Universal Life Insurance - What's the Use?

"Googling" the phrase "universal life insurance" yields lots of quote engines, Wikipedia definitions, and articles discussing the benefits and costs of Universal Life. I recently read two of these articles, and they both warned the reader to avoid purchasing Universal Life insurance.

The first article pointed out that Universal Life is more expensive than Term Life, and that the opportunity cost of purchasing a Universal Life policy could be better placed into a 401K or tax-managed funds. The other article castigated Universal Life as a product marketed only to provide the agent of record with a higher commission check than that provided by Term Life. Both of these articles miss the point: What is the use of Universal Life?

Keeping matters simple, Universal Life is primarily useful for the following three situations: 1) term coverage for life, 2) estate tax planning, or 3) tax-free cash accumulation. Each of these situations requires unique strategies and products to achieve the desired objective. Respectively, the strategies are: 1) lowest premium, 2) flexible face amount, and 3) maximum cash accumulation. Accordingly, if you purchase the wrong product for your strategy, you will achieve less than satisfactory results.

Take a look at the case studies in the article below for examples of how life insurance products were used, both successfully and unsuccessfully, for clients in situation 1): term coverage for a specific period of time.

See our future articles on Indexed Universal Life and Premium Financing, featuring life insurance products used for tax-free cash accumulation.

Term or Universal Life Insurance?

Consider the case of Tim and Jenny, a young couple five months shy of delivering their first child. They’ve recently moved into their dream home, a spacious lot in a family neighborhood which cost them a pretty penny. While their combined wages will adequately support their 30 year mortgage, they worry about the prospect of falling into debt should the family retain just one breadwinner.

For Tim and Jenny, the low premium of a 30 year Term Life policy allows them to purchase much larger amounts of coverage than they would have otherwise hoped to afford. Term Life provides them income replacement and protection for their mortgage, while allowing room in their budget for additional financial investments. For Tim and Jenny, Term Life is the best alternative for achieving their financial goals: income replacement and protection against an existing lien for a specific period of time.

Let us now consider Ed: age 57 and three years away from retirement. Ed’s employer-provided life insurance policy will expire on his last day of employment. Ed’s children are fully grown, his mortgage is paid up, but he wants to leave $250,000 for his loved ones. Ed buys 20 year Term.

Although the 20 year Term policy was more affordable than Term to Age 100 (Universal Life), it may not have been the best choice for Ed, given his financial goal: namely, a guaranteed payout of the benefit. The fact is that over 95% of term life insurance policies never pay out a benefit.

If Ed lives to age 78, his 20 year Term policy will expire. The premiums for a new policy will have tripled just due to his increased age. Hopefully he will not incur an illness or disability that will make him unable to replace his policy at any cost. Ed faces the prospect of outliving his Term Life policy.

Life Insurance - What's the Return?

What return on investment can you expect from a life insurance policy? Actually, this question is misleading, because life insurance is not an investment in the traditional sense. The purpose of life insurance is usually to provide money for someone else, not for yourself. Beyond that, you must consider the purpose and time frame for the life insurance policy.

Term Life insurance should be obtained for a specific time period. Most likely, you are hoping for NO RETURN: you hope to outlive your coverage. Use Universal Life insurance when you need a GUARANTEED RETURN: you want the benefit to be paid, whether you die tomorrow or in 50 years.

Given these considerations, let's look at Ed's case. Currently, the best rates for a 57 year old, non-smoking male are $950 per year for 20 year

Term, and $3,060 per year for Universal. If Ed dies this year, his beneficiary will receive $250,000. No other financial product provides an immediate return of $250,000 on an investment of either $950 or $3,060.

After age 77, the return is zero for Term, but still $250,000 for Universal. Ed will have spent $61,200, which means that his GUARANTEED ROI is 308%, or 15% per year. Certainly, there are other financial products providing 15% per year, but only life insurance provides it immediately.

The lesson is that no financial product is "better" or "worse" than another, without considering your objectives. Every product has its own advantages and disadvantages. Understanding these differences is essential in determining the product that will best suit your personal financial goals.