Universal Life – liked or loathed?

What a great and timely topic!  Just to clarify things, UL is not a new product – it was originally available under the name “Variable Life” more than 60 years ago – this is just the latest incarnation and undoubtedly not the last version we will see.

The original concept stands true to today’s products – un-bundle things and see what might happen.  Let the policy-owner play with some things and the insurance company can twiddle the remaining parts.  Nothing new with the 2012 version, although both consumers and insurance companies have learned a few things along the way.

Most life insurance companies in Canada offer at least one version of this product while others offer three or four.  Generically, the owner selects a death benefit amount, a death benefit type, any additional benefits desired and a premium deposit from within a broad range and which investment options they desire.

Let’s start with the amount and type of death benefit coverage.  The least complex product is usually called “Level Death Benefit” and is very simple.  When the life insured dies (while the policy is in force of course!), the insurance company pays a flat amount to the named beneficiary – whether it is 1 day from now or 50 years in the future – the death benefit never changes.  There are often two other choices – “Indexed Death Benefit – IDB” and “Face Plus Fund – F+F”, both of which, if offered, come with increased costs.  With IDB, the amount of life insurance increases each year by either a fixed percentage or by reference to an outside index such as the Consumer Price Index – the cost also goes up annually.  For F+F, the death benefit is the original amount purchased plus any accumulated cash values and are paid to the beneficiary after the death of the insured.

Additional benefits may include such items as a Disability Waiver of Premium Rider, Guaranteed Insurability Benefit or a Family Insurance Rider.  Disability Waiver provides that premium deposits are waived if the owner is disabled according to the terms of the policy.  Guaranteed Insurability means that the life insured can get additional insurance in the future without providing medical evidence – within limits and up to certain ages only.  Family Riders typically provide term insurance coverage on a spouse and dependent children.

The Premium Deposit ranges from a minimum amount calculated by the insurance company (that only covers the cost of providing the death benefit and any riders) up to a maximum amount (also calculated by the insurance company) the allows the policy to accumulate cash values up to the maximum limits permitted by the Income Tax Act.  The owner can choose any amount from minimum to maximum and anywhere in between – and they can change the amount at any time of their choosing.

On to investment choices.  Initially, insurance companies felt they had to offer literally dozens of choices – one company had 49 options!  Fortunately, some level of rational thought has returned and most policies offer a range of 4 to 12 although some do offer more.  It is normal to offer a series of guaranteed interest accounts that function in the same manner as GICs and range from Daily through 1, 3, 5, 10 and maybe 20 years.  Rates are published at regular intervals and can also be found on the website of the respective insurance companies.  On the equity side of the investment house, most companies offer 4 or 5 indexes – such as a Canadian Balanced Index, Canadian Equity Index, Canadian Fixed Income Index or similar on an International basis – plus two or three performance benchmarks using well-known mutual funds.  It is important to note that the UL policy does NOT invest in these indexes or funds – it merely mimics the results of the movement – up or down – of the benchmarks.

There have been some horror stories in the history of UL – particularly when advisors were using assumptions – with the approval of the insurance companies I must add – that had projected results in the 14% to 18% annual range – and of course, that never happened.  The result was that many policies collapsed and clients were left without their life insurance – in some cases if clients wanted to retain their coverage they had to make additional deposits – sometimes in the tens-of-thousands of dollars!  Thankfully, most insurance companies now severely limit illustrated growth rates and insist on showing results under three different assumptions – usually at something such as 2%, 5% and then an alternative rate of maybe up to 7% or so.

The taxation of UL is no different than for any other permanent insurance product.  CRA rules allow the plan to accumulate values up to prescribed limits.  At death, there is no taxation of any portion of the death benefit.  If the plan is surrendered or cash values are withdrawn from the policy before a death claim occurs, a portion of the withdrawal may be taxed as Ordinary Income.  Most insurance company’s illustration software provides samples of how this works based on the level of deposits the client has chosen.

UL is both a very good product and a very bad product – it is there to serve specific markets and is not right for every client or every situation.  Primarily, it is very good at providing an economical death benefit for larger face amounts where clients want the insurance to be fully paid up quickly and the insurance is designed to pay for taxes on death.  It is also good at accumulating cash on a tax-preferred basis if a client has substantial disposable income and does not want to attract any additional taxes on investment income.  I do expect those last two statements to come under some dispute from some quarters as some advisors and insurance companies think UL is the be-all, end-all of permanent insurance – but it isn’t!  Don’t be fooled – always ask for at least one other alternative besides UL from your advisor and evaluate things for yourself!