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In contrast to traditional whole life insurance policies — which feature fixed, level premiums and are often referred to as level death benefit, level premium life insurance — modern alternatives offer greater flexibility for policyholders. These nontraditional life insurance products include universal life insurance, variable life insurance, indexed universal life insurance, variable universal life insurance, current assumption whole life (CAWL), yearly renewable term (YRT), and annually renewable term (ART). Developed primarily in the 1970s and beyond, these plans are characterized by adjustable or variable death benefits and premiums, allowing for more personalized coverage and financial planning.
This type of permanent insurance product combines elements of traditional fixed premium whole life insurance with the potential to adjust the coverage or face amount based on the policy owner's changing needs.
Adjustable life provides an adjustable death benefit and cash value, while also possessing all of the features of traditional whole life policies. Its distinguishing characteristic is a provision referred to as the adjustment provision. The advantage of this policy is that it permits the policy owner to make prospective adjustments (i.e., in the future) to the policy's coverage amount. The policy premium is fixed for the policy year. If an adjustment in coverage is made (obviously, if more coverage is purchased, then the consumer pays more), the policyowner cannot waive premiums.
An individual whose income has been fluctuating over the past several years, or a couple who plans to have children over the next several years, are examples of prospective clients who may purchase an adjustable life policy to provide flexibility to meet their "changing needs." There may be some confusion regarding premiums for adjustable life. In the future, the policy owner may pay more or less per year than the original premium, because the premium is adjustable. However, remember the original definition: at any point in time, adjustable life insurance is a level-premium, level-death benefit policy. This means that whenever a coverage amount is increased, the premium that is due is level for the upcoming policy year. If the policy owner decides to increase the coverage amount, the insured party must always prove insurability. To simplify, an adjustable life policy is a traditional whole life policy with an adjustable death benefit. This type of policy is characterized by prospective (i.e., future) adjustments only.
Universal life insurance provides its owner with the most flexibility compared to a traditional whole life plan. It may be referred to as an adjustable form of life insurance (flexible premium adjustable life) since it allows contract owners to change the coverage amount at their discretion. This type of policy may be characterized as interest-sensitive as it utilizes changing interest rates (or rate of return) to determine cash values. These changing interest rates are not used to determine death benefits or future premiums.
Universal life premiums pay for pure protection (i.e., YRT term insurance), plus a portion is deposited into the Accumulation Account. The cash value may also be referred to as: (1) a cash value fund, (2) a cash savings plan, (3) policy equity, or (4) a savings feature. As with traditional whole life policies, a fixed interest rate is paid on the cash savings as it accumulates. The minimum fixed interest rate paid on the cash value of a universal life contract is equal to the maximum interest rate paid (3.5% to 4.5%) on traditional whole life policies. This interest rate paid on the cash savings plan may be higher (i.e., interest-sensitive), depending on the insurer's investments.
A flexible premium also characterizes universal life. The policyowner may pay any amount of premium they wish each year or no premium at all if there is sufficient money in the accumulation account. This flexibility can be a disadvantage for an undisciplined policyowner. The only required premium is the first year's. If premiums are not paid following the first year to keep coverage in force, the cost of death protection will be withdrawn from the cash savings plan. The policy can pay for itself if there are sufficient cash savings. If no additional premiums are paid, the policy uses the cash value to keep coverage in force. However, if there is not enough cash to pay for death protection, the policy lapses.
When considering a universal life policy, a person must remember:
In a universal life insurance policy, the premiums, cash value, and the face amount can be adjusted. However, it is neither identical to adjustable life nor is it backed by equities, as in variable life products. Universal life policies are transparent since they're characterized by unbundled premiums. This means the contract owner is provided with information describing where the policy costs are allocated. In other words, the contract owner receives a breakdown of premiums, death benefits, mortality charges, expenses, and cash values. This breakdown shows the contract owner the disposition of the policy funds.
Some insurers offer a target premium, allowing contract owners to plan their premium payments regularly. Since premiums are flexible, many contract owners may see their coverage lapse if they don't manage the plan. To avoid possible tax problems, premium allocations to a universal life policy's cash value must comply with tax law (IRS) guidelines.
Funds withdrawn from the policy's cash value may not be subject to interest when used to pay premiums. As premiums are paid, and as cash values accumulate, interest is credited to the contract's equity. Companies pay a guaranteed rate but may also pay a higher (current) rate depending on the company's investment performance. They will never pay less than the guaranteed rate. The company may adjust the rate quarterly. Fixed interest rates paid on the cash value traditionally include a guaranteed minimum of 2% to 4%; however, this will vary based on market conditions.
Since universal life is an unbundled product, the different factors that affect cash value are considered individually, including surrender charges. Insurers apply a surrender charge against the existing cash value if a policy is cancelled by the insured during the first 10 to 15 years of the policy. Surrender charges may also be applied to partial withdrawals in some cases, depending on the size of the withdrawal as a percentage of the total available cash.
