Universal life insurance is characterized by its flexibility and transparency of expenses. Unlike whole life insurance, where expenses operate under the cloak of proprietary information, we can easily call up the expense breakdown of universal life insurance policies and see exactly where the money goes.
For universal life insurance policies, expenses fall into four main categories:
- Premium load
- Policy Fee
- Per 1,000 Charge
- Cost of Insurance
Variable universal life insurance policies will also have an asset fee associated with the investment account(s) chosen.
Let's dive into the details of each expense category.
I want to start with premium load because it often causes the most confusion. This is an expense taken from every premium the policy owner pays into the universal life insurance policy. It ranges, from company to company and even product to product, but to give you an average range, 5-10% is pretty normal.
This expense “comes off the top” meaning that it's applied before the money actually goes into the policy. For example, if you pay a $10,000 premium and your policy has a 7% premium load, the insurance company will deduct $700 from your $10,000 payment and then credit $9,300 to your policy.
The major reason for this expense is to cover premium taxes, which are a significant expense to insurers and also a significant tax revenue source for most states.
There is something subtle about this expense that a lot of people overlook when reviewing an expense breakdown of a universal life insurance policy. If you do not pay a premium to your policy, you do not pay a premium load. I bring this up, because a lot of people tend to look at expenses in their aggregate. There is nothing inherently wrong with this. But, when adding up the expenses of a universal life insurance policy vis-à-vis the notion of how are the expenses balancing against my cash value, the premium load doesn't really apply. Since it's not an expense that is ongoing without a premium payment, and because it's only based on the actual payment of a premium, the premium load cannot cause a universal life insurance policy to lapse. If the policyholder decides to stop paying premiums–something he/she is free to do at any time and for any reason with universal life insurance–the premium load expense goes away.
All insurance policies have a fee charged against them annually. This fee generally ranges between $50 and $100. The fee covers administrative/operational expenses such as printing and mailing an annual statement to the policyholder and maintaining a web portal access to policy values. This fee applies each year and will not go away. This fee is also usually a flat fee and is not affected by the size of the policy expressed through the death benefit amount outstanding.
Per 1,000 Charge
The per 1,000 charge is a terminal fee placed on universal life insurance policies for the first several years of the policy–generally the first 10 or so years. Insurance companies use this expense to recover the money they spent on acquiring the policyholder.
Functionally the fee is formulaic and based on the amount of death benefit outstanding on the policy–specifically the net amount at risk. This is to say that no insurance company has taken the time to specifically figure out exactly what it cost them to acquire you as an individual policyholder. It might have cost more or less than this expense comes out to, but the spirit of this approach is that everything averages out in the end.
I mentioned earlier that this expense is terminal and generally lasts for around 10 years. This means after this time frame, the per 1,000 charge goes away.
Because the per 1,000 charge is tied to the death benefit of the policy, changing the death benefit will change the per 1,000 charge. For example, reducing the death benefit while the charge is still applicable, will reduce the per 1,000 charge.
Cost of Insurance
Cost of insurance (COI) is probably the most familiar expense of the group. It is the raw cost the insurance company recognizes for providing you with the death benefit on your policy. This expense rises over time as the probability of death increases with age. This expense will not go away and it's based on the death benefit–again specifically the net amount at risk of the policy.
Because the Cost of Insurance charge is tied to the death benefit–specifically the net amount at risk–it's possible to refine this expense to some degree depending on the needs of the policyholder. This means you can reduce or increase the COI expense by changing the death benefit.
Special Expense for Variable Universal Life Insurance
Variable insurance products invest the cash value in mutual-fund-like accounts that rise and fall with the underlying market securities held in the fund. These funds also have management fees typical of a traditional mutual fund. These fees come out of the policy's cash value on a regular basis as stipulated in the prospectus provided to the policyholder at the purchase of the policy.
These fees are based on the account value of the fund. The fee will vary from fund to fund and most variable universal life insurance policies have several fund options, so the actual fee paid is dependent on how many different funds the policyholder chooses within the variable universal life insurance policy.
Variable universal life insurance policies do often offer non-investment options like a fixed interest account or an indexed account–similar to indexed universal life insurance. There is no investment management fee associated with these options.
The Surrender Charge: A Non-Expense Expense
Universal life insurance policies also commonly have surrender charges. These are contingency deferred sales charges that only apply under specific circumstances–namely canceling a policy within a specific period of time.
This means that surrender charges are not deducted from a universal life policy like the other expenses mentioned above, rather they only apply if the triggering event–canceling the policy during the surrender period–occurs.
For most universal life insurance policies, the surrender charge applies for the first 10-15 years of the policy's existence. During this time, if the policyholder decides to cancel his/her policy, the surrender charge will be deducted from the cash value in the policy and the insurance company will pay the policyholder the net cash value after applying the surrender charge.
For example, let's say you own a universal life insurance policy that is five years old and has $100,000 of cash value. The current surrender charge applicable to the police is $5,000. If you cancel your policy this year, the insurance company will keep $5,000 and send you the remainder of $95,000.
There are a few higher-level considerations to understand about surrender charges.
First, all the cash in a universal life insurance policy receives interest payable to the policy regardless of the surrender charge. So using our example above, all $100,000 will earn interest payable to the policy, not just $95,000.
Second, the surrender charge grades down over time. So in our example above the $5,000 surrender charge this year, maybe $3,000 next year, and this trend will continue until it reaches zero.
Third, the surrender charge does impact how much of the policy's cash value is available as a loan. Using our example above, the maximum loan amount will be based on $95,000 and not $100,000 because the insurance company is not going to lend beyond the $95,000 amount.
Fourth, the surrender charge does not apply at death and does not impact the net payable death benefit. So using our example above, if the policyholder died, the death benefit is payable without regard of the surrender charge because it does not apply.
Lastly, if you own a universal life insurance policy and hold on to it beyond the surrender period, you no longer need to worry about the surrender charge because it has expired.