We make a lot of comparisons at The Insurance Pro Blog and whenever and even more behind the scenes at The Salus Agency. And one of the biggest questions that consistently comes up from some of those comparisons has to do with the gap between income projections for universal life insurance and whole life insurance.
So what gives with the disparity between these two products? Do the universal life carriers lie? Or is there something else underlying the situation that explains this difference?
We’ve said before that life insurance is life insurance. So any attempt to suggest that there is some wild difference behind the expenses one is likely to incur when it comes to universal life insurance vs. whole life insurance is entirely fiction. The whole life companies are not in possession of a magic pebble that allows them to insurer a 35 year old male more cheaply than a universal life company (not to suggest that it’s unheard of to find one company issuing both contracts, just somewhat unusual).
So if the expense is the same, how can one provide more income than the other? And why does there tend to be such a consistent trend in the difference. Universal life insurance tends to come out on top, and not by a little bit. Seems as though this life insurance is life insurance business is poppycock and it’s the universal life carriers who possess the magic pebble. I assure you, this is not the case.
Instead the answer is rather direct, and yet quite a bit subtle. And that answer is simply that, according to the U.S. government, there is more than one type of life insurance.
We’ve addressed before that something changed in the life insurance word in 1984. Congress, facing a tricky tax situation and realizing people could practically place a limitless amount of money into universal life insurance and shelter its gain from taxes imposed new rules that curtailed that “limitless” part. This started the process of testing life insurance contracts to ensure that they complied with Federal Law to qualify as life insurance.
There were two tests created from this change in legislation, and if you skipped the link above, here’s a second change to find more information on that.
Really quickly the two tests are the Cash Value Accumulation Test and the Guideline Premium Test. The detailed differences between them is largely unimportant for today’s discussion, but the big take away for now is simply this: the Guideline Premium Test allows for a smaller “gap” between cash surrender value and death benefit, and since this gap (also known as the net amount at risk) is the only insurance cost to the insurer, universal life insurance is theoretically less expensive when designed and implemented to optimize cash values. This means most (but I assure you not all) carriers will recognize this lower expense with a policy that has lower expenses to you the insured/policy holder.
The guideline premium test allows more money into the contract in early years, and the “gap” mentioned above is allowed to get much smaller as the insured ages. In essence, when cash values are our main goal, most of the time we’re looking to make death benefit as minimized as possible. Universal life insurance allows us to do this more efficiently, and for this reason, we often times find that universal life insurance is capable of producing more money out as income per premium dollar when the policy is being funded.
No. Just because something works most of the time doesn’t mean it will work all of the time. And there are plenty of situations where cash values are important, but death benefit is also very much desired; in these circumstances whole life insurance has a serious fighting chance.
So the answer to our initial question has to do with the fact that universal life insurance can (but I’d be a tad remiss if I didn’t mention doesn’t always have to) qualify for as life insurance in a way that makes it slightly functionally different from whole life insurance. And it’s for that reason that it has a “learner” design for optimizing low death benefit and more cash.
Brandon launched the Insurance Pro Blog in July of 2011 as a project to de-mystify the life insurance industry. Brandon was born in Northern New England, and he currently calls VT home. He attended Syracuse University and graduated with a triple major in Economics, Public Administration, and Political Science.