The Myth of the Rising Cost of Universal Life Insurance

For years, those who favor whole life insurance have told us that universal life insurance has an evil side.

The product with an optimal expense structure that affords the policyholder ample opportunity to adjust premiums as personal finances require also possesses the nasty cost of “shifting the risk back onto the policyholder,” thus (a favorite line of mine) “taking the sure out of insurance.”

This “awareness” campaign has enjoyed a certain degree of success. The number one concern about universal life insurance that we hear from those looking to buy a policy is the rising cost of insurance as they age.

Somehow, the companies that manufacture whole life insurance magically stop your probability of dying from increasing as you age.

Perhaps there is a fountain of youth in every home office. Maybe they dip the policy pages in it prior to sending it to you, and that’s why it takes them so long to arrive!

The Theory…

Just so we’re all clear, let’s start by laying out the “theory” about how universal life insurance works vis-à-vis the crippling expenses later on in a policy’s life.

I was a career agent at one of the big and well-known mutual life insurers where universal life insurance was a dirty word, so I know this story pretty well (sadly, I used to tell it).

Universal life insurance is nothing more than yearly increasing term insurance with a savings account.

So, long as you have enough money in the policy to pay for the rising cost of insurance (as well as a few other administrative fees), the policy will remain in force.

But…

Just like the seemingly out-of-control rising premium on level term insurance that has come out of its level period, universal life insurance has an exploding expense component that has ruined many a life insurance buyer’s policy as they aged.

Whole life insurance doesn’t suffer from this problem since the premiums are fixed from the beginning, and no rapidly rising cost of insurance can come along and bury your policy.

Oftentimes, a term insurance ledger/illustration (having nothing to do with universal life insurance and therefore priced on very different assumptions) is used to illustrate (more like overemphasize) the point.

…and the truth

The actual expense for universal life insurance comes from the net amount at risk.

This is the difference between the death benefit and the cash value. When properly designed for cash accumulation, the plan is to continuously minimize the net amount at risk to ensure minimal insurance expense under the regulations that stipulate the qualification features of life insurance.

Since this amount (the net amount at risk) is ever-decreasing in later years, the actual expense does not rise nearly as substantially as would be the case under a constant death benefit amount.

This example will help separate fact from fiction.

Example

Using an indexed universal life insurance policy sold to a 35-year-old male with a standard risk class funding at $35,000 per year to age 65 and using the policy to generate income from age 66 to age 100 (projected generated income assuming our regular 6% per year index credited interest rate is ~$172,000 per year), we see that the average cost of the insurance contract relative to the total cash value in the policy from age 66 to 100 is 0.23%.

That’s very slightly below one quarter of one percent.

For those who are interested, here’s the per year breakdown of the contract from ages 66-100:

Age COI Policy Fee Insurance Contract Costs Total Cash Value Contract Costs/Total Cash Value
66 $4,584 $60 $4,644 $2,745,361 0.17%
67 $5,051 $60 $5,111 $2,912,502 0.18%
68 $5,636 $60 $5,696 $3,088,999 0.18%
69 $6,188 $60 $6,248 $3,275,446 0.19%
70 $6,865 $60 $6,925 $3,472,305 0.20%
71 $7,586 $60 $7,646 $3,680,152 0.21%
72 $7,646 $60 $7,706 $3,900,328 0.20%
73 $7,623 $60 $7,683 $4,133,654 0.19%
74 $7,244 $60 $7,304 $4,381,288 0.17%
75 $6,536 $60 $6,596 $4,644,428 0.14%
76 $5,550 $60 $5,610 $4,924,292 0.11%
77 $6,583 $60 $6,643 $5,219,800 0.13%
78 $7,753 $60 $7,813 $5,531,745 0.14%
79 $9,119 $60 $9,179 $5,860,905 0.16%
80 $10,853 $60 $10,913 $6,207,928 0.18%
81 $12,388 $60 $12,448 $6,574,086 0.19%
82 $14,628 $60 $14,688 $6,959,795 0.21%
83 $17,169 $60 $17,229 $7,365,906 0.23%
84 $20,113 $60 $20,173 $7,793,218 0.26%
85 $23,518 $60 $23,578 $8,242,519 0.29%
86 $27,738 $60 $27,798 $8,714,272 0.32%
87 $33,165 $60 $33,225 $9,208,561 0.36%
88 $39,631 $60 $39,691 $9,725,643 0.41%
89 $46,807 $60 $46,867 $10,266,130 0.46%
90 $56,019 $60 $56,079 $10,829,293 0.52%
91 $66,659 $60 $66,719 $11,414,982 0.58%
92 $62,577 $60 $62,637 $12,039,732 0.52%
93 $54,599 $60 $54,659 $12,709,921 0.43%
94 $41,828 $60 $41,888 $13,433,249 0.31%
95 $23,084 $60 $23,144 $14,219,116 0.16%
96 $26,203 $60 $26,263 $15,048,724 0.17%
97 $559 $60 $619 $15,954,431 0.00%
98 $638 $60 $698 $16,914,289 0.00%
99 $724 $60 $784 $17,931,546 0.00%
100 $825 $60 $885 $19,009,642 0.00%

