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.

While the product affords the policyholder ample opportunity to adjust premiums as he/she desires, it 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 potential clients is the rising cost of insurance as they age.

With lots of stories about run-away insurance costs that pillage the cash value in a universal life insurance policy, it's no surprise that laypeople approach this product with extreme caution.

But is this worry warranted?  Is this story real?  None of these supposed protectors of the innocent tell their tale with any real numbers to back their claim.  Instead, they opt for vague references to anecdotes they took from a colleague or a poorly written newspaper article.

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 when the insured reaches advanced ages.

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%.

Please note, this example uses figures that were reasonable when we originally published this article.  Today, we might make some adjustments to the assumed index rate for projected value values.  This, however, would not impact the ratio of expenses to cash value.

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.

11 thoughts on “The Myth of the Rising Cost of Universal Life Insurance”

  1. 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?

    Reply
    • 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.

      Reply
  2. 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.

    Reply
    • Hi Wade,

      Unfortunately, there is a lot of strawman in your comments. While it’s technically possible for the 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 primary goal, the death benefit is inconsequential. 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 the 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 of the scenario, we’ve definitely witnessed 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.

      Reply
  3. I love the content you guys put out, and you are undeniably a force for good in this industry.

    I hate making comments like this, because it’s going to sound like a “hater” comment; I have to push back a teeny tiny bit on the rising expenses thing. COIs are one expense. There are other expenses that do rise (or rather, they change, often unpredictably) over time which can (and does) unravel the expectations originally set at policy issue. These expenses often undo many of the benefits or advantages of UL policies.

    As a product category, every UL concept has been designed with certain tailwinds in mind. And, eventually, those tailwinds become headwinds. UL is a “concept sale” in life insurance. You see this in the CAUL products of the 80s, which won’t work in today’s low interest rate environment.

    You saw this in the 1990s with VUL and GUL, which (functionally) fell apart after the stock market boom was over and after insurers discovered offering long tail, overly generous, guarantees in a declining interest rate environment was not sustainable.

    You see this now with IULs, which had tremendous tailwinds when the product was developed. Now, headwinds are upon us with rising options costs (which is why there are so many leveraged IUL products on the market). It will only get more and more expensive and less and less appealing to offer these products.

    And then… before you know it, the next iteration of universal life will be here.

    Despite falling dividend rates, this doesn’t happen to whole life insurance. Do some agents overpromise? Sure they do. But, as a product category, insurers don’t need to reinvent whole life insurance. It wasn’t designed with specific tailwinds in mind. Insurers might introduce different variations in the form of limited pay products, but they are all fundamentally the same product. I believe this is because whole life is structurally different, and arguably more stable, than UL.

    I don’t think this necessarily means UL is a “bad” product. But, it’s not “just like whole life but better” or “very similar to whole life, so don’t hate on it”. It’s different. Full stop.

    Reply
    • Hi David,

      No worries about critical comments. We very much enjoy and appreciate open discussions with differing opinions. While we take time to form our opinions, we don’t believe we’ll always be right, so when someone has the courage to come along and offer up an alternative view, we’re more than willing to hear it out.

      This said I’m afraid you’ve committed the same act we criticized in this very blog post/podcast. You referenced said headwinds, but you never offered any concrete evidence of their existence. Nor did you offer any evidence that their existence has actually caused any major harm to indexed universal life insurance.

      I also find your labeling IUL as a concept sale, which I take to mean whole life insurance is not curious. How do the two differ in a meaningful enough way to remove whole life from the concept sale notion while leaving IUL in that category?

      Reply
      • Hey, thanks for taking the time to reply. You didn’t have to do that, and I know you are very busy, so I appreciate that.

        So, I have mentioned it before in other comments, but comments on the internet are like gusts of wind lol. There’s so many of them…

        There are many headwinds… too many to discuss in a comment section (and because IUL is way more complex that CAUL and VUL), one of which is persistently low interest rates putting pressure on options budgets and as a side effect, the caps and par rates of products. That’s not a full explanation, I realize, but just want to indicate the big picture problem that’s been developing for quite some time.

