Why I Will Not Sell Universal Life Insurance
I do have access to most carriers and their entire list of products, and it is my choice as to which products I work with for the benefit of my clients.
I’m a “professional” and subject to fiduciary responsibilities. Hold that statement for a moment.
What is a “fiduciary?”
“A fiduciary is a person or organization that acts on behalf of another person or persons, putting their clients’ interests ahead of their own, with a duty to preserve good faith and trust. Being a fiduciary thus requires being bound both legally and ethically to act in the other’s best interests.” Source: Investopedia
https://www.investopedia.com/terms/f/fiduciary.asp - What Is A Fiduciary
How do fiduciary responsibilities tie into this? Let’s start with a description of Universal life (UL).
UL was created on Wall Street by Jack Barger at E.F. Hutton in 1978. It was part of the “Limited Partnerships” effort, with the purpose of client tax avoidance, not wealth creation. Yes, UL has a death benefit and therefore carries some tax benefits per the US Tax Code (Section 7702), but an “insurance” label was Jack’s goal to allow for that tax avoidance. Jack testified before congress to get the approval from lawmakers and the label was awarded.
Universal Life insurance is often referred to as “permanent” insurance since the DB is meant to last until the insured dies, presumably in old age.
It is helpful to think of UL as a combination of two pieces: 1) the death benefit (the actual insurance) and 2) a savings or cash growth basket. The United States tax code allows for cash inside a “permanent” life insurance policy to grow tax-deferred and to potentially provide access to the use of cash tax-free.
So, what is the cost of the first part, and how does it affect the second part?
Cost of Insurance (COI)
When you buy a “permanent” or “cash value” life policy and pay for it via a premium, that premium is immediately divided into two pieces by the insurance company. The first piece goes to the company to cover what we call the cost of insurance (COI). The second piece goes to administrative expenses (mostly in the early years) and then to build the cash value over time.
This is true for both Universal Life and Whole Life (WL) Insurance, but differences do exist. When comparing UL COI and WL COI, it is notable that the UL cost starts lower, but continually, annually increases, while Whole Life COI does not. WL COI starts at a higher rate than UL’s but remains stable as the WL insurance company invests/prepares for the eventual death benefit claim.
Architecture of UL for Death Benefit…the Real Cost:
Regardless of which UL design is used, the supporting insurance death benefit (the Chassis), consists of a series of annually renewable term policies (ART) strung together. That means every year the insurance in the policy is re-priced for the insured’s new, older, age. The cost of insurance (COI) is therefore ever-increasing.
ART (term insurance) is integral to the designs, so to clarify:
Term insurance: Term insurance that the consumer knows is typically available for terms of 10, 20, even 30 years; coverage beyond the age of 80 is very difficult to find, if at all. Any of these multi-year policies is essentially a series of one-year policies with the premium (price) reflecting the average of those one-year prices.
You should know that if you apply for term life insurance at age 25, the cost would be lower than if applying at age 26. Every year you age, all other things staying equal, the price increases. The rate of increase grows as we age; the older we get, the steeper the price climb…. The difference in price from age 68 to age 69 is far larger than from age 30 to age 31.
We know that the cost of term policies is low due to the statistically low probability of the insured dying during the years of term coverage. However, if you were able to find an insurer willing to sell a term policy that would continue coverage to age 100 or beyond, you would find the cost to be dramatically higher.
Think of it this way: every year’s purchase of Annually Renewable Term (ART) is a singular stand-alone bet by the insurance company that the insured will or will not die that year and force a death claim payment.
Within each UL there is a string of these bets. Each year’s premium has nothing to do with any previous premiums. The company does not accumulate and invest cash for the eventual and inevitable death claim in a separate account. The COI climbs and grabs more and more of the premium and can eventually exceed the premium; it can grow to enormous levels.
Yes, in theory there is a cash build-up for the policy owner’s use, but with UL, the issuing companies reserve the right, with regulator review, to increase the COI structure (costs) in later years, above the already increasing levels. The policy owner has no say in this change.
There are three main Universal Life structures: Basic or Crediting-Rate UL (the 1978 original), Variable UL (VUL, brought out circa 1986), and Indexed UL (IUL, circa 2000).
