Okay, here it is. Another insider secret to the life insurance industry. I’m going to explain to you why yours and/or so many other Universal Life insurance policies are failing. You might ask what are they failing? It’s easy to see how a UL policy will fail the person who bought it when they get a letter in the mail that says that they owe more money. How is that for a surprise? They are also failing insurance agents everywhere because bad news travels faster than good and all insurance agents then have to pay the price for the one who sold the policy. Maybe he or she sold it chasing commission, maybe they didn’t know what they were doing or maybe they just didn’t understand how the policies works. Whatever it may have been the rest of the insurance people pay the price. It is failing for the insurance industry because it perpetuates people’s negative feelings about insurance. It gives them a big reason to not put life insurance in place. Most importantly it fails the dependents. It fails the spouse, the children and loved ones that need the financial help if something where to happen. Due to the failure of the policy it just might not be there when the payout is needed most. In social media today it is known as an epic fail.
Historical Overview of Universal Life
To understand how this is happening we must first look at the history of the Universal Life policy. A UL policy came to being during the 1970s. That means they have only be around about 40 years now. So they are still young. The old Whole Life policies were very rigid. You go to purchase a policy and you get a set premium with a set face amount. That’s it. You pay the premium policy is good. You don’t and you risk losing the coverage. If you need more coverage, you get another policy. No flexibility. There needed to be a change.
Do you remember the economy of the 1970s? It was a decade of poor economic performance, some may say the worst since the great depression. It was high inflation coupled with rising unemployment. Interest rates began to soar. What did this mean for savings and investments? People fled stocks and the mutual fund industry that had just really started to come into its own in the 1960s. They fled for the high interest returns on bonds and even savings accounts. Double digit interest rates were normal by the late 1970s setting the stage for some of the highest interest rates in history in the 1980s.
What did this mean for Whole Life insurance? The performance in Whole Life insurance is more dependent on the insurance companies general account. Within these accounts insurance companies hold a high percentage of bond with a mixture of maturities (lengths). The insurance companies would hold the bonds to maturity. This made it very difficult to keep up with the dramatic increases in interest rates near the end of the 1970s. People were seeing bigger returns in savings accounts and kept hearing about ‘buy term and invest the rest’. How could you lose when savings accounts are outperforming your policies?
The insurance companies recognized this. Or maybe they recognized that they were loosing a lot of money through canceled policies and policy loans. They knew they had to react to this trend. The original concept was an annual renewable term policy with an annuity. Then the Universal Life policy which inside it is an annual renewable term policy with a separate account that gives a fixed interest rate. With this the policy charges become more transparent. since the cost of insurance is based on annual renewable term it created an added flexibility in the premiums. Each year the charges in the policy change, with an overall trend upward. You contribute more than the costs and charges and the extra money goes into a separate account giving you a fixed rate of return. It’s ‘buy term and invest the difference’ in one vehicle which allows you to enjoy the tax benefits of life insurance.
Structural Overview of Universal Life
Now that you understand the history of a Universal Life policy you can begin to understand its structure. As stated previously at its core a Universal Life policy is annual renewable term insurance with a side account for fixed returns. The initial expenses and charges of a new policy are always high. The insurance company wants to protect against quick deaths and they want to get some money working for them. They also have to pay commissions. Commissions on a Universal Life policy usually range from 50% to 90% of the policy’s target premium anything over carries commission of around 1-2%.
After this high upfront charges, the major charges in the policy is the mortality costs or cost of insurance. The lure of the policies is the same as term insurance. At a young age the cost of insurance is low. Once the policy is up and running you are basically buying annual renewable term. Now annual renewable term is really cheap in your 20s and 30s. As you hit your 40s and 50s it has a noticeable rise in cost. Then by your 60s and 70s it’s becoming downright expensive. It’s this the problem with term insurance. The hope with a Universal Life policy is that the extra money you have paid in coupled with the interest earned on this extra money will be enough to offset the rising mortality costs.
To Be Continued…
This brings part I to a close. I hope you are starting to have a good understanding of how the Universal Life policy was created and what the structure of the policy is. This is going to set the stage for the second part. In Part II, we are going to look at how we got to where we are today. Today there is a whole different type of Universal Life policy out there. A lot of changes have occurred. These changes have been mainly spurred by interest rates and economic growth. What do you think is going to happen with a policy with rising internal expenses and decreasing returns? Sounds like a problem. Then add economic growth helping to spur the performance of the stock market…guess you’ll have to wait and see.
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