        Notice how insurers have gotten very creative with charge-funded bonuses and multipliers? This is a direct result of not having a healthy options budget.

        Right now, to support a 10% cap rate, insurers need a 4.7% options budget. The options budget, on average, for most insurers, is 2.6%. This would support a 5% cap rate. Yet, insurers are not, by and large, moving to a current market priced cap rate for their option expenses. This is creating incredible pressure on insurers. They have two options: assume mean reversion pricing (very risky) or adopt current market pricing. They are mostly choosing the former, which is compounding the problem they will eventually be forced to face.

        Bobby Samuelson write a lot about this phenomenon, and IUL in general. He is a product dev guy, not an insurance agent, and is one of the few in the industry real expertise on the product deva and pricing aspects of UL. IMO, his Life Product Review service worth checking out.

        What I mean by “concept sale” in this context is a product that is built on certain current market assumptions which are market trends, but are not normative. I hope that helps clarity. Sorry if I wasn’t clear.

        Reply
        • Hi David,

          You are certainly correct in that the entire life insurance industry is facing significant headwinds. However, I’d also point out that the headwinds are facing nearly every industry. Life insurance companies are not facing problems in isolation. To that extent, the headwinds are relative.

          That being said, there is nothing special about IUL that causes it to face headwinds that do not exist for whole life insurance policies as well. Today’s post and podcast discuss some of those problems more specifically: https://theinsuranceproblog.com/impending-whole-life-insurance-doom/

          You are also correct that certain insurance companies chose to load up their IUL policies with bonuses and multipliers to make things look better than they really were. We’ve been critical of that from the beginning as we feel that it is entirely unnecessary and makes for terribly expensive products that are confusing to consumers.

          Look no further than PacLife. Though based on the fact that they laid off over 300 people last week, I’m guessing their strategy to “buy the business” hasn’t worked out all that well? They’ve added a lot of premium to their books but at what cost to every one of their policyholders?

          We are familiar with Samuelson’s work. Being a product dev guy and not an agent buys no favor here. Our task is to communicate with clients (the people who actually pay premiums) effectively so that they understand how their policies work in the real world, not to debate the merits of one product versus another academically. Those discussions can be interesting but they’re not terribly useful to clients.

          I challenge your assumption that IUL is a concept sale to any greater degree than whole life. Just consider all of the various iterations of the “banking concept”.

          It’s all a concept sale, otherwise, we’d sell tons of permanent life insurance by asking, “Hey, David, wanna buy some life insurance?” That’s always an option but based on my personal experience, it’s not very effective in selling permanent life insurance of any kind.

          As for what’s normative, I’d say there is nothing about 2020 that fits into a box that could be described as normative. Options budgets are lower than all would like for sure but that same pressure is applied to the general accounts of mutual life insurers as well. They’re all holding more in lower-yielding assets which robs them of the ability to achieve significant alpha and will negatively impact future cash value growth.

          Reply
          • You said: “That being said, there is nothing special about IUL that causes it to face headwinds that do not exist for whole life insurance policies as well.”

            Oh, but there is something special about IUL. IUL is powered by derivatives contracts. Whole life is not. Those options contracts are not insignificant. The pricing for them, and how the products are supported, are very very different than with whole life. Comparing options contracts in the UL to the GIA of an insurer doesn’t make a lot of sense. The pressure of rising options contracts is nothing like the pressure of lower yields. We’re talking two totally different pricing mechanics which have very different effects on the underlying product.

            One of your comments on the podcast was that insurers probably have ways to support their current cap prices, irrespective of current options pricing.

            Yes, they do. They can:

            1) Prop up some of the options budget with what remains of their portfolio yields.

            2) subsidize the options contracts with policy fees/charges.

