Variable universal life insurance and universal life insurance are two very different products. While both function similarly in terms of the flexibility of premium payments, cash value accrual account, and changes in premium payments, the difference lies in the way the cash value account earns money. While a universal life insurance product pays interest, a variable universal life insurance contract is invested in variable sub accounts. There are advantages and disadvantages to each type. Read on to learn more.
How Universal Life Contracts are Structured
Universal life insurance are very different from whole life and term products. While each form of life insurance provides a death benefit to beneficiaries for the purpose of mitigating financial risk from the loss of an incoming earning member of a family, the other features of the contract are vastly different.
A whole life insurance contract has level premiums, pays dividends, and cash value is guaranteed by the insurance company.
A universal life insurance contract (UL), or variable universal life insurance contract (VUL) does not have minimum cash value guarantees in the same way that whole life does. Nor do they necessarily require level premiums. They are also not “participating” policies, so they do not pay a dividend from the life insurance company as owners do not have a right to benefit from the life insurance companies earnings.
A UL or VUL contract has a monthly cost of insurance which changes (on a per dollar basis) as the insured person ages. The per dollar charge is multiplied by the net amount at risk to the life insurance company (net amount at risk is equal to face value minus current cash value) to determine the total monthly cost of insurance. Because insurance charges are calculated in this way, the premium required to keep the policy in force rises as the insured person ages, unless cash value accrues at a greater rate than the rise in cost per dollar.
The actual premium that a client is required to pay is technically only the amount that satisfies the monthly cost of insurance. Any excess premium remitted accrues in the cash value account. This is one of the ways that a client increases their cash value (the other being internal earnings). If an owner does not consistently pay more in premium than the cost of insurance over the lifetime of the contract, the cost of insurance later in the insured lifetime are not feasible for most people to cover (and they are not efficient to pay in this manner).
A client actually has the choice to pay any amount in premium that they wish, as long as they either pay enough to cover the cost of the life insurance, or the cash value account has enough money to cover the cost (all payments technically first go to cash value, and all insurance charges are taken from the cash value).
The goal of owners of successful UL and VUL products is to fund the products sufficiently early in the contract enough that earnings accumulate at greater rates than increasing costs of insurance. This is how an agent is able to illustrate a level premium for a UL or VUL product that is able to stay in force for the lifetime of the insured person.
The Difference Between a VUL and VUL Lies In How They Earn Money
While the contracts both allow flexible premium payments, and the cost of insurance changes over the course of the policy, they way in which the cash value account earns money is what separates a UL contract from a VUL contract.
A VUL Invests In The Market
A variable universal life insurance contract invests the cash value in what are called variable “sub-accounts”. These variable sub-accounts essentially function just like mutual funds (in fact most mimic existing fund offerings from major financial institutions but differ in cost structure). There are many different sub-account offerings, which gives the owner of the contract the option to invest the money however they see fit. Usually all asset classes will be offered within the contract, (ie large cap funds, small cap funds, commodities funds ect).
The performance of the VUL ultimately comes down to the performance of the variable funds. If the money is invested wisely, and the market performs well, the contract can make a significant profit for the owner (even after insurance charges are taken out).
The potential for high profits is the reason that some owners choose VUL over universal life insurance contracts. The amount of money that can be earned in a variable life contract is not capped. If the performance is high enough, and owner may be able to stop making payments very early in the insured persons life and the contract will not only remain in force for the duration, but will continue to earn money.
A Universal Life Insurance Contract Is Paid Interest
Counter to a variable life insurance contract, a universal life insurance contract earns money from interest paid on the cash value. While the interest rate that is paid can change as prevailing interest rates increase or decrease, it is usually fixed for 1 year periods. By law, the interest rate in a universal life insurance contract can not fall below 2%.
A universal life insurance contract maintains the flexibility of the universal products and the potential to earn money more quickly than a whole life insurance policy. During times of high interest, or times of quickly rising interest rates, a universal life insurance contract will likely increase the amount of interest paid much more quickly than a whole life insurance policy would increase the dividend payment.
Now I am totally confused. I am a federal retiree, I will be 65 next month. Unfortunately when I was younger I chose to pay a FEGLI life insurance policy that had a 75% reduction and I paid $17 per month for the premium. However, It will go from the current value of $55,000 down to $13,500 in 3 years and 2 months and I cannot do anything about it. I don’t want to lose or decrease its worth. The policy is with Met Life. What is the best way to making this an individual policy with a worth of around $16,000 to $20,000 down the road.
The FEGLI life insurance policies have rules, but possibly Metlife can help you purchase additional life insurance with limited underwriting. I would contact them directly to discuss options. You can also consider purchasing a new whole life policy or a final expense whole life policy.