Universal life insurance originated in the 1980’s. It was an innovation in the life insurance business facilitated by the availability of powerful computers and sophisticated computer systems. Universal life policies are a variation of the older types of life insurance portfolios that included an investment portion. The main difference between the newer universal life and the older linked policies is that the amount of life cover charged for will vary from month to month depending of the value of the investment portion.
Traditionally, endowment type policies included both an investment and a risk cover portion. Many people were disappointed each year with the investment performance of many of these policies. During the 1980’s computer processing power was becoming much more powerful. The newer machines were capable of performing a multitude of complex calculations on every policy without bringing the entire system to a standstill. Universal life policies became a possibility.
Conceptually, Universal Life Insurance is sound. These policies usually have a fixed premium. At the beginning of each month, or when the premium is collected, the cost of life cover for the month is calculated, and the balance less expenses is used to fund investment. At the outset, the insured selects the amount of cover required as a death benefit. The philosophy behind the product is that it is better to buy investment rather than risk cover. As the insured’s age increases, so does the cost of life cover. The investment portion is therefore used to offset the cost of this risk cover. With a large enough investment portion over time, the risk premium could eventually fall away altogether.
Universal life policies generally provide a cash value after a number of years. The cash value reflects the value of the investment portion of the policy.
Variations of the universal life policy are ‘vanishing premium’ or variable universal life. The policy eventually reaches the stage where the investment funds the policy, or the insurer has the option of a premium holiday.
The main problem with all investment based life insurance is the small issue of the expenses that are charged against a policy. These include massive commissions and administration and investment fees. These fees are levied monthly and charged against the investment portion of the policy. A major portion of the expenses is incurred at the outset, resulting is minimal investment for most of the first year. Additional expenses or early termination penalties could also be levied against the cash value of the policy should you decide to cash it in early.
The next problem lies in the calculation of the cost of life cover. Some companies charge more than others!
The general rule when buying life insurance is that term insurance provides the best value. Commissions and expenses are much lower, but there is generally no cash value when the term expires. Term insurance is much cheaper than investment type policies and the money saved can be used to fund a purpose built investment.
For anyone with the discipline to invest monthly and not use the investment, the term insurance option is the best. Universal life provides an alternative for those that do not have the discipline to maintain a monthly long term investment.