Universal Life Insurance-From Pure Evil to Absolute Truth

First, I feel like I should explain what I mean when I sub-titled this post a “view evolved from evil to truth”.  It really goes back more than a decade when I was first “quietly” recruited and subsequently “trained” by one of the big Blue mutual insurers.

Keep in mind in those early days of my life insurance career, the only thing I knew was that there were basically three types of life insurance available—term life, whole life, and universal life insurance.  And I only knew that because I’d endured the pre-licensing classes and passed the licensing exam.

universal life insuranceHonestly, at that point, I had no opinions on any particular flavor of life insurance which was probably more indicative of the fact that I barely understood those three basic types of insurance in the first place.

However, that was all about to change as my real education began in the training room of that mutual company career agency.  I was about to become an apostle of the gospel of whole life insurance and simultaneously denounce the evils of that marked beast—universal life insurance, a product that was surely birthed in the bowels of hell!

Thinking back on those days, I realize myself and the one other guy in my training “class” were merely sheep being led to the slaughter.  We were ripe and ready to be educated on all the glory that is participating whole life insurance, that shining city on a hill.  I was young, right out of college (with a BA in History=unemployable), broke, and scared to death.

Fast-forward to now, a little better than twelve years later, and at least a little bit more wise than I was back then.  I would consider myself a student of the life insurance industry and while I still value participating whole life insurance as a viable tool, I also consider universal life insurance as a shovel than can be used quite effectively.  See, the reality of the life insurance industry is much the same of any other, the tools are the various types of policies.

What do I mean?

Well, if you were mining for gold, you’d surely want to have a shovel, a pick-axe, a rock hammer, chisel and a sledge hammer…right?  They’re all different tools that perform in completely different ways but none more or less important than any other…just serve different purposes.

Life insurance policies are no different.  And frankly it’s time for everyone in the financial services industry to stop pitting one type against the other.

So, I know you’re wondering, why I have my feathers all ruffled today?  Why is he on his soapbox?

Well, my partner, Brandon Roberts, sent over this article to me last night.

Now, I’ve seen my fair share of pieces that were obviously written with bias toward a particular product but honestly I’ve never seen anything that was as much of a total “hack job” as this article.  To be fair, I don’t know the author at all, but I’m amazed that Forbes would publish such absolute drivel.  I encourage you to take a few minutes and read the whole article…you’ll quickly see what I’m getting at.

So, I know this has been an extremely long introduction but hang in there, I’m just getting warmed up.  I’m going to quote bits of the article throughout this post just to make the discussion more clear and to directly dispute particular points that are made within the article.

Let’s get started.  We’ll just tackle this one piece at a time, there’s too much to do all at once.

 

“The problem is buried in the fine print of universal life policies, widely promoted since the 1980s as a new and improved version of the old-fashioned whole life insurance product our grandparents relied on as the surest way to save for retirement.”

Response:  Universal life insurance has nothing to do with whole life insurance–other than the fact that they both pay a death benefit.  Universal life insurance has never been marketed as a “new and improved version of the old-fashioned whole life insurance“, at least not by anyone who wanted to stay out of jail and retain their insurance license. If one were to make statements as such, it would be a clear misrepresentation and more pointedly an outright lie.  Universal life insurance is not a new version of whole life insurance, it is an alternative to whole life insurance whose internal mechanics are very different.

“The new and improved universal whole life policies were designed to take advantage of high interest rates and growth in stock prices to reduce premiums and boost cash values—the term for the built-in savings component of a life policy.”

Response:  First of all, there’s no such thing as a “universal whole life policy”, I’m pretty sure that no state insurance regulator would every allow an insurer or an agent to characterize a policy as such.  That’s like saying, “I got one of those new Turbo Diesel Gasoline cars”.

Huh??

So, I can only infer that he is again trying to bash universal life insurance here.  At any rate, he’s referring to high interest rates and growth in stock prices which are really two totally separate issues–interest rates are a key component of traditional universal life insurance but the stock market is not.

Variable universal life insurance is where the returns of the market come into play but this is a choice that someone would willingly and clearly make when purchasing a policy, it’s not something you wouldn’t be aware of as a consumer.  Furthermore, neither of these components, interest rates nor market investment, make universal life inherently good or bad.

Remember, a life insurance policy is amoral, it’s neither good nor evil.  The problem with these policies that were originally sold in the 80′s is how they were illustrated by ignorant or unscrupulous agents, both are exclusive in most cases but nonetheless equally as dangerous.

If the policy illustrations were run with showing returns that were unrealistically high over the life of the policy, then the policies run into real problems down the road.  For example, when universal life insurance first debuted in the early 1980′s, it was not uncommon for a policy to earn 14% in a given year–this is a fact. But  the problem is that those types of returns were not sustainable and because agents fell into the trap of showing policies with this sort of interest rate, people were grossly under-funding their policies in the ensuing years as interest rates declined.

What’s even more unfortunate is that the people who bought these policies weren’t paying attention to the statements they received annually.  To cast blame equally, the insurance companies did a horrible job of servicing their policyholders as to the problems their policies may be facing.

“That was the same argument the financial industry used to kill off the defined-benefit pension plans our grandparents relied on in order to sell a new generation of savers on the idea that 401-Ks had the potential for higher returns.”

Response:  It’s no secret that I’m not a lover of 401k plans, I take them to task a bit in my post back a few months ago where I discuss creating your own pension.  However, I’m not sure how the author connects the birth of universal life insurance to the death of defined benefit pensions.  That’s not how universal life insurance was sold at all.  It was sold mistakenly in many cases, as the cheap alternative to whole life insurance.  You could have coverage that would last forever, build cash value and pay a whole lot less than you were paying for that silly old whole life insurance.

