A Quick Guide to Understanding Universal Life Insurance

Many agents shy away from presenting universal life products because they can be confusing to clients, especially seniors. But when the going gets tough, top producers get going.

It’s important you understand universal life products and how they work so you can present them to clients in a way they’ll understand. Our guide helps make all that easy.

There are three main types of universal life products — traditional, index, and guaranteed. Let’s review their basics.

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Traditional Universal Life (UL)

Traditional universal life (UL) insurance, sometimes referred to as “adjustable life insurance,” is a specific form of coverage that combines the features of term life insurance with an investment component. With a traditional UL policy, a portion of the premium is allocated to the investment component to build cash value over the life of the policy. These funds usually earn interest at a percentage rate declared by the carrier, typically monthly.

The biggest advantage of a traditional UL policy is that the premiums are flexible.

The biggest advantage of a traditional UL policy is that the premiums are flexible. Policyowners can adjust the amount and frequency of their premium payments to suit their changing needs over the life of the policy. Ideally, they’d pay higher premiums during times when they’re earning more or have expendable income. Then, in times of financial stress, they’d have the option of paying less or nothing at all and using the cash value of the policy to pay premiums.

However, policyowners often don’t pay more than the minimum required premium to maintain the policy. In this case, only a little of the premium, if anything, is allocated to the investment portion of the policy; thus, the policy builds little cash value. As time goes on and fees increase, the policy could become underfunded and lapse if the policyowner continues to pay only the minimum premium.

Generally, an illustration for a traditional UL policy will show the prospect several different premium payment options — a minimum premium, target premium, and cash accumulation premium. It is extremely important you ensure your client understands the minimum premium should only be paid when there is a financial stressor that prevents the target premium from being paid. If your client’s goal is to build significant cash value in the policy, they should be paying the higher cash accumulation premium. Most illustrations will show when the policy will lapse when paying only the minimum premium, target premium, or any amount of premium in between the two.

Typical uses for these policies are to provide for estate planning or to cover a loss of income, mortgage, or educational need for young children.

Who should buy traditional UL insurance? Typical uses for these policies are to provide for estate planning or to cover a loss of income, mortgage, or educational need for young children. When funded properly, the client can access and use the cash value of the policy for these purposes.

Index Universal Life (IUL)

Index universal life (IUL) is arguably the most complex form of universal life insurance out of the three main types. It can be difficult for clients to understand how the policy works, how their funds are invested, and what returns they can expect.

Like a traditional UL policy, an IUL policy includes a life insurance component and a cash value component. The biggest difference between the two types of policies is that carriers tie the cash value component of an IUL policy to the performance of one or more indexes rather than a declared interest rate. Additionally, IUL policy premiums, which are flexible, are deposited entirely into the policy’s cash value component. The insurer then deducts policy charges from that account. As the account earns interest, the cash value of the policy grows.

Many agents describe IUL to their client as a product that “offers the upside of investing in the stock market, without experiencing any of the downside.” The better way to describe an IUL product to a potential client would be to say, “This product is designed to help you realize some of the upside of investing in the stock market while protecting you from market downturns.”

The better way to describe an IUL product to a potential client would be to say, ‘This product is designed to help you realize some of the upside of investing in the stock market while protecting you from market downturns.’

While it’s true that IUL policyowners will never lose any of their principal funds due to a decline in the chosen index, there is still a downside to these products. It comes in the form of interest rate caps and/or participation rates applied to these kinds of policies.

Interest rate caps are common on IUL policies. They work like this: If a carrier caps the interest on a policy at 7 percent, and the chosen index rises 15 percent during the interest crediting period, the policyowner will only receive 7 percent interest. The carrier retains the remaining interest. If there is a participation rate applied to the policy in addition to the cap, the client will be credited the interest up to the cap, then receive interest at the participation rate. For example, if the policy has a 7 percent interest cap and a 50 percent participation rate, the client will be credited interest up to the cap and then at a 3.5 percent rate.

IUL’s primary purpose is for cash value accumulation over the long term.

When preparing an illustration for a potential purchaser, many carriers’ illustration software will default to the highest illustrated rate possible — sometimes showing as much as 7 percent to 8 percent returns. Consequently, the client may expect to receive these higher returns, when it is unlikely that the policy will perform at the highest rate every year. We recommend you run the illustration at a much more conservative 4 percent to 4.5 percent interest rate. This lower rate will provide the client with a more accurate idea of how the policy will perform, when it will lapse based on the premium that they are planning to pay, and what they can expect in returns.

Once a client purchases an IUL policy, it’s also important for the agent to review that client’s policy annually. Rarely does the policy perform exactly the way the policyowner expected. During an annual review, the agent can determine if the policyowner is achieving the returns they expected, answer questions about the policy, and if necessary, take steps to correct anything that may be amiss, such as revising the chosen indexes, increasing the premium payments, etc.

IUL’s primary purpose is for cash value accumulation over the long term. In addition to providing a death benefit, it can also create a tax-free income stream later in retirement when funded properly.

Guaranteed Universal Life (GUL)

Often referred to as “no-lapse universal life insurance,” guaranteed universal life (GUL) is an ideal product for older clients looking for affordable life insurance coverage. GUL is comparable to term life insurance that will likely stay in effect for the remainder of the policyowner’s life.

GUL is an ideal product for older clients looking for affordable life insurance coverage.

Most of your clients have probably had a term life insurance policy in the past or currently have a term life policy that is nearing its expiration date. These individuals should have an excellent understanding of how term life insurance works. Once the original term is up, the premiums to keep the policy in force usually grow significantly higher.

GUL policy premiums are guaranteed to remain fixed, even as a client’s age and health changes.

GUL insurance is similar to term life insurance in that they both have guaranteed fixed premiums throughout the life of the policy. Like term life policies, GUL policies do not earn cash value. There may be a small amount of cash value in the first few policy years, but it is usually an insignificant amount. As a result, GUL policies don’t have expensive management fees and can have lower premiums than traditional whole life or traditional UL.

Whereas term life policies are usually in effect for a certain period of time, like 10, 20, or 30 years, GUL policies stay in effect until a specific age, such as age 90, 95, 100, 105 or older (so long as the premiums are paid). For the GUL policy to remain in effect for the remainder of the policyholder’s life, it’s important to select a guaranteed period that the client will likely not outlive. The most common age to select is 105 or later, as most clients are comfortable that they will not outlive their policy at this age.

GUL has several distinct advantages over non-guaranteed universal life policies. One of them is that it is significantly less expensive than non-guaranteed universal life products. In addition, GUL policy premiums are guaranteed to remain fixed, even as a client’s age or health changes. Since the premiums are fixed and the policy is not tied to an investment or index, there is no chance that the policy will ever be underfunded or lapse.

Determining the Best Option

As you start including these products into your presentations, remember to always ask yourself, “What is the client’s goal?” If you cannot answer that question, find out the answer from the client! Then, make sure the client’s goal matches the purpose of the product you present to them.

A traditional universal life and index universal life can work if building cash value is the primary intent of the client, with the death benefit coming in second. For an older client with little interest in and little time to build cash value, a guaranteed universal life product is probably most appropriate.

While not for every client, universal life insurance can play an important role in meeting the needs of an agent’s book of business. Yes, your clients may find these products confusing; however, with a little effort, you can educate them and put them into the right plan. Nobody said being an insurance agent was going to be easy, but it can be extremely rewarding, especially when you don’t pass the buck to someone else.