Protect What Matters
Indexed Universal Life Doomed for Failure Part 4
Universal Life (UL) was introduced to the insurance industry in the early 1980’s. The UL model is combined term insurance and cash value accumulation, two different components. Unlike whole life where the life insurance and the cash value were one and the same, the UL model separates one from the other so that instead of one component (whole life), you have two components. The idea behind this model was that if you could buy term insurance and add an additional premium for the cash account, that you would have better returns than whole. That was the idea. So, a Universal Life Policy would buy term insurance, and use the excess premium to purchase in interest bearing investments such as bonds. Well, this worked for only for a few short years.
Back in the 80’s you could get 8%, 9%, even 10% interest on your investment and still maintain your money pretty save from losses. Remember, the ideal behind the UL was to obtain better returns than you could inside a whole life policy. It was a good idea for those times. However, the universal life model has had two major flaws which deemed it for failure from the time of inception:
Annual Renewable Term - the term insurance inside of a UL is none other than annual renewable term. Do you remember our discussion on annual renewable term insurance? The cost of insurance goes up every year as you age. Annual renewable term was not an issue during your younger years, but as you aged into retirement it become extremely expensive and unaffordable. The idea behind the UL was that the cash value component would perform so well that the cash would accumulate and grow substantially to be able to cover the high rising costs of the insurance component in the later years. As long as you had enough cash value, you wouldn’t have to pay premiums out of pocket; instead the cash value in your account would be used to pay for those high premiums. This leads us to the second flaw.
Interest Rates - assuming that interest rates would remain constant. If interest rates would continue to perform as they did in the early 80’s (8%,9%,10%), then the UL might have worked. But, what happened? Interest rates did not stay at those levels, they began to drop and the cash value did not grow as expected. This resulted in the quick erosion of the cash value by the ever-increasing cost of insurance. You see, the cash value was expected to grow and offset some of the cost of the insurance. When there is no cash value to offset that cost, then the premium needs to come out of your pocket. So, as you age, your cost of insurance gets more, and more, and more expensive to the tune of several thousand dollars per month in your later years. That is why most people had to eventually drop their insurance; the costs become so astronomical that it becomes unaffordable for most people during their non-working years. Once you drop your insurance, all that money that you put into it is lost, gone forever, eaten away by the cost of the insurance.
Many people that bought those policies lost their money, lots of it. Of course, losing money was painful; especially because this type of policy was supposed to do the exact opposite, generate better returns from the investment. Now, for those people that obtained a UL and died young, having a UL was not a problem. But those that lived a long time were eventually outpriced of their policy and their policy lapsed (cancelled due to nonpayment). This was the first attempt and the first failure of Universal life. Let’s call this Strike One!
Do we have a strike two? Read on.
Life Insurance Types