The Doomed Index Universal Life Insurance Policy

You don't have to look far on the interwebs to stumble upon a blog post, video, or infographic that throws a little shade at indexed universal life insurance.  The product is attacked relentlessly by both the “never-insurance” crowd and the “whole life insurance is the answer to everything (aka Nelson Nash posse)”.

I never thought that infinite bankers and Suze Orman would agree on everything.  But they've found a common enemy in the undeniable fact that indexed universal life insurance is bad for you.

Why?  Fees…mostly.  You see, indexed universal life insurance is more doomed than the Titanic, the Hindenburg, and the Alamo.

The fees run out of control and you simply cannot escape them.  There's proof of this, somewhere.

Where is the proof? Good question…as best I can tell…the agent in the office down the hall who has a brother who knows a guy who had an agent that told him about a cousin he had on his mother's side who once bought a universal life insurance policy that didn't work out.

Didn't work out you say?

Speak no more…I'm convinced!

Except for that One time…

Early in my insurance selling career, I hated indexed universal life insurance (actually all universal life insurance) and told tales of its ills.  What was my evidence of universal life insurance's great offenses?  See the story above about the guy down the hall.  But a few years into my career I asked myself a silly little question.

What if I was wrong about universal life insurance?

If universal life insurance is so bad, why does it still exist?

So my annoying inquisitive nature forced me to investigate a bit further.  I don't intend this blog post to be about how I found religion with universal life insurance, perhaps in an upcoming blog post.

But here's the short version of what I learned: way too many people bought universal life insurance because they thought it was cheaper than whole life insurance.  The failure was operator error, not the product.

Thankfully I warmed up to universal life insurance after only a couple of years of lying to people about how awful it was.  I even did something crazy.  I sold a few.

Universal Life Insurance Expenses Shoot Up and Leave you Penniless

I admit it, I'm an insurance nerd so I watch insurance videos on YouTube.  I giggle a bit at the ones staging an attack on indexed universal life insurance–mostly because I'm amused at how the hate-filled playbook never changes.

The haters are obsessed with the rising cost of insurance in an indexed universal life policy.  What exactly are they talking about?

You see, universal life insurance pioneered the idea of transparency.  I know I know, the world is going to hell in a hand-basket.  We're gonna let people see what we're charging them for their insurance policy? Preposterous.

Apparently, prior to the existence of universal life insurance, everyone assumed that insurance companies had a magic way of preventing people who bought whole life insurance from dying.

Proving that no good deed goes unpunished, the full disclosure of fees leaves universal life insurance wide open to criticism.  It's the cornerstone of any good argument against it, especially among the proponents of super transparent whole life insurance.

The problem, they say, is that universal life insurance is just yearly renewable term life insurance with a savings account.  Somehow whole life insurance is magically different.

This rising cost of insurance eats away at your policy's cash value and eventually bankrupts the entire thing.  Let me show you an example.

Using a 40-year-old super healthy insured, rated at preferred plus, a $1 million death benefit indexed universal life insurance policy with a $7,000 per year premium has cash value grow and decline as follows:

The cash value in the policy increases year-over-year until the 40th policy year.  Then the cash begins to decline year-over-year–and those declines accelerate within a few years.  Just 10 years later, the policy runs out of money and the policy owner would need to either put a lot more money into the policy or else let the policy terminate.

The policy owner would be age 90 at this point, so there's a good chance he'd be unwilling to fork over lots of money to keep the policy afloat.  What's more, these numbers assume the highest possible assumed interest rate on the indexing feature.  This thing is just designed to fail.

Except for one tiny detail…

A $1 million death benefit policy should have about twice the premium.  A $1 million whole life policy would require roughly a $14,000 annual premium for the same super health insured.  What happens if I go back and increase the premium to this amount?

It looks like this:

Well that doesn't seem so bad now does it?

Keep in mind that both of these policies have the same $1 million death benefit, the same insured, and the same “rising cost of insurance” (if you read the quoted text in a mocking tone, you read it correctly).  The only difference is that one policy has half the premium paid as the other.

And this, my friends, is the epicenter of our problem.

Whole life insurance has rising costs as well, life insurers simply demand you pay them enough money to cover that rising cost.  Years ago, I highlighted this notion in this article.

And if you go read that blog post from 2013 you might ask why I bothered rehashing this subject today?  Because I want to focus in on the “rising cost of insurance” aspect of universal life insurance (again still using the mocking tone on a quoted section).

Theory Versus Reality

The majority of the doom and gloom stories that focus on the “rising cost of insurance” for universal life insurance speak in theoretical terms.  They make references to the idea, declare that it will eventually bankrupt the policy, and then tell you it's no good.  They lack specific examples.  And I might know why.

Let's look back at an indexed universal life insurance policy I wrote several years ago, I want to share some key observations.

First, when I sold the policy, we assumed it would earn an effective 6% index crediting rate each year.  At that time, the policy had a 12% cap rate.  Today it has a 9.5% cap rate.

In fact, it only had a 12% cap rate for roughly a year and a half after I sold it.  So for the majority of this policy's existence, the cap rate has been lower than 12%.  Despite this, the policy is considerably ahead (by tens of thousands of dollars) of where the 6% assumption projected cash values to be at this point.

Total annual expenses on the policy equal a little over $2,000 by the end of the next policy year.  At that same point, the policy is guaranteed to earn $10,500 (the indexing feature has a floor that is above 0).

Now here's the truly dramatic part.  Looking at retirement age, age 67, the policy will have just over $3,800 in expenses that year (yup cost of insurance does go up every year).  That roughly $3,800 in expenses will be about 0.09% of the total projected cash value at that time.

It's extremely difficult to find a passive index ETF with an expense ratio that low–let's not forget that this has a death benefit.  That expense is all in.  Everything.  Net, net.

What's more, the costs of the policy never project expenses higher than 0.40% of the policy's cash value (they reach 0.40% around age 116…insured might live that long…who knows).

And don't forget that the cash value will grow between now and age 67.  So the while the policy today earns guaranteed interest in excess of the expenses the policyholder will have at age 67, that guaranteed earning will be substantially higher at 67 than it is today.

Bottom Line

The “horror stories” about universal life insurance are more a lesson on user error.  When agents tried to sell unwitting clients “cheap permanent life insurance,” it resulted in a number of people who owned a poorly capitalized product.

Whole life insurance avoids this pitfall because the life insurer demands more money (i.e. it doesn't let agents sell it as cheap insurance), but the reality of the expenses exists just the same.

While it's absolutely correct to point out that whole life places the guarantee on the shoulders of the insurance company, an individual who buys universal life insurance and pays a premium commensurate to a whole life premium with the same death benefit has little to worry about as it relates to the rising cost of insurance.

But going beyond that, we see plenty of universal life insurance policies around today that are in no trouble at all.  As you can see from the example above, indexed universal life insurance policies correctly designed will far outpace the costs and will very likely continue to do so forever.

This doesn't suggest one is bad and the other good.

In truth, we write about 10 whole life policies for every one universal life insurance policy these days.  It just happens to be the case that whole life matches the needs better for a majority of people who choose us as their agents.

We clearly see the value in both, and we refuse to take a myopic approach to life insurance that suggests one approach rules them all just because we don't always see a benefit to one product or another.