Architecture of UL for cash growth:
Crediting-Rate UL has an interest rate, for growth, provided by the issuer insurance company. The rate might be e.g., 4% but will vary based on the economic and competitive environment when the policy is issued. This rate can change, typically to a lower level, after issuance. This rate is applied to the cash balance in the policy annually, like the growth process in a bank savings account. The risk is carried entirely by the policy owner.
VUL offers the policy owner “sub-accounts” which resemble mutual funds. The policy owner can invest the portion of the premium intended for cash growth in those sub accounts; they rise and fall in similar fashion to mutual funds. Growth or loss is entirely the result of those “investments,” and the risk is carried entirely by the policy owner.
IUL offers “participation” inside a spread between a “floor” and a “cap.” The idea is that an index, typically an S&P index, will go up and down with stock market volatility, and the IUL’s growth will move in relation to that index within a range.
If the index goes down, the IUL cash is “stopped out” at zero (some have 2%), so no loss; that’s the floor. If the index goes up, the IUL will see growth of its cash, up to whatever the “cap” is; common caps are at or near 10 to 12%. For example, if the IUL has a cap of 10% and the S&P index goes up 17% (in a designated timeframe), the IUL’s cash balance will see an increase of 10% (the cap). If the index rises 5%, the cash balance will see a 5% improvement. The risk is carried entirely by the policy owner.
IUL marketing point: It is common to hear “you can’t lose money because you have a floor of “0.” “Zero is your hero!”
Key point: The company reserves the right to, with regulator review, lower the participation cap (e.g., from 12% to 10.5%). This is particularly negative in a volatile investment environment since a lowered participation would decrease the ability for the policy owner to recover from a “0” year to a positive year and catch up to expected values. The owner has no say in this change.
Key point: any growth is on the cash in the policy. If there is no cash, there can be no growth.
Let’s back up. When you buy a policy, where does the cash in the policy come from?
Point 1) To repeat, when you buy a “permanent” or “cash value” life policy and pay for it via a premium, that premium is immediately divided into two pieces by the insurance company. The first piece goes to the company to cover what we call the cost of insurance (COI). The second piece goes to administrative expenses (mostly in the early years) and then to build the cash value over time.
Point 2) Initially, the portion of the premium that goes to cash build-up is likely larger than the portion going to the life company. But the portion going to COI grows and the portion going to cash shrinks. Eventually, the entire premium goes to COI.
Point 3) The design of UL (and variants) relies on the idea that the cash build-up will be large enough that COI increases will not harm the policy since cost will be shrouded inside the cash. Wait, what?
“Will not harm the policy” refers to the idea that the death benefit will continue to exist.
Point 4) The insurance company reserves the right to cover any shortfall in its (ever-increasing) COI by withdrawing cash from the policy’s cash value. That causes an “erosion” of cash. If cash in the policy is insufficient to cover the COI, the policy owner will receive a notice of cash required to maintain the policy.
This is where “just overfund the policy” is heard from the salesperson. You know, adding more cash so that the insurance company can grab more without having to send you a request for that cash.
If your house has termites and mold, would installing a new kitchen prove to be wise?
IF THE COI IS DEPLETING THE CASH VALUE, THE EFFICIENCY OF CASH GROWTH IS AFFECTED. IF THE CASH VALUE SHRINKS, THE VIABILITY OF THE POLICY ITSELF IS QUESTIONABLE. THE COI MUST BE COVERED OR THE POLICY LAPSES.
Key point: Regardless of which UL is used, the COI rises every year.
Two key phrases in the marketing of UL:
“Flexible premiums.” “If you’re having a good cash-flow year, put extra money into the policy to get additional growth. If you’re having a bad year, you can decrease the otherwise appropriate premium and make it up later.”
Who wouldn’t want that flexibility? The addition of extra cash is encouraged to grow the policy to strong levels, but this is a further shrouding of the eventual erosion of cash as the COI grows.
“Can’t lose money in the markets” although this is sometimes heard as “Can’t lose money!”
