value to an annuity, which may be able to sustain a higher payout ratio (perhaps double, perhaps 2.5x higher in some cases).

Universal Life Insurance Riders And Options

Universal life insurance can also be modified with riders (which add additional features and benefits to the basic policy contract), like:

  • Extended Coverage Rider
  • Accelerated Death Benefit Rider
  • Disability Waiver of Premium Rider
  • Accidental Death Benefit Rider
  • Disability Income Rider
  • Guaranteed Purchase Option Rider

Each of these individual options can be combined to create a truly customized policy and… each combination can have dramatic long-term implications for your finances.

That's because every dollar you spend on insurance premiums is a dollar you cannot spend (or invest) elsewhere, so choosing the right product and features is really super-important so as to not screw yourself over later on in life.

Moving right along…

Common riders include:

Extended Coverage Rider

This rider option adds additional insurance coverage for a family member. It's kind of like getting 2 (or more) policies in 1. Most of the time, the coverage is extended to your spouse and children. The supplemental insurance death benefit has its own premium and terms and cannot be separated from the base term policy.

Terminal Illness Rider

More and more term policies are coming equipped with accelerated death benefits. This means you get to spend your death benefit before you die.

Of course, there's a catch (isn't there always?). For the terminal illness rider to kick in, you have to be expected to kick the bucket within 12 or 24 months. It's a way for you to enjoy your death benefit while you're still alive and go make peace with the world before your time is up.

Chronic Illness Rider

Similar to the terminal illness rider, this rider benefit lets you spend down some or all of your death benefit before you die. However, to exercise this rider, you have to suffer a heart attack, stroke, or have some other permanently disabling event.

Some policies will also allow you to use the death benefit to pay for long-term care costs, but you must be expected to need care for the rest of your life to qualify for the death benefit acceleration.

Some riders allow you to suffer non-permanent disabling events but this tend to be expensive for insurance companies to underwrite. So, most specify that your chronic illness be permanent.

And, as always, there's normally a flat-extra premium (extra charge) for the privilege.

This is usually a good option to include on a universal life policy.

Disability Waiver of Premium Rider

If you become disabled, the insurance company will waive the premium payments until you are back on your feet (up to the maximum payment allowance). Normally, this rider option is good for either a 3-year disability or a 6-year disability, with some companies offering a 2-year benefit or grade benefits depending on your age.

Most insurers also require you to be disabled for at least 6 months before they will waive the premium payments.

If you're concerned about disability, look for a company that offers "own occupation" definition of disability.

Most companies only offer "any occupation" definition of disability. The difference is… huge. With an "any occupation" definition of disability, the company will only waive premiums on your policy if you are unable to do any work at all. Meaning, if you can still pump gas at a gas station, you can still work or… if you can still sweep floors, flip burgers, or work for minimum wage, you won't qualify for disability coverage.

"Own occupation" means you cannot work in your primary occupation or line of work doing the exact same job you were doing before you became disabled. If you do some kind of skilled labor job, or own a business, or you're a high-level executive, this is usually the definition of disability you want to have from your insurance company.

It's more favorable to you and thus easier to get approved for the disability benefit if you ever need it.

Disability Income Rider

This rider is different from the premium waiver. Under this rider benefit, the insurer will actually make a cash payment directly to you if you become disabled, just like a regular disability income insurance policy. The same rules and caveats apply with regard to "any occupation" vs "own occupation" definition of disability.

Accidental Death Benefit Rider

This rider adds additional insurance to the basic policy which only pays out if you die as a result of an accident. Usually it's not worth it, but some people like the idea and get it, anyway.

Guaranteed Purchase Option Rider

Handy if you know you'll be purchasing more life insurance in the future.

This rider lets you buy more life insurance at specified ages without going through medical underwriting to prove your insurability. That means, if you get sick later on in life, you can still get life insurance.

There's usually a hefty fee for this option as you're basically putting the life insurance company on the hook for potentially high-risk coverage (high risk for them).

Supplemental Term Insurance Rider

Supplemental term insurance riders allow you to blend term insurance into a universal life policy, so your policy even more term insurance. Sometimes, you'll hear this described as "term blending."

Usually this is done to lower the overall cost of the policy, but, some savvy agents discovered that term blending also allowed more premium to be paid into the policy before hitting MEC limits, thus accelerating its cash value growth. Because the early year costs are low, more premium makes its way back into the policy's cash value and earns interest.

The net effect is rapid (and high) early year cash values. However, long-term cash values may or may not be higher than they otherwise would be and the long-term performance of the policy ultimately hinges on how the insurer prices the supplemental term rider.

Overloan Protection Rider

Many companies offer this on universal life and it's one of the most useful riders to have if you intend to use your policy for retirement income later on.

Usually, there's no cost to have it or use it.

What it does is… it prevents your policy from lapsing due to policy loans. Instead of lapsing, your policy will stay in-force and automagically convert into a "reduced paid-up" (RPU) policy if you have any outstanding policy loans which exceed 99% of your policy's cash value.

Sometimes there are restrictions, like… you have to be retired or over a certain age (e.g. 70 or 75) for this rider to be triggered. It's designed to protect you in your old age from an unwanted and accidental policy lapse and the resulting massive tax bill.

So… Are Any Of These Riders Useful?

The short answer is: Yes, definitely.

The slightly longer, more nuanced, answer is: It depends on your long-term financial plan.

Your universal life insurance policy configuration and supplemental riders or options come in handy if you need them. And, if you don't need them, then it's money wasted.

When Does Universal Life Insurance Make Sense?

Rarely, if ever.

As mentioned earlier, today's universal life insurance policies are riskier counterparts to whole life insurance. This isn't conjecture. They are actuarially (mathematically) riskier policy types.

Every universal life insurance policy (including the new indexed universal life policies) is an assumption-driven product with no explicit guaranteed cash value or death benefit. To the extent guarantees exist, it generally comes in the form of a no-lapse guarantee rider or policy benefit (which can be suspended under various conditions). Universal life policies share the same chassis, and have the same core features. They also share the same risks. 

Policyholders share the risk of loss with the life insurance company in exchange for some other benefit——no-lapse guaranteed death benefits, cash value performance tied to a market index, cash value performance tied to the stock market directly, or cash value performance tied to the non-guaranteed new money rates (interest rates), usually with a guaranteed minimum rate or "floor".

The hypothetical market for universal life is thin. In reality, most life insurance agents are selling universal life insurance (especially indexed universal life) by the boatload, and are using unrealistic assumptions given to them by their marketing department or directly from the insurer.

Because of its extremely complex nature, most clients never fully understand their universal life insurance policy or the nuances that determine its long-term performance (or lack thereof). Because of this, I rarely-to-never recommend universal life insurance to my clients. However, I am always watching the marketplace and reassessing the product to see if anything fundamentally changes about its risk profile and suitability for my clientele. 

In the final analysis, universal life policies are somewhat of a double-edged sword: the individual component parts are easy to see and understand. But, combined, they create a contract few truly understand or know how to use. In the end, that transparency can be (and often is) used to introduce complexity, where fees, expenses, and "trap doors" (yes, that's what they're actually called in the industry) hide in plain sight.

If you'd like to learn more about guaranteed life insurance policies (the type I design and sell to my clients), then please check out the sections on term life insurance and whole life insurance.