For what it’s worth, this specific contract has a 1% floor on the indexing account; at no point does the expense of the contract ever exceed 1% of the cash value in the policy (at it’s peak, it barely breaks one half of a percent).

Furthermore, if the indexing account does better than the assumed 6%, the ratio of expense to cash value goes down (i.e., it gets more favorable to the policyholder).

As we can see in the above example, the suggestion that universal life insurance expenses explode later in the insured’s life is a story based on an itty-bitty piece of truth (the cost per thousand of death benefit does rise) blown largely out of proportion in an attempt to scare people away from a perfectly good product.

Universal life insurance is not a ticking time bomb, but I suppose that story makes for a more interesting headline.

If you’d like to see how a universal life insurance policy might work for you, book a consultation with us.


4 Responses to “The Myth of the Rising Cost of Universal Life Insurance”

  1. Miriam says:

    Actually, I’ve recently started to worry about this. I was not aware my premiums would ever increase with age or CV accumulation, but my father-in-law was very depressed over recently having to let his policy go because his premiums rose to $800/month!! Now I am worried the same thing could happen to me. That’s the size of a small mortgage payment!! Do you have any idea about what could have gone wrong for him?

    • Brandon Roberts says:

      Hi Miriam,

      Yes, he underfunded the policy (i.e. the premium he was paying for a long time was no where near what it should have been for the death benefit he had on the policy). A number of universal life policies were sold as a cheap alternative to whole life insurance, which was a HUGE mistake.

      Unfortunately, once the time has passed the effect this has on the policy cannot be reversed. The policy holder can increase premiums or decrease death benefit if the premium increase is unaffordable. Had he been set up properly in the beginning (probably a conversation about what he realistically needed to be placing into the policy for the death benefit he had) this would not have happened.

  2. Wade Borth says:

    Yes the issue with this article and all UL products is that it shift risk from the insurance company to the client. In this case what if the policy doesn’t achieve 6% and the net amount at risk is higher in the older years, what if the COI, which the insurance companies can change, goes up? What if the client can’t fund to the level illustrated and the net amount of risk goes up and therefor actual cost of coverage goes up? Over 25 yrs I have sold both and understand both products and I prefer to have the company take the what ifs out of my life and participate in their profits.

    • Brandon Roberts says:

      Hi Wade,

      Unfortunately there is a lot of strawman in your comments. While it’s technically possible for net amount at risk to change that speaks to an entirely different universal life insurance design to the one discussed in this post. The death benefit option here is increasing with cash value, and in all cases of this death benefit option, the net amount at risk remains constant. Further, if one were buying a policy with cash and income as a primarily goal, death benefit becomes consequential. In that case, let’s assume 6% is not earned as the average for several decades. this would not affect the cost of insurance since net amount at risk has not changed.

      In the case of needing to reduce premiums due to cash flow problems, one could opt to lower the net amount at risk through a death benefit reduction. This would be especially advisable if this person was extremely certain that he or she is extremely unlikely to recoup prior cash flow and fund the policy at the planned level.

      Speaking of required reductions in outlay, if I reduce my funding on a whole life policy for a sustained period of time, I’ll forfeit my ability to fund at my original level unless I opt to take a policy loan to pay the planned premium, and that option isn’t going to help sustain my policy or keeps its guarantees intact.

      Whole life does not take the ifs out the scenario, we’ve definitely witness what happens when whole life focused carriers are strained for cash flow due to falling interest rates.

      As far as sharing in their profits goes. A number of mutual life insurers are posting increased to net income for 2014, but several of their dividends rates don’t appear to be moving in the same direction.

      Whole life insurance is a great product, and we’ve written several hundred thousand dollars in premium of whole life insurance this year alone. But it’s not the answer to everything and it’s not categorically superior to universal life insurance. That’s an incredibly dishonest allusion some within this industry have perpetuated for far too long.

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