Universal life insurance (often shortened to UL) is a type of cash valueThe National Association of Insurance Commissioners' Life Insurance Buyer's Guide on page 3 refers to "cash value life insurance," rather than permanent life insurance. On page 4, the guide notes how Universal Life coverage can end due to depletion of the cash value and thus not be permanent. See http://www.naic.org/documents/consumer_guide_life.pdf. life insurance, sold primarily in the United States. Under the terms of the policy, the excess of premium payments above the current cost of insurance is credited to the cash value of the policy, which is credited each month with interest. The policy is debited each month by a cost of insurance (COI) charge as well as any other policy charges and fees drawn from the cash value, even if no premium payment is made that month. Interest credited to the account is determined by the insurer but has a contractual minimum rate (often 2%). When an earnings rate is pegged to a financial index such as a stock, bond or other interest rate index, the policy is an "Indexed universal life" contract.
Similar life insurance types A similar type of policy that was developed from universal life insurance is the variable universal life insurance policy (VUL). VUL lets the cash value be directed to a number of separate accounts that operate like mutual funds and can be invested in stock or bond investments with greater risk and potential growth. Additionally, there is the recent addition of indexed universal life contracts similar to equity-indexed annuities which credit interest linked to the positive movement of an index, such as the S&P 500, Russell 2000, and the Dow Jones. Unlike VUL, the cash value of an Index UL policy generally has principal protection, less the costs of insurance and policy administrative fees. Index UL participation in the index may have a cap, margin, or other participation modifier, as well as a minimum guaranteed interest rate.
Universal life is similar in some ways to, and was developed from, whole life insurance, although the actual cost of insurance inside the UL policy is based on annually renewable term life insurance. The advantage of the universal life policy is its premium flexibility and adjustable death benefits. The death benefit can be increased (subject to insurability), or decreased at the policy owner's request.
The premiums are flexible, from a minimum amount specified in the policy, to the maximum amount allowed by the contract. The primary difference is that the universal life policy shifts some of the risk for maintaining the death benefit to the policy owner. In a whole life policy, as long as every premium payment is made, the death benefit is guaranteed to the maturity date in the policy, usually age 95, or to age 121. A UL policy lapses when the cash value is no longer sufficient to cover the insurance and policy administrative expense.
To make UL policies more attractive, insurers have added secondary guarantees, where if certain minimum premium payments are made for a given period, the policy remains in force for the guaranteed period even if the cash value drops to zero. These are commonly called no lapse guarantee riders, and the product is commonly called guaranteed universal life (GUL, not to be confused with group universal life insurance, which is also typically shortened to GUL).
The trend up until 2007–2008 was to reduce premiums on GUL to the point where there was virtually no cash surrender values at all, essentially creating a level term policy that could last to age 121. Since then, many companies have introduced either a second GUL policy that has a slightly higher premium, but in return the policy owner has cash surrender values that show a better internal rate of return on surrender than the additional premiums could earn in a risk-free investment outside of the policy.
With the requirement for all new policies to use the latest mortality table (CSO 2001) beginning January 1, 2004, many GUL policies have been repriced, and the general trend is toward slight premium increases compared to the policies from 2008.
Another major difference between universal life and whole life insurances: the administrative expenses and cost of insurance within a universal life contract are transparent to the policy owner, whereas the assumptions the insurance company uses to determine the premium for a whole life insurance policy are not transparent.
