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When looking at universal life insurance – especially in the context of its ability to accumulate cash value – and comparing it to other life insurance products such as whole life insurance, people often note that it appears to have much lower guarantees. In fact, here’s an excerpt from an indexed universal life insurance proposal that highlights said low guarantee:
Now let me give you some background on this policy so you can understand some of the surprise at this information.
This is indexed universal life insurance for a man who is 45 years old. It has a death benefit amount of $815,241. If you’re wondering why the death benefit is such an odd number and not a nice round number like $850,000 (for example), it’s because this policy was designed using the scheduled premium amount to calculate a necessary death benefit (I’ll elaborate a bit more on that in a bit). The projected premium for this policy is $50,000 per year (probably sounds extremely high if you’ve always thought of life insurance as an expense, but there’s something else we’re aiming for in this case).
Because this policy design uses a minimum unmodified death benefit and also follows the premium test guidelines, that $50,000 premium is the maximum allowed without causing material adverse tax consequences to the policy.
…but the quoted text, which was taken Immediately from the proposal issued by the company, clearly states that if the prospective policyholder so wishes guarantee that his initial death benefit of $815,241 remains in effect until his 121st birthday, he pays a lot $150,535.39. This sounds terrible.
And if he really wanted to guarantee his death compensation for his 121st birthday, this would be an absolutely terrible product choice. But that’s not the goal here so this fact is … moot for the most part.
Different life insurance policies have different goals
There are many life insurance policies out there. And this may come as a surprise, but with all this diversity of options comes a diversity of goals addressed by different policy areas.
While many people understandably think of life insurance as universally the same – you pay a premium, and it pays a death benefit when you die – it’s not. Some policies aim to offer an inexpensive death benefit. Other policies aim to offer a high accumulation of cash value. Generally speaking, these two goals are on opposite sides of a benefit spectrum.
If the individual in this situation wanted to guarantee an $815,241 death benefit by age 121, there are products that would do it for far less than $50,000 a year – say nothing of $150,535.39.
But if, on the other hand, he wants to achieve the highest return on a $50,000 annual payment into a life insurance policy to build wealth that enjoys many tax benefits, this product is arguably the best currently on the market.
Life insurance guarantees cost money
Life insurance guarantees cost money. This applies to both the insurance company and the policyholder. The insurance company must shoulder the risk associated with the death guarantee and have sufficient reserves (ie money it holds but is very limited in investment options) to prove that it can profit from the guarantee. This cost is usually realized for the policy owner through an accumulation of less cash value on the policy.
Insurers are keenly aware of this trade-off and are bringing products to market that sacrifice guarantees in favor of providing much more attractive non-guaranteed features – usually expressed in terms of cash value accumulation.
So in our example above, the product in question has such a low guarantee in terms of the death benefit because it also has an extremely high potential to produce non-guaranteed cash value. The insurance company removed guarantees of high death benefits from the product in order to provide the opportunity to produce such features that accumulate higher money.
The same company offers other universal life insurance products. They have higher guarantees. They will almost certainly accumulate much lower cash value for the same premium as our 45 year old male insured.
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