Universal life policies offer two death benefit choices: Option A and Option B. Under Option A (also referred to as Option One), a level death benefit is provided. The net amount at risk (NAR) is adjusted after each month. As such, a mortality charge is deducted from the policy's cash value monthly. Therefore, the cash value and NAR (benefit) together provide a fixed death benefit. Option B (also referred to as Option Two) provides an increasing death benefit as the cash value increases. As such, the death benefit equals the face amount plus the cash value at the time of death.
The amount of pure insurance protection above the cash value is often referred to as a corridor. In order for a contract to qualify as life insurance for tax purposes, there must be "space" between the total death benefit and the cash value of the policy. An automatic increase in the death benefit results when the cash value approaches the initial face amount under Option A.
If this space is not present, the policy will lose its favorable tax treatment and become a modified endowment contract (MEC) since it will not meet the Internal Revenue Code's definition of life insurance. In addition, for cash value accumulations to receive favorable tax treatment (i.e., tax deferral), a specific percentage of universal life premiums must be used to purchase the death benefit amount.
Some insurers offer a "waiver of monthly deduction" rider to be added to a universal life policy. Much like the waiver of premium rider used on term and traditional whole life policies, the waiver of cost of insurance rider waives premiums when the policyowner is permanently disabled; however, it does not waive the total premium. This rider waives only the cost of the pure protection (mortality, interest, and expenses), not the portion allocated to the cash value.
A no lapse guarantee rider may be added to a universal life policy. Universal life insurance offers the contract owner premium flexibility that could result in insufficient premiums being paid to support the policy. As previously described, paying insufficient premiums could cause the policy to lapse. The no-lapse guarantee benefit rider prevents a lapse by imposing a premium payment schedule that requires minimum premiums to be paid on a regular basis. In other words, the no lapse guarantee rider guarantees that the policy will not terminate before a determined date if specified amounts of premium are paid, and any policy loan plus accrued loan interest does not exceed the cash surrender value. The length of the policy's guarantee period generally ranges from five to 40 years, depending on the age of the insured when the policy was issued. Some (but not all) insurers charge an extra premium for this rider.
Universal life insurance comes in several forms, including fixed-rate policies controlled by the insurer and variable policies in which the policy owner can allocate premium dollars in separate accounts that invest in equities. Fixed-rate policies offer a degree of security. Variable policies offer the potential for higher returns if the policy owner accepts the risk of losing cash value in a market downturn.
Indexed universal life, also known as equity-indexed universal life, is a fixed (non-variable) product that offers policy owners a third option, one that offers some potential for higher returns, but also ensures that policy owners will not lose money in a stock market downturn. Indexed policies link their rate of return to a stock market index, such as the S&P 500, but the funds are not directly invested in it. Instead, insurers determine their rate of return based on the market index's value at two specific points in time. If the index is higher at the end of the period, policy owners receive a percentage of the gain, usually capped at a stated maximum. If the index has declined, the policy owner is protected; no cash value is lost. However, no interest will be earned.
Guaranteed universal life insurance — which is also referred to as no-lapse guaranteed universal life or guaranteed death benefit universal life — is a type of life insurance that provides a policy owner with a guaranteed death benefit, as long as the required premiums are paid. Therefore, even if there's insufficient cash value in the contract to support the death benefit, the policy will remain in force due to the coverage protection guarantee. For this guarantee to be provided, the contract stipulates that minimum premiums must be met and paid on time. As such, a guaranteed universal life insurance contract will still pay out a death benefit even if the accumulated cash value decreases or goes to zero.
As with most types of universal life insurance, guaranteed universal life offers flexible premium options that can vary based on an individual's ever-changing financial situation. However, a minimum premium (or premium target) must still be met to prevent the policy from lapsing. Also, any variation in premium amounts will affect the interest rate within the contract, which will affect the cash value accumulations. The focal point of this type of product is the guaranteed death benefit rather than the cash value accumulation.
Most insurers allow a policy owner to select a guaranteed coverage period (e.g., age 90 or age 120). In effect, this means that the contract provides permanent protection with the flexible premium structure of a traditional universal life insurance plan. Additionally, some insurers provide the policy owners with the flexibility to change the coverage period as their needs or situations change.
A survivorship universal life insurance contract is often referred to as second-to-die insurance. The contract covers two people and pays a benefit only after both covered individuals have died. Since it costs less than two individual permanent policies, it's an affordable option for a person who wants to leave a larger nest egg for their heirs or a favorite charity.
| Policy | Death Benefit | Premium | Cash Value | Policy Loans | Partial Withdrawals of Cash Value | Surrender Charges |
|---|---|---|---|---|---|---|
| Adjustable Life | Level, but changeable by request | Level, but the level may change when the policy change is requested | Predetermined and tax-deferred, but new schedule needed after each negotiated policy change | YES, if there's cash value | NO. To receive cash, it must be borrowed. | NO |
| Universal Life | Flexible; original DB cannot be guaranteed if the owner is not funding the plan with premiums. A flexible premium insurance plan. | Flexible premium. Required first year target (i.e., suggested level premium), and then the owner may pay flexible premiums each year or nothing at all. | Guaranteed minimum interest rate (e.g., 4%). The interest rate will vary each year based on the money market index. Interest is tax-deferred. | YES. Loans affect the interest rate credited to the cash value. | YES | YES |