Universal life insurance

Universal life insurance is a type of insurance that combines an insurance component and a savings component. It gives you lots of flexibility, including in determining the amounts and timing of your premium payments. You can also choose how the money in your accumulating fundA capitalization fund is the amount accumulated in a universal life insurance policy. is to be invested. However, you have to make good decisions to avoid ugly surprises like the ones Steve experienced.

Steve’s case

At 54, Steve bought a $100,000 universal life insurance policy with a fixed annual premium of $600. After seven years, Steve had over $1,600 in his accumulating fund. Sounds good, right? Not really. At 68, Steve lost all the savings he’d accumulated, he owed $503 to his insurer, and the annual cost of his insurance was $1,384 and would continue to rise for the years to come. How did this happen? Could it happen to you?

Steve didn’t realize that, with universal life insurance, the premium doesn’t necessarily correspond to the cost of insurance. The cost of insurance is the amount charged by the insurer to cover you. Steve’s universal life insurance premium is the amount that is deposited in his accumulating fund. Steve may choose to pay a higher or lower amount. If he pays more than the minimum amount due, the additional amounts will be deposited in his accumulating fund. He may choose to pay less—or even nothing—in a particular year, in which case the insurer will use a portion of the amounts in Steve’s accumulating fund to pay the cost of insurance.

Steve’s insurance policy indicated the cost of insurance he would be required to pay each year, but the information wasn’t on the main page, so Steve didn’t see it. If you don’t know where to find it, ask your representative. Also, if any calculations need to be done, ask your representative to do them for you.

In Steve’s case, we have the following table:

AgeAnnual insurance costAnnual premiumFunds accumulated
54$320$600$288  
55$327$600$578
56$359$600$844
57$396$600$1,079
58$437$600$1,280
59$481$600$1,440
60$535$600$1,551
61$594$600$1,603

Yes, you saw it right! The cost of insurance nearly doubled in just seven years, rising from $320 to $594!

As this cost remained lower than the premium paid, the amounts in Steve’s accumulating fund continued to grow, leading Steve to think that all was well.

Let’s look at what happened in the years that followed:

AgeAnnual insurance costAnnual premiumFunds accumulated
62$659$600$1,591
63$733$600$1,501
64$813$600$1,327
65$903$600$1,055
66$1,006$600$668
67$1,118$600$155
68$1,243$600$(503)

Once again, the cost of insurance nearly doubled, this time rising from $659 to $1,243.

At 68, Steve’s insurer sent him a notice demanding payment of $503 to keep the insurance in force. His insurer indicated that the cost of insurance for the following year would be $1,384. Steve didn’t understand what had happened!

The cost of insurance will keep on increasing from year to year. In the extreme case, to be covered in his 99th year, he will have to pay $26,918.

What options are open to him?

At this stage, his options are limited. Although it isn’t required to do so, Steve’s insurer could offer him two possible solutions:

  • Convert his insurance with an increasing cost into insurance with a fixed annual cost
    However, the cost will be based on Steve’s current age. Therefore, fixed-cost life insurance could cost him thousands of dollars a year.
  • Purchase reduced insurance with a fixed annual cost
    For example, instead of being insured for $100,000, Steve could agree to be insured for only $25,000 and take advantage of the resulting cost of insurance. That way, the amount payable might be within his budget.

In both scenarios, Steve must give up the insurance he thought he had, namely a $100,000 life insurance policy at a cost of only $600 a year.

Insight

The role of the financial security advisor

The advisor provides a lot of information when selling life insurance. Steve’s advisor had undoubtedly explained the principle of universal life insurance to him. He likely had also told him that the cost of insurance would increase. Several years later, however, Steve had forgotten that. Make sure you note down or highlight the key points in your contract when your advisor explains them to you. Few people can remember whether their advisor did or didn’t explain something.

Read the information that your insurer sends you periodically in order to keep track of the cost of your premium, the cost of insurance and the amounts available in the accumulating fund.

End of the insight

Do you think you have increasing-cost universal life insurance?

If you’re not comfortable with the rising cost of your insurance, check with your representative to see whether you can convert your insurance into insurance with fixed (level) premiums. The earlier you switch to this type of insurance, the lower the level cost will be. Conversely, the older you get, the higher the cost of insurance will be at the time of conversion.

Be informed. Ask your financial security advisor if this type of insurance is still right for you.

Warning

Be aware of examples provided by the advisor (often referred to as “policy illustrations”)

Generally, universal life insurance is sold using examples of amounts you will save up in your accumulating fund over time. The projected amounts are often significant. Be careful! What rate of return is being used in the examples? Is the rate guaranteed? Is it realistic? Does the projection extend until age 100? If not, be careful! Sometimes, the projection doesn’t cover enough years for you to see the moment at which problems emerge, such as a large increase in the cost of the insurance.

End of the warning