So, your life insurance agent sold you a Universal Life (UL) insurance policy. You have no idea how it works, only that it has a “tax-deferred” investment account along with permanent life insurance. Sounds like a great idea, right? Maybe.
Many UL policies were sold in the ’80’s and ’90’s when interest rates were much higher than today and when getting a 6% – 10% return on a low risk investment was possible. The permanent insurance component of these policies was often set up as YRT (yearly renewable term). Term life insurance is the cheapest kind of insurance. This means the UL policy follows the mantra of some investment gurus who say “buy term and invest the rest”.
UL insurance works like this; Let’s say John, a 25 year old male bought a $100,000 UL policy in 1989. His agent showed him on the insurance illustration that his minimum premium was $50 per month. (There was a maximum premium offered, but why would anyone want to pay more than the minimum?) Of the $50 per month, $15 was to pay for the cost of insurance, and $35 was invested. The next year the cost of insurance was $16 per month and $34 per month was invested. The cost of insurance (YRT) increased every year, so the amount to be invested decreased each year. When John reaches age 60 his cost of insurance is $80 per month. Since he pays $50 per month, the difference will come out of the investment account. The problem is, instead of his investment account growing at 6% to 10% every year, there have been years of negative returns and years of very low returns. By the time John is is 75 there is no more money in the investment account. His choice is to pay thousands of dollars per year to continue the insurance coverage, or let the policy lapse.
I have met clients with UL policies from this era who had no idea that this could happen until they received the letter from the insurance company advising them of the policy lapse unless additional funds were paid. By then it is too late to change anything. If caught much sooner, there may have been solutions.
Today, any insurance company selling UL Insurance offers “Level Premium”(term to 100) as the insurance component. This means that whatever may happen to the investment in the policy, you will continue to have life insurance.