What Is Universal Life Insurance?
Life insurance can be bought in many forms and universal life is one of those forms. Universal life insurance is a permanent type of insurance that is based on a cash value. With this type of insurance, the insurer pays a somewhat higher premium than he or she would with a term life policy. A portion of that higher premium is used to pay for the life insurance itself and the remainder is placed into an investment portfolio. Premiums are usually paid monthly and that portion that is used as investment is credited, with interest to the policyholder's account. The portion that is used to pay for the insurance itself is deducted from the total amount that is sent in.
This is known as the COI or Cost of Insurance portion. In the event no payment is sent in for a month, the amount of the COI is deducted from the cash amount in the account. The amount of interest that will be credited to the account is determined by the insurer. In many cases, this will be determined by a financial index of some type. Because only the amount of interest credited and not the cash value itself varies, universal life policies offer a stable investment option for some consumers.
It should be noted that there is a similar type of policy that was designed from aspects of the universal life policies and that is called the Variable Universal Life (VUL) insurance policy. VUL policies allow the cash value to 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 reward. Lastly, there are the Equity Indexed Universal Life policies that work by investing in Index Options such as the S&P 500, the Russell 2000, the Dow, and other indexes. These types of contracts only participate in the movement of the specified index and do not participate in the actual purchasing of stocks, bonds, or mutual funds. One reason people choose universal life policies is that they offer a greater potential for increasing cash value growth when the interest rates that are used for the policy outperform the insurer's general account. There are other benefits as well. Universal life insurance is also more flexible than whole life insurance in two important ways: The death benefit amount and often the premium payment amount are more flexible. Under certain conditions, the death benefit can be increased or decreased without actually losing the policy or having to begin anew as would be the case with whole life. The second way universal life offers more flexibility is that it allows for a larger range of premium payments. These can range from the minimum amount allowed to cover the policy up to the maximum amount allowed by the IRS.
In closing, the main difference between whole life and universal life is that universal life shifts some of the risk for maintaining the death benefit to the insured. Conversely, with a whole life policy, as long as all the premium payments are made, the death benefit is guaranteed to be paid once the insured dies. With universal life, the policy will lapse and the death benefit will no longer be available if the cash value or premium payments are not enough to cover the cost of insurance. Before purchasing universal life, make sure you speak with a qualified broker or agent. He or she can answer your questions and help you decide which type of policy is best for you.
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