Uses of universal life insurance Final expenses, such as a funeral, burial, and unpaid medical bills Income replacement, to provide for surviving spouses and dependent children Debt coverage, to pay off personal and business debts, such as a home mortgage or business operating loan Estate liquidity, when an estate has an immediate need for cash to settle federal estate taxes, state inheritance taxes, or unpaid income taxes on income in respect of a decedent (IRD) Estate replacement, when an insured has donated assets to a charity and wants to replace the value with cash death benefits Business succession & continuity, for example to fund a cross-purchase or stock redemption buy/sell agreement Key person insurance, to protect a company from the economic loss incurred when a key employee or manager dies Executive bonus, under IRC Sec. 162, where an employer pays the premium on a life insurance policy owned by a key person. The employer deducts the premium as an ordinary business expense, and the employee pays the income tax on the premium Controlled executive bonus, just like above, but with an additional contract between an employee and employer that effectively limits the employee's access to cash values for a period of time (golden handcuffs) Split dollar plans, where the death benefits, cash surrender values, and premium payments are split between an employer and employee, or between an individual and a non-natural person (e.g. trust) Non-qualified deferred compensation, as an informal funding vehicle where a corporation owns the policy, pays the premiums, receives the benefits, and then uses them to pay, in whole or in part, a contractual promise to pay retirement benefits to a key person, or survivor benefits to the deceased key person's beneficiaries An alternative to long-term care insurance, where new policies have accelerated benefits for Long Term Care Mortgage acceleration, where an over-funded UL policy is either surrendered or borrowed against to pay off a home mortgage A life insurance retirement plan utilizes the cash value of a life insurance policy to invest in the stock market and provide income. The cash value can be withdrawn tax-free, but requires "overfunding" the policy with large premiums and service fees to be considered viable Term life insurance alternative, for example when a policy owner wants to use interest income from a lump sum of cash to pay a term life insurance premium. An alternative is to use the lump sum to pay premiums into a UL policy on a single premium or limited premium basis, creating tax arbitrage when the costs of insurance are paid from untaxed excess interest credits, which may be crediting at a higher rate than other guaranteed, no risk asset classes (e.g. U.S. Treasury Bonds or U.S. Savings Bonds) Whole life insurance alternative, where there is a need for permanent death benefits, but little or no need for cash surrender values, then a current assumption UL or GUL may be an appropriate alternative, with potentially lower net premiums Annuity alternative, when a policy owner has a lump sum of cash that they intend to leave to the next generation, a single premium UL policy provides similar benefits during life, but has a stepped up death benefit that is income tax-free Pension maximization, where permanent death benefits are needed so an employee can elect the highest retirement income option from a defined benefit pension Annuity maximization, where a large non-qualified annuity with a low cost basis is no longer needed for retirement and the policy owner wants to maximize the value for the next generation. There is potential for arbitrage when the annuity is exchanged for a single premium immediate annuity (SPIA), and the proceeds of the SPIA are used to fund a permanent death benefit using Universal Life. This arbitrage is magnified at older ages, and when a medical impairment can produce substantially higher payments from a medically underwritten SPIA RMD maximization, where an IRA owner is facing required minimum distributions (RMD), but has no need for current income, and desires to leave the IRA for heirs. The IRA is used to purchase a qualified SPIA that maximizes the current income from the IRA, and this income is used to purchase a UL policy Creditor/predator protection. A person who earns a high income, or who has a high net worth, and who practices a profession that suffers a high risk from predation by litigation, may benefit from using UL as a warehouse for cash, because in some states the policies enjoy protection from the claims of creditors, including judgments from lawsuits
Living benefits of life insurance Many people use life insurance, and in particular cash value life insurance, as a source of benefits to the owner of the policy (as opposed to the death benefit, which provides benefit to the beneficiary). These benefits include loans, withdrawals, collateral assignments, split dollar agreements, pension funding, and tax planning.
Loans Most universal life policies come with an option to take a loan on certain values associated with the policy. These loans require interest payments to the insurance company. The insurer charges interest on the loan because they are no longer able to receive any investment benefit from the money they lent to the policy holder.
Participating loans are generally associated with certain Index Universal Life policies. Since these policies will never incur a loss on the investment portion due to hedging, participating loans are secured by the policy's Account Value, and allow whatever index strategy that was in place prior to creating the loan to remain in place and unaffected as to whatever index return is realized. Standard loans require conversion of any ongoing index allocations to be terminated, and an amount at least equal to the loan moved into the policy's Fixed Account.
Repayment of the loan principal is not required, but payment of the loan interest is required. If the loan interest is not paid, it is deducted from the cash value of the policy. If there is not sufficient value in the policy to cover interest, the policy lapses.
Loans are not reported to any credit agency, and payment or non-payment against them doesn't affect the policyholder's credit rating. If the policy has not become a "modified endowment", the loans are withdrawn from the policy values as premium first and then any gain. Taking Loans on UL affects the long-term viability of the plan. The cash values removed by loan are no longer earning the interest expected, so the cash values don't grow as expected. This shortens the life of the policy. Usually those loans cause a greater than expected premium payment as well as interest payments.
Outstanding loans are deducted from the death benefit at the death of the insured.
Withdrawals If done within IRS Regulations, an Equity Indexed Universal Life policy can provide income that is tax-free. This is done through withdrawals that do not exceed the total premium payments made into the policy. Also, tax-free withdrawals can be made through internal policy loans offered by the insurance company, against any additional cash value within the policy. (This income can exceed policy premiums and still be taken 100% tax-free.) If the policy is set up, funded and distributed properly, according to IRS regulations, an Equity Indexed UL policy can provide an investor with many years of tax-free income.