If that was all you’d have to worry about for cash growth, it would be a very positive attribute. As discussed above, that isn’t the whole story. With a constantly growing COI, it is inevitable that the cash growth (and balance) will be affected in a very negative fashion; the “markets” part is only half of the story.
What both professionals and laymen express as average return is Average Change, a far different thing. This is essential to get your arms around:
https://82financial.com/blog/2020/5/13
In sales “illustrations” of projected future values and performance, the financial industry silos (Insurance, Investments, Banking) all use “straight-line projections.” Unfortunately, these straight-line things are based on “Average Returns” which is a total fiction. There is no inclusion of potential volatility and a total omission of its damage.
In relation to the marketing of VULs and IULs, here is the problem: inside the mandatory sales illustration describing either the IUL or VUL, there is a multi-column series of numbers and the growth of cash (projected). The display of “growth” is consistently positive until it might eventually start to decrease in later years. But it’s shown to be reasonably consistent! This is fiction. This is a stock market-reliant vehicle we’re discussing, and the stock market moves in a very inconsistent fashion.
If I say “the average return was 7%” it has the listener thinking 7% is the important part, and if thinking about future returns, envisions 7% year after year, without wondering if any year will vary.
If there is volatility, the likelihood that you will reach the straight-line target is low!
In the world of ULs, volatility plus ever-increasing cost of insurance (COI) is deadly. The lapse rate of ULs (VUL and IUL in particular) is, in one study “Lapse-Based Insurance” by Gottlieb and Smetters, June 6, 2016, as high as “88% of these policies not ending in a death claim.
https://eprints.lse.ac.uk/110241/1/Lapse_Based_Insurance.pdf
Got that? Nine out of ten, 9 out of 10 lapsing! That’s beyond crazy high.
What happens if a life policy lapses? Premiums previously paid are free money for the insurance company as the future liability of a death claim disappears.
Planning is problematic as conceptually it must address the possibility of change and the unexpected in the client’s life. Normally, there is an expectation for “permanent” life insurance policy to provide a death benefit or legacy, and perhaps contribute to retirement income. Certainly, a lapse does not help.
And Guaranteed Universal Life (GUL)? First, the guarantee is only on the death benefit. Secondly, It appears that a missed (in some cases “late”) premium erases the guarantee! What might have been affordable only due to the guarantee holding what the company could charge becomes a problem. So, do you know any 80 or 90-somethings with a failing memory?
What of Long-Term Care riders attached to UL? If the policy becomes too expensive and lapses, the LTC coverage is gone. Is it possible that the premium is forgotten as the policy becomes useful for that LTC coverage?
Read about this related effort: https://www.heiratlas.com/
As Straight-Line Projections are used to create an illusion of achievable goals, while relying on the imagery of consistent returns in an inconsistent world of volatility, the likelihood of failure is high. With a lapse rate of 88% the failure for many is assured.
UL is an item that many will not realize presents a problem until many years go by, and it will be too late to correct the problem.
Back to why I won’t sell it: What happens if I sold the policy, and it lapses? Am I on the hook for, at least, a nasty phone call? A lawsuit? Maybe…after all, I’m a fiduciary, right? Should I know that the likelihood for a successful run with these policies is low? Yes, I should, and I do; I’m a professional. Can I hide behind “He’s an adult…he made an adult decision?” No, it’s not in me.
The UL design flies in the face of insurance companies’ reason to exist: to transfer risk utilizing the law of large numbers, protecting their clients from financial peril. I would even make the case that the issuing/marketing companies are grievously mercenary and ignore the responsibility for their customers’ financial well-being by hiding behind “he’s an adult…he made an adult decision.” It’s a Wall Street-oriented vehicle. It is in the wrong arena. It belongs in the Wall Street arena catering to speculators. But at an 88% failure rate, not even there.
Why do so many companies and advisors sell it? My guess is profitability. Some salespeople believe they’re helping clients, but I think more homework would be a good idea. First stop: “Average returns” is fiction; volatility is the enemy. Gee, if only ever-increasing costs were tied to stock market performance and would fall when the index falls…
I won’t sell it, and I certainly would not buy it...unless I was certain my estate would be filing a death claim soon.