Universal Life Insurance came into play in the 1980’s to be a more flexible and transparent form of permanent life insurance than the original Whole Life product. Universal Life was created by the stock brokerage firm E.F. Hutton, not a life insurance company, and is without the guarantees Whole Life Insurance has to offer.
Where Whole Life Insurance investments are ‘hands-off’ for the policy owner, this relatively new insurance product provides the policy owner with permanent insurance and more control over the tax-advantaged investment component inside the policy. It also offers more flexible premiums and coverage options. With more control over the different features, comes more responsibility on the policy owners shoulders for the performance of the product as you will read about below.
Over the years Universal Life Insurance has offered:
- Traditional Universal Life – an insurance product similar to Whole Life insurance but with flexible premiums.
- Indexed Universal Life – an insurance product with investments that are not in an equity index itself but that simply track an index instead. When the index that is being tracked goes up, the cash values of the policy are credited and when the index goes down, the cash values remain the same. Flexible premiums, investments, and coverage options are available with this type of Universal Life Insurance. (Please note Indexed Universal Life is not the same as the indexed coverage option, where the death benefit of a policy is indexed to inflation every year.)
- Variable Universal Life – an insurance product with the most investment risk. With this product, the cash values of the policy can be reduced to zero based on the performance of its investments at the time.
For a detailed history of Life Insurance please go here.
Now, the purpose of these articles is to provide you with the basics of the different financial products available in Canada today and from the perspective of key features desired by most Canadians. Because of this perspective, not every product will be an apples-to-apples comparison to the other. For example, the information here will not necessarily be in the same order as in the Whole Life 101 article. Here, I would like to highlight the difference in premiums, investments, and coverage options available for Universal Life policies, and not the type of insurance product that were mentioned above.
Unlike Participating Whole Life Insurance where premiums go into a pooled account to pay for the cost of insurance, expenses, and then investments, premium payments for a Universal Life Insurance policy go into the individual policy’s investments first. The cost of insurance and other administrative expenses are then paid from the policy investments. Policy investments also make up the policy’s cash values.
Policy owners can choose to fund their policy with the minimum or maximum amount allowed, or anywhere in between. Other premium options for this product include Yearly Renewable Term (YRT) or Level Cost of Insurance (LCOI):
Yearly Renewable Term
A YRT premium option is like the Term Insurance premium structure, only instead of calculating the cost of insurance for a 10-year term, for example, the cost of insurance will be calculated for one year only. This cost will need to be recalculated again in the following years. While initially much cheaper during the insured persons younger years, the cost of insurance may become unaffordable in the later years of the policy. The reason a person may choose the YRT option is to keep the cost of insurance low in early years so a greater amount, or the premiums above this cost, remains in their policy’s tax-advantaged investments.
Level Cost of Insurance
The LCOI premium option is more like a Whole Life Insurance premium structure, or Term 100, where the total cost of insurance from the life insureds current age to age 100 are calculated and averaged out. Choosing this option will increase the immediate cost of insurance and possibly decrease the amount remaining inside the investments.
A Very Important Note On Premiums
The flexibility of Universal Life Insurance can be especially useful to the policy owner in financially stressful years with the option to decrease premiums and in years of plenty where they may increase their premiums for investment purposes. Practically speaking, however, it is not uncommon for a policy owner to maintain minimum premiums over the years, only to realize their cash values have been eaten up by the additional costs. If cash values are not properly maintained, the policy may lapse on itself and the policy owner will be left with no life insurance in place.
Investments for Universal Life Insurance can be allocated between low risk, medium risk, and high risk investments. Different insurance companies may offer different investment options including Guaranteed Investment Certificates, Tax Free Savings Account, Daily Interest Account, Guaranteed Deposit Account, Mutual Funds, Indexed Accounts, and more. A person purchasing a Universal Life policy may be interested in the opportunity to earn tax-advantaged growth on their investments.
The cash values of the policy are tied to investments, so it is a good idea to know what type of Universal Life you are getting and if the cash values are guaranteed or not. If you are planning to withdraw a portion of your cash values, there may be a surrender charge in the first 10 years of the policy. If you are planning to take out a policy loan against your cash values, there may be a reduced amount available to you within the first 10 years. If you are taking out a policy loan, and your investments are in a high-risk category, these will need to be transferred to a low risk investment until the loan is repaid.
Again, premiums paid into the policy are allocated to the different investment categories according to the insured person’s risk profile and time horizon. The cost of insurance and other administrative costs are then paid out from the investments inside the policy accordingly. The costs will be paid one way or the other, either by premiums designed to cover theses costs, or by withdrawing from the policy cash values. If the premium being paid into the policy is not enough to maintain these costs, it is possible to “eat up” a portion of, or the entire amount of cash values in later years.
Technically, Universal Life Insurance is the only type of insurance that offers an increasing death benefit in its coverage options. This ‘unbundled’ permanent life insurance product offers different coverage options including level coverage, level coverage plus account value, level coverage plus premiums, and indexed coverage.
Level coverage is simple. If a policy owner were to purchase a $500,000 policy, this means if the insured person were do die, $500,000 will be paid out as a tax-free death benefit. Any investments or cash values will make up part of this death benefit and will not be paid out in addition to it.
Level Coverage Plus Account Value
For this coverage option, any cash values from the investment accounts will be paid out in addition to the $500,000 death benefit. Though it is more than likely the value of the investments will have increased over the years, it can make final planning arrangements more difficult given the unknowns of the financial markets.
Level Coverage Plus Premiums
Like the Level Coverage Plus Account Value option, this one will see the $500,000 death benefit increased every year by the amount of premiums paid. The value of the investments or cash values will already be included in the death benefit.
This is where the death benefit of a policy is indexed to inflation every year. This can be done as a fixed percentage, say 2.5% every year, or based on inflation up to a maximum percentage, say 3.5% every year.
Different insurance companies offer different insurance riders. Riders are the options you can add on to a basic insurance policy. While some insurance companies offer more riders and some less, here is a list of the basic riders available in Canada:
- Term Insurance
- Critical Illness Insurance
- Long Term Care or Terminal Illness
- Accidental Death and Dismemberment
- Death or Disability Waiver of Premiums
- Future Guaranteed Insurability
- Child Rider
- Spousal Rider
- Paid Up Additions
A Very Important Note on Universal Life
There are many variations to the premium, investment, and coverage options of these policies depending on the insurance company you are working with. There are also many ways to set these policies up. Each option has a unique cost associated with it and it is up to you (and your financial advisor) to determine the best way to make this work for your unique financial situation. Please also note that Universal Life is NOT recommended for Infinite Banking purposes.
Looking for a safe place to put your money? There’s no better place to build wealth WITHOUT risk than in an Infinite Banking policy. Learn more here.
Key Features Desired By Most Canadians
Safety and Security:
- Predictable Results
- No Capital Loss
- Guaranteed Cash Accumulation
- No Capital Loss
- Guaranteed Cash Accumulation
Access to Money Without Penalty:
- Liquidity, Use and Control
- Guaranteed Loan Option
- Collateral Opportunity
- Free of Government Involvement
- Tax-Deferred Growth
- Tax-Free Distribution
- Tax-Free Death Benefit
- Tax-Deductible Contribution
Insurance Planning Opportunities
- Infinite Banking
- Short term savings
- Long term savings
- Education Planning
- Mortgage or Debt Insurance (Buy Term, Invest The Difference)
- Income and Family Protection
- Retirement Planning
- Estate Planning
- Corporate Retirement Planning
- Corporate Estate Planning
- Buy/Sell Agreement
- Key Person Protection