Universal Life Insurance Death Benefit Options

Universal life insurance provides the policy owner with two different death benefit options.  One option is a constant or level death benefit, while the other increases over time based on some feature of the policy (either cash value accumulation of premiums paid).

When you apply for a universal life insurance policy, you will need to choose which option you want, so it's important to understand and weigh the consequences of both options before making a final decision.  In some cases, you can change the option you chose after the policy is in force, but there are some important rules concerning this.

Death Benefit Option A: Level Death Benefit

The first death benefit option is a level death benefit.  This often goes by the name death benefit option A or 1.  The Level Death Benefit Option maintains a constant death benefit amount throughout the life of the insurance policy regardless of accumulated values and/or premiums paid by the policy owner.

You may notice in advanced years, a universal life insurance policy using Option A does experience an increasing death benefit.  This is due to regulations that govern what constitutes life insurance versus other pseudo or non-life insurance accounts.  Universal life insurance policies that would violate these rules, will automatically increase the death benefit in order to remain compliant with these regulations.

Choosing this death benefit option will tend to produce lower overall expenses of the universal life insurance policy.  This happens because as the cash value in the policy grows, the gap between the death benefit and the cash value decreases.  The insurance industry officially calls this “gap” the Net Amount at Risk and it's the value all insurers use to charge you for insuring your life under a life insurance policy.

For example, say you had a universal life insurance policy with a $1 million death benefit and $100,000 in cash value.  You will only pay insurance fees on $900,000 because that's the actual amount of death benefit outstanding on the policy.  If next year, this same policy now has $150,000 in cash value, you will only pay fees on $850,000 in death benefit.

But just because this option tends to lower overall expenses in absolute terms does not necessarily make it the best option for all people who buy universal life insurance.  The Level Death Benefit Option can also severely restrict the amount of premium a policy owner can pay into a universal life insurance policy and remain compliant with the Modified Endowment Contract (MEC) Rules.  This limitation may not be worth the savings in raw cost of insurance.

Death Benefit Option B: Increasing Death Benefit

The second death benefit option is an increasing death benefit.  This death benefit option allows the death benefit to increase based on some feature of the universal life insurance policy.  Most commonly, the feature that increases the death benefit is the accumulation of cash value.

For example, say you purchased a $1 million death benefit universal life insurance policy.  Five years later you open your policy statement and discover that you now have $100,000 in cash value in the policy.  You also happen to have $1.1 million in death benefit outstanding on the policy.

This happens because the increasing death benefit option increases the payable death benefit by the amount of cash value in the policy.

This death benefit option usually costs more than Option A because the Net Amount at Risk remains constant year-over-year.  From the example we just looked at, the Net Amount at Risk remained $1 million in all years, instead of declining by the cash value in the policy as would be the case with Option A.

The increasing death benefit option has two very distinct uses for policy owners.

First, those seeking a higher death benefit as their obligations grow, or who seek to grow their death benefit due to inflations value on buying power, might opt for Option B as a way to accomplish this sort of goal.

Second, the Increasing Death Benefit Option allows more premiums to go into a universal life insurance policy without violating MEC Rules.  Even though this option will cost more than Option A, the additional money in the policy could outweigh the increased expense.

While it's far more common for cash accumulation to increase the death benefit under an Option B scenario, there are some life insurers that offer an increasing death benefit by the premiums paid into the policy.  There are even some companies that make this a third death benefit option.  So technically the policy owner can choose between a level death benefit, a death benefit that increases by cash value accumulation, or a death benefit that increases by premiums paid.  Companies that offer this, usually refer to the death benefit increasing by premiums paid as a third death benefit option.  This “third” death benefit option is far less commonly available.

Changing the Death Benefit Option on a Universal Life Insurance Policy

Universal life insurance policy owners do have the option to change the death benefit option on their policies.  Traditionally the change is from Option B to Option A.  This means the policy owner benefits from increases in the death benefit over some period of time but then chooses to switch the option to a level death later.  Most policy owners switch to a level death benefit either because they reached the death benefit goal they wanted or because they want to limit expenses moving forward.

While it's far less common, it is possible to change the death benefit option from Option A to Option B.  Usually making the change from a level death benefit to an increasing death benefit requires the insured of the policy to undergo a health underwriting review.  If the review assesses the insured satisfactorily (meaning the underwriter would approve the insured for another life insurance policy if applying at that time) then the company will grant the death benefit option change.

The circumstances that would warrant a death benefit change from Option A to Option B are far more unique than the circumstances that warrant a change from Option B to Option A.  In fact, they are so unique that I can't really categorize and explain them here.  Instead, you should understand that they are very case-specific.  So while a change from level to increasing death benefit is rare, it's not completely unheard of.

Different from a Face Amount Change

I want to note that a universal life insurance death benefit option is different from a death benefit amount change.  Universal life insurance allows policy owners to rather easily make adjustments to the death benefit (or face amount) of their policies.  This is often far more easily accomplished with universal life insurance than with whole life insurance.

A face amount change differs considerably from a death benefit option change.  Changing the death benefit amount on a policy involves an irrevocable change in the outstanding amount of death benefit on a universal life insurance policy.  Death benefit option changes merely change from either a level or increasing death benefit, but the switch is by no means irrevocable.  In theory, universal life insurance policy owners have the option to make death benefit options changes several times–although this is extremely unusual.