            3) Use mean-reversion pricing and and lapse supported pricing.

            Insurers all shop the same handful of investment banks for their index options. They don’t have a magical pool to draw from.

            Mutuals aren’t doing the latter two. In fact, some mutuals, like Mass have come right out and said they refuse to do mean reversion pricing. That’s a very good sign for them, but it also draws a line in the sand. There’s going to be bloodbath if interest rates don’t rise on policies with mean reversion priced in. Of course, if an insurer did not use mean reversion, the rising rates are going to make those insurers look like investing wizards.

            I realize mutuals lean heavily on their bond income, which is declining, but obviously that is one part of their investment component, which itself is one of three parts of their dividend. You’re never going to see a 0% credit on WL because of falling yields. That can happen in UL if credits don’t keep pace with policy charges.

            ULs are a lot more sensitive to interest rates than WL. This is something we learned earily on. It was one of the benefits of UL. Let me rewrite that. It’s not that WL isn’t sensitive to interest rates. It’s that UL is much (MUCH) more sensitive to interest rates than WL.

            The way these things are built and managed are completely different than WL. Said another way, if they were that similar to WL, there would be no economic incentive to sell them.

            I think maybe you misunderstood the last paragraph of my previous comment. When I say “concept sale”, I don’t mean concepts aren’t used. To reiterate: “What I mean by “concept sale” in this context is a product that is built on certain current market assumptions which are market trends, but are not normative. I hope that helps clarity. Sorry if I wasn’t clear.”

            Whole life insurance, as a product category, works fine in every market. By “fine”, I mean a block of business is designed to be profitable on its own under the most severe economic conditions.

            UL, as a product category, doesn’t really work this way and it’s not supposed to. More risk, higher *potential* return, but also more risk — risk meaning risk of loss of policy value. GUL works under very specific market conditions. Ditto with VUL, IUL, etc. It is not designed to work in every market condition. Again, if it did, CAUL sales would be soaring right now.

          • Hi David,

            A few issues:

            1. What evidence do you have the whole life insurance is designed to “be profitable on its own under most severe economic conditions?” Also, what evidence do you have that this is not the case for universal life insurance? Real evidence, like facts and figures not just something someone said that sounds good.

            2. A lot of your argument to date appears to assume that “headwinds” for indexed universal life insurance are permanent. If we accept that the market is volatile…a reason you’ve identified as a potential problem for IUL…then we have to accept the contra of this attribute, which is conditions could improve quite significantly in IUL’s favor.

            3. Your depiction of IUL appears to focus on two vantage points that appear a bit myopic. Perhaps this is just my interpretation of your argument and your thoughts are more robust than I realize. But a lot of what you have come here to argue appears:

            a. slanted in the direction of all the sketching things PacLife has been doing (no argument their approach is potentially dangerous, but what they do does not speak for the entire marketplace of IUL)
            b. influenced by the framing certain mutual insurers use to argue against IUL right, wrong, or indifferent

            4. Explain Mean Reversion Pricing and specifically how it’s going to create a bloodbath if interest rates don’t rise. Numerically explain please with cited evidence to support quantifying the problem. And please identify the size of the problem in terms of likely IUL products using it.

            There are certainly bad IUL players. There are also bad whole life players. We know some agents who have rescued potentially disastrous whole life situations with IUL policies that very quickly righted the ship with the indexing feature. Could they have corrected the same problem with a better whole life policy? Maybe. But IUL got them there much much faster with less compromise.

            There are shades of grey. That has been our position all along. But pretending like bad examples are damning evidence that the whole product line is garbage commits the same intellectual dishonesty that we (and I’m quite sure you) criticize the stock-market-fanboy-bloggers of when they talk about whole life insurance et. al.

  4. I just have to say awesome content. A breath of fresh air when it comes to your take on both whole life and IUL.

    👍👍👍👍👍

    Reply

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