A 3-legged stool is great unless one of the legs is not aligned with the others. If they are not in perfect harmony then you’ll be severely off balance and tip over. This analogy describes some of the features of Universal Life(UL) and Variable Universal Life(VUL) policies.
These policies offer flexibility: flexible premiums, death benefits that can change, some control in how your funds are invested and more. Sounds great on the surface but the long-term question should be, can the stool stay balanced? To see we need to know what each leg of the stool is.
- Input of Premiums – The first leg is your input of premiums. UL & VUL policies do not require an annual premium to be made. In order to guarantee that the policy will not lapse you must continue to input premiums.
- Interest Earned – The interest earned on UL and VUL policies can vary widely. Life insurance companies tend to invest conservatively in order to ascertain the benefits they have guaranteed. Variable Universal Life Policies allow the policyholder to exercise some direction over the investing of the funds within the securities markets. Performance risk is then transferred to the policyholder where traditionally that risk was retained by the insurance company.
- Internal Costs - The insurance company has costs that get passed through to the policyholder in UL & VUL policies. The largest of these is typically the cost of insurance. As the cost of the internal term life insurance rises, that cost gets transferred to the policyholder. Again, traditionally this risk was retained by the insurance provider. Other costs include monthly administration fees, sales charges and monthly premium expenses. These expenses vary widely from policy to policy.
These are the legs but how can they get mis-aligned?
- Market Fluctuations – A typical illustration will show a rate of interest that must be earned every year the policy is in existence. But the market is not perfect. Underperforming years require greater performance in future years to breakeven. For example a 25% loss on $1000 leaves a balance of $750. In order for that $750 to grow back to $1,000 requires 33% rate of return. Market fluctuations reduce the interest earned and reduce the cash values within the policy. To prevent a lapse in the policy, additional premiums will have to be deposited. With a whole life policy a reduction in interest earned effects the cash values but with a UL policy it can also reduce the length of coverage.
- Policy Loans or Cash Withdrawals – Reducing the cash within the policy reduces the pool of funds that are used to pay the internal costs. Couple a need for cash with a period of reduced interest earnings, like we have seen in the past few years, and it can spell disaster for the policy. When the well runs dry it requires additional infusion of premiums.
Once these policies are in the hole, it gets pretty tough to dig them out.
So if you’re looking to buy a stool, look real hard and get some help. Many of the benefits also come with additional risk. And be sure to look into participating whole life policies. You’ll find all the traditional benefits, with added amounts of safety and peace of mind! After all how much flexibility should a stool have anyway?
Scott Storace
Tags: cash value, guarantee, life insurance, safety, whole life
[...] to the RSS feed for updates on this topic.Powered by WP Greet BoxA few weeks ago I wrote about 3-Legged Stools and the pitfalls of UL & VUL policies. This has been a rather hot topic, so I wanted to expand upon it this [...]