As Brandon pointed out in his post Universal life is NOT the Cheap Alternative to Whole Life Insurance, if you paid the same premium into your universal life insurance that you were required to pay on a comparable whole life insurance policy, there wouldn’t be an issue.  The problem with universal life is not the mechanics of the policy, it’s how it was sold and that it wasn’t funded correctly.

“Universal policies became attractive because they offered a higher rate of return (the dividend) on the savings component than one could get from old-fashioned whole life. The trade-off was that, unlike old-fashioned whole life, the effective premiums for the universal policy death benefit rise as the policyholder ages.”

Response:  There is no dividend in a universal life insurance policy.  Clearly, the author has no understanding of how either type of policy is constructed or how they function.  Participating whole life insurance policies can earn dividends if the company has a divisible surplus.  Universal life insurance never earns a dividend.

The premiums not rise on the death benefit in a universal life policy as you get older.  One of the underlying mechanisms of all permanent insurance policies is the “cost of insurance” (COI) and in fact this does rise as a person gets older.  The likelihood that you’re going to die increases with your age, not a big revelation I’m guessing?  So, the COI does increase every year but this doesn’t by default cause your premiums to increase, the two are not inextricably linked.

I encourage you to watch these two short videos explaining the basic mechanics of whole life insurance and universal life insurance.  In fact, I urge Mr. Girouard to do so as well.

 

“Policyholders can borrow the money they paid in anytime for any purpose, no questions asked, which in turn reduces the death benefit to compensate. Policyholders can repay the loans later and the death benefits go back up again. In effect, policyholders are borrowing from and repaying themselves just as they do with any bank or investment account.”

Response:  When a policyholder makes a loan on the cash value in their policy, they are actually borrowing from the insurance company.  The cash value build up inside of their policy acts as collateral for the loan, which is why the insurance company reduces the death benefit until the loan is repaid.  In some cases, the insurance company will continue to pay interest on the borrowed funds.

Yes there is cost associated with the loan, the insurance company charges an interest rate, but it is possible to earn more in interest on your borrowed funds than you are accruing in interest.  I’m not going to delve into the nuances of those features, but rest assured that I’ve never had a bank loan or bank account where I was paid interest on money that I’d withdrawn.  If you know of such a thing please let me know.

How are you repaying yourself by taking  a loan from a bank or investment account?  I wasn’t aware that interest paid on a margin loan was in any way contractually guranteed nor am I aware of any investment account that will guarantee the safety of principal while on margin?  Ever heard of margin calls, when the value of the underlying investment that collateralizes that loan dips and your broker calls and says you have  ”x” amount of time to add more money to your account or they’re going to force liquidation to cover your loan? Yeah, that won’t happen in your life insurance contract…ever.  As a matter fact, you don’t have ever repay the loan.

Why?

Because the life insurance company reduced your death benefit remember, that loan is taken out of your death benefit…they get repaid, it’s just down the road.

“I know all this because I am a reformed universal life believer. In the 1980s I became successful by helping clients replace their old reliable mutual whole life policies with the new and improved universals. By the 1990s, when some of my clients began to reach retirement age, the hidden flaws showed up when the projections fell below their targets.  I felt betrayed by the companies that had persuaded me that universal life was a better policy because stock markets historically averaged a better return. I wondered what I’d done wrong, so I went back and studied the fine print, discovering that these policies were written to shift risk from the company to the policyholder. Universal life policies allow companies to raise premiums or siphon off cash values if they can’t make enough from investments to meet their costs and still earn a profit.”

Response:  I too am a reformed believer when it comes to universal life insurance, but it seems my reformation has been more on the side of acceptance than denial.  Maybe the author feels guilty that he replaced a lot of whole life policies back in the 80′s?  The reason the projections “fell below their targets” is because the projections were unrealistic in the first place and furthermore he should have realized this much sooner than he did.  As soon as interest rates started to normalize in the mid-late 1980′s a light bulb should have gone off…hey, those UL policies I illustrated at 14% probably aren’t going to work out so well now that rates are at 8%.

You can blame the insurance companies all you want but at the end of the day you have a responsibility to your clients to be honest and say, “Hey this isn’t going to work out they way it was projected and here’s the alternatives”  But you must have that conversation early on when you realize things aren’t shaping up as they were projected.  In my experience, your clients don’t expect perfection, they understand that market shifts and there is risk involved…at least they do if you educated them on this in the beginning.

What is an absolute truth about universal life insurance vs. whole life insurance?

UL requires much more active policy management by the agent and the insured.  Whole life is much more forgiving in this regard as the death benefit and the cash values have underlying contractual guarantees that don’t require an agent or a client to monitor near as closely.

If the dividends in a participating WL contract don’t work out as projected, it won’t cause any real problems for the insured.  The cash value won’t look as good, but the death benefit is not in jeopardy nor will it result in a higher premium to keep the policy in force.

As an agent, you have to always to be suspect of what an insurance company tries to persuade you to sell.  I’m not saying that to be cynical, but you have a responsibility to your clients to be diligent in deconstructing the various insurance contracts, thinking through all the moving parts, asking lots of questions of the company who’s trying to persuade you and then explaining all the nuances within to your clients.

Let people know the good and the bad of each option and most importantly–make sure that you understand every detail of the contracts you offer.  If you can’t get absolute clarity from the insurance company on each of your questions regarding their universal life insurance or whole life insurance contract, loan provisions, guarantees etc….don’t offer it to your clients, how can you expect them to understand it if you don’t.

 

 


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