How the Fees Destroy Indexed Universal Life Insurance

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We’ve long argued that many of the scare tactics used to dissuade people from universal life insurance products are very heavy-handed. The “evidence” exists mostly as anecdotes concerning “I know someone who knows someone who” once owned one of those products and bad things happened.

For the most part, bad things involve a requirement to contribute additional premium later in life because, as the story always goes, the product failed to deliver. This is a fundamental misunderstanding of universal life insurance and shows the lack of proficiency these so-called experts have regarding the product.

Universal life insurance, by its design, affords the greatest amount of design flexibility of all the available life insurance products. But with this design comes the responsibility of the owner–and almost equally the agent–to use the product for its correct intended purpose.

It is not a cheap alternative to whole life insurance. $1,000,000 of universal life insurance should not be considerably cheaper than $1,000,000 of whole life insurance when seeking comparable features. This idea, that universal life insurance somehow magically allowed people to buy death benefit at serious discount to other life insurance options, is at the core of every universal life insurance horror story floating around the internet.

We’ve pointed this out a few times in the past.

But today, I want to highlight the frailty of the common argument against universal life insurance through real evidence. An actual policy. An actual policy put in force 10 years ago and not implemented by the owner as originally designed. But also a policy that made use of most of the features that would ensure its survivability nonetheless.

A Real Historical Indexed Universal Life Insurance Policy

We have indexed universal life policies in force. And when you’ve been doing this as long as we have, it’s not impossible that we might have a few clients who didn’t execute their policies entirely to plan. For what it’s worth, the same can be said for whole life insurance. Looking at the two products, the percentage of policyholders who strayed from the original policy plan is identical. It’s not a product problem, it’s a function of life.

We happen to have one that’s got a number of years on the clock now, and has been underfunded by a considerable amount. Is the policy doomed? No.

In fact, it’s doing just fine.

Originally, the policy projected having just under $250,000 of cash value at this point. It actually has a little under $120,000. But here’s the kicker. If the policyholder were to have paid the originally planned premium through this current year, they’d have more than $250,000 in cash value. So adjusting for the significant reduction in actual vs. planned premium, we can see rate of return is far ahead of expectations.

But this policy does have considerably more death benefit than it needs given the actual premium paid, surely this must set the stage for a dire problem. Not really. If the policyholder wanted, they could go back and back up for the forgone payments. They’d be able to make a sizeable contribution to the policy. A six figure contribution. They’d ceased paying premiums as planned around year 3 and haven’t made a single premium payment to the policy in the last three years. But that doesn’t mean they missed the boat on funding their policy.

Universal life insurance is flexible, and it allows extreme flexibility of the premium payment. So if the policyholder wanted to, they could go back and make up those premium payments. Universal life insurance is the only life insurance product that permits such timing flexibility of payments.

Doing this would obviously significantly augment cash in the policy and completely wipe away even the smallest of fears that this policy might run into trouble some years later.

But speaking of those troubles down the road, let’s take a look at some really interesting expense figures for this policy.

The Crippling and Rising Fees of Universal Life Insurance

10 years into the contract, and the current annual expenses of the policy total roughly $3,700. As you are likely aware, this year hasn’t been a particularly good one for indexed universal life insurance earnings. The market is down hard and so the interest paid on these products has been close to zero. In this case, this policy has a 2% guarantee paid each year, so the policyholder will earn at least 2% on their money regardless of the market. Those earnings this year happen to be just over $4,100. That’s right, in a down market year, they will still earn $400 net of expenses. So much for bad market years resulting in losses due to policy fees.

Keep in mind that his policy is still at a point where expenses are somewhat elevated. We anticipate fees relative to cash value will continue to decline in the future, so that 2% guarantee will handily beat out expenses then as well.

But let me remind you that this policy is no where close to the maximally funded scenarios we talk about when in the past we pointed out the low probability of policy expenses truly becoming a problem. This is a so-so execution of indexed universal life insurance and it’s still fine.

There are Also Other Options with this Life Insurance Policy

The policyholder can make other decisions about this policy now or in the future to mitigate expenses. If they truly feel that they will never again make contributions to the policy, they can elect to reduce the death benefit. This will cut out considerable expense and sure maximized cash value growth for the premiums that were paid to date.

I estimate we could probably reduce policy expenses at least by half of their current level–if not slightly more.

That makes the delta between guaranteed interest–created by the 2% guarantee–and ongoing policy expenses even greater in the policyholder’s favor. In addition, this policy is now in a phase where another guaranteed bonus applies. Moving forward, the policyholder will receive a bonus interest payment as the insurance company’s way of saying “thank you” for being a policyholder for all these years.

Over-State Problem

I’m not saying there aren’t universal life insurance policies out there with problems. What I am saying is that any attempt to use those problems as a reason to avoid universal life insurance today that is implemented in the way it was intended is myopic at best and intentionally misleading at worst.