This blog will focus on why we DO NOT use Universal Life (UL) or any of the variants of UL for the IBC.
We will go through the different types of UL policies and also discuss why it was invented. There is a lot of content out there on UL, and I know you can feel overwhelmed trying to understand every different product and company. Our goal is to give you an overview of what UL is.
When did Universal life come on the scene?
The Universal Life product was invented in the early 1980s by a stock brokerage firm by the name of E. F. Hutton.
There was a lot of anti-whole life insurance propaganda circling around in the late 1970s. UL was created to be more “transparent” than regular whole life.
How is Universal Life more transparent than whole life?
UL gives a clear breakdown of mortality and other expenses with the insurance contract.
UL also offers a very flexible premium that can be adjusted up and down quite easily, or not paid at all. Just to be clear with you, we all reap what we sow. When you aren’t responsible and pay less than the target premium or nothing at all, you put your policy at a much higher risk of a lapse in the future.
I do want to add a quick note here that a properly structured WL contract with some companies offers very flexible payment terms as far as timing throughout the year, and can have payments adjusted up and down. You also know what the bare minimum is you must pay for the insurance company to GUARANTEE your policy stays in force. This cannot be done with UL.
How is Universal Life constructed?
In simple terms, UL is nothing more than one-year term insurance with a side fund of an interest-bearing account. UL unbundles the savings element from the life insurance element for transparency.
This type of product offers more earning potential than a whole life policy, especially with variable UL and indexed UL. You will see in almost every case though that on a guaranteed ledger the insurance costs will outpace your guaranteed earning rate and the policies lapse.
Is this likely to happen?
No, but it is something you need to be aware of. The thing that is much more likely to result in a policy lapse in the future is a policyholder paying less than the target premium repeatedly. One other common reason these policies get a bad rap is the client is shown a rosy illustration assuming a high rate of return which keeps the policy in force until the insured would pass away. If this high rate of return is not achieved AND you have paid in less than the target premium repeatedly, you may need to put some hefty premiums into your policy in the future to keep it in force.
This is due to the fact that as you age the cost for one-year term insurance increases because you are getting older. If you don’t have an adequate amount of cash surrender value earning interest to help take care of this, it can be very expensive!
With whole life, the insurance company guarantees that if you pay at least the minimum required premium your policy will stay in force, even if the policy doesn’t perform like originally projected. There are also non-forfeiture options with whole life. The most popular of these is “reduced paid up,” meaning the cash value you have accumulated is used to purchase a lump sum of death benefit which is smaller than the amount of death benefit you would currently have, therefore “reducing” your benefit. No future premiums would be allowed from this point forward but your cash value and death benefit continue growing and you can still exercise your right to policy loans. This option doesn’t exist with UL.
Another variant of UL was released in the late 1990s
This product is called Indexed Universal Life or IUL. IUL was touted as the one product that does it all. It allows you to partially or fully capture the gains of the stock market without having any downside risk. These policies usually have a 0% floor and an 8-11% cap on gains (this varies with each insurance company, and the insurance company controls the right to lower or raise this). Cap rates can be much higher or lower than what is stated, but this is close to where contracts are right now.
When you look at this briefly, it appears to be a near-perfect product.
After all, a 0% floor means you can’t lose money, right?
The problem with this is if the return from the stock market one year was negative, your cash value participates at the 0% floor. If your mortality costs and other expenses that year are .5% of your cash value, your policy will actually decrease in value to cover the expenses.
I do want to note to be fair that some IUL contracts do have 1% or even 2% floors with the tradeoff being a lower cap rate typically. Another positive for them is that after a bad year for the market it is very possible to see big gains the following year. So, while you may have a very slight gain or be slightly negative 1 year, you have a real chance at capping out the next year.
Why do we not use UL or any UL variants for IBC?
Overall, the UL types of life insurance lack the solid guarantees that regular whole life provides. With these policies, the insurance companies move the risk from themselves to the policyholder over time. There is no guarantee that your premium will stay the same (at least the same to keep your policy in force with the same face value), and there is no guarantee that your policy will last your whole life.
While I believe these are real issues with the product, I know that it does work when treated correctly. If you would just take what it would cost for a whole life policy and pay that into a UL policy of the same face amount, I know you're putting yourself in a good position.
One fact that I particularly don’t like about the product is the fact that your cash value can go backward and it could happen for multiple years in a row. If you are leveraging your policy heavily to practice the IBC, this would not be ideal at all!
So why do we only use whole life insurance for IBC?
You have a level premium that is fixed for the life of the policy. Your premium can never be increased by the insurance company, but with your unique IBC designed policy, you do not have to pay the total premium every single year either. The death benefit and cash value are guaranteed to only INCREASE in value. The cash value is in no way tied to the stock market so there is no risk of loss. The gains in the policy can be accessed tax and penalty-free if properly used (as can UL), and the death benefit is always passed on an income tax-free with a properly structured policy.
With this product, the insurance company is taking on all the risks.
To learn more about the power of dividend-paying whole life insurance, Book Your IBC Discovery Call today.