What are Some of the Ways Whole Life Insurance Differs from Universal Life Insurance?

In the 1990’s, Universal Life insurance companies expanded a feature known as a secondary guarantee which is now commonly referred to as a no-lapse rider. Until that time, universal life policies could expire (lapse) without value, even if all planned premiums were paid on a timely basis. This was because the universal life was designed to develop cash value (based on projections) that supplemented the premium. In other words, the anticipation of high-interest rates allowed for a much lower premium structure than whole life. The future costs of insurance would not be satisfied by premiums alone and depended on high-interest rates to keep the policy in force. The cash value was depended upon to earn sufficient interest that (1) could subsidize the increasing insurance costs* and (2) still be able to grow.

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Unfortunately, this did not turn out to be the case in many situations. Interest rates started to decline and as a result, the projected interest earnings on the cash value failed to materialize. Rather than have a cash value that continued to grow, the policy had to dip into the cash value to subsidize the premium. As the years went by, the cash value continued its downward spiral which ultimately resulted in the cash value becoming zero. To their dismay, policyholders found that they either had to pay rapidly increasing premiums or their policies would lapse without value.

No-lapse Riders

Today, the no-lapse riders on newer policies prevent that from happening. If the cash value does go to zero these riders allow the death benefit to continue with no increase in premium. However, the money must come from somewhere. This may be a riskier product than whole life, from the insurance company’s perspective.

Whole life insurance works differently. A whole life policy is generally guaranteed to do one more job than the universal life policy. That is, on a guaranteed basis, the cash value will grow each year (after the first year or two) until it ultimately equals the death benefit. This is why the premium is higher. Whole life makes relatively conservative assumptions with respect to guaranteed values and these assumptions require larger premiums.

Saying this another way, when you see a universal life premium that is approximately half of a whole life premium, even if it has a no lapse rider, the cash value could still become zero after paying premiums for 10 or 20 years or more.

Paid-up Additions

There is another reason why whole life may be found to be more attractive than universal life with a no-lapse rider. Some whole life policies participate in dividends. Most policyholders use these dividends to buy paid-up additions (PUA’s). PUA’s are small paid-up insurance policies that have a death benefit and cash value. Over time, dividends used this way can dramatically increase both the death benefit and cash value of the policy. Dividends are not guaranteed prospectively, but they are the norm. Furthermore, once a dividend has been paid and used to buy PUA’s, the PUA’s are guaranteed from that time forward.

A whole life policy may be able to have its premiums offset by dividends. This means that a policyholder could stop paying premiums out-of-pocket, still have the insurance and continue to have rising cash values. If dividends subsequent to the offset diminished, it is possible that premiums could again become required out-of-pocket, but prior year’s premiums would not be due because they would have in fact been paid by dividends during those years.

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Universal life with no lapse provisions may also be able to have premiums satisfied from the earnings on the cash value in the policy. However, if certain assumptions are not realized, all premiums that were not paid by the policyholder could become due, plus interest. This is sometimes referred to as a make up provision. Other plans may guarantee a certain premium for a given number of years, with the death benefit then guaranteed to age 100, 115 or 120. However, there is generally no long-term cash value guarantee.

Some universal life policies with no-lapse features can also be designed to have a guaranteed number of premiums (e.g. 10, 15 or essentially any number of years). This will, of course, result in a larger premium than one that requires premiums to be paid in all years.

Some advocates of no-lapse universal life insurance policies might suggest that whole life insurance is “expensive”. However, whole life merely requires a larger premium as it uses more conservative assumptions than no-lapse insurance policies. If the whole life insurance company makes a significant profit as a result of the higher premium (or otherwise is profitable) most of the profits are returned to the policyholder in the form of dividends (i.e. in mutual companies). These dividends can effectively lower the true cost of insurance dramatically. Conversely, in severely bad economic situations, the fact that a whole life insurance company is receiving larger premiums for a given amount of life insurance helps protect the company and ultimately, the policyholder.

Interestingly, the whole life insurance may very well give the policyholder a very similar, if not better return on his or her premium dollar over the long term. This is because even though the premium of a whole life policy is often twice the premium for the same amount of insurance, over time, dividends of whole life insurance can make the total death benefit more than twice the original amount.

To summarize, normally whole life insurance premiums are significantly higher than universal life premiums with no lapse riders. The whole life policy, however, has the ability to have a rising death benefit. There is always a guaranteed cash value and that cash value may grow much more rapidly if dividends are paid and used to purchase PUA’s.

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