Disadvantages of Universal Life Insurance

Up until this time, this website has not discussed a second popular form of permanent life insurance: Universal.  Universal life insurance is very complicated. Overly complicated in our opinion. There are important Disadvantages of Universal Life Insurance that you should consider.

A recent article in the Wall Street Journal, titled Universal Life Insurance, a 1980s Sensation, has Backfired demonstrates the needlessly complex nature of these contracts. In this long form article the Wall Street Journal does a fair job of demonstrating what the major issue with UL (as Universal Life is abbreviated) policies are.  In essence these policies were sold as not just insurance but as an investment as addition. Given their "flexible" nature these Universal policies succumbed to their own disadvantages.  So what are the disadvantage of Universal Life Insurance?

In this short article we will review One by One the disadvantages of Universal Life Insurance and then cap it off by explaining the best type of policy you probably should consider.  There are numerous drawbacks / negatives to all three of the major types of Universal policies: IULs, VULs, and GULs. But in general the guaranteed universal life policies are possible the least problematic. 

Most universal life insurance is sold by universal life specialists. Why? Because the policies are very complex in nature.  As opposed to whole life insurance which has a fixed yearly payment, universal life allows for flexibility. However this flexibility is both good and bad.  The disadvantage of the complexity of universal life insurance is that clients will not understand it, and possibly may not be able to understand them. Many insurance agents do not understand them. Occasionally, I am certain, agents selling them do not fully understand them.  Certainly some insurance agents selling UL policies in the 1980s did not really comprehend what they were pitching.

Universal Life policies are designed to allow you, the owner, to vary how much money you put in year over year, which is sold as a benefit.  It is a benefit, but it is also a big negative. Consider it as a way to decide how much money you want to put into your pension each year.  After thirty years of under-funding this pension though, sooner or later the bill will come due. Or you could indeed make the required payments but the investment performance ends up being too low.

IULs, VULs and such are so variable as to confuse most consumers of insurance.  UL policies take into account certain expectations of future returns to assist you in understanding how much you need to put in on a yearly basis.  As the Wall Street Journal article showed though, those assumptions can go horribly wrong resulting in underfunded UL policies. This is a huge disadvantage of ULs.

Fees should be disclosed up front and center when you go to buy one. However sometimes the fees are rarely used and hence may not be brought up. The truth is that the fees of "investing" with universal policies is not the same as investing in a stock or mutual fund.  Typically they are far far higher.  Care should be taken purchasing these products to understand all the fees associated with them.

Yes you read that correctly, one of the biggest disadvantages of Universal Life Insurance is that the policies can lapse, even if you are making payments.  With this negative, we are not as much referring to Guaranteed Universal contracts as much as IULS and VULs. If the investment performance does not materialize these policies can lapse.

These three broad categories of Universal life insurance represent the major choices.

Guaranteed Universal Life Insurance is somewhat similar to whole life in that it is designed to last throughout your natural life. It may be the best of these options.  These policies are new and are actually similar to term insurance as well. Often this type of policy is one of the more simpler ones to explain to new clients.  Overall these policies feel less like investments and more like insurance.

Indexed Universal Life Insurance is newer product that many life insurance agents push. The policies are tied to an "Index" on the stock market.  There are floors and ceilings, often to the returns that you can get. These policies are deviously confusing.  Indexed Universal Life Insurance policies, abbreviated IULs are numerous disadvantages of their own as they are complex beasts.

Variable Universal Life policies also allow some market exposure, but is a more nuanced way through mutual funds typically. These policies are more akin to more direct investing, however through a life insurance policy.  These contracts are really more investment concepts than life insurance, in my professional opinion, and putting money in them should be for that reason.  Similar to IULs these policies are so complex and complicated I struggle to see their use to the average american.

There is just no beating around the bush on this - Universal Life Insurance policies are just no match for Buy Term and Invest the Rest first in Qualified and second in Non Qualified accounts.  Why? Mostly because term insurance is just so inexpensive.  Also because qualified accounts such as 401Ks, Roth IRAs, IRAs and accounts such as HSAs have so much potential upswing and so little drawbacks.  We have run the numbers hundreds of times over the years when comparing whole and term insurance policies are rarely if ever believe that whole ends up winning.  Therefore the same is true for VULs and IULs.  

For those considering GULS - Guaranteed Universal Life Insurance, our opinions are muted depending on the need and the desire of the policy.  In more situations I can imagine these being an acceptable policy for a consumer.

As a reminder a Convertible Term policy is one that allows the owner of the policy to possibly convert the policy at some later time to another form of insurance, often universal or whole.

Frequent readers of this blog may be surprised to hear me say this - but I truly believe that participating whole life insurance is a more suitable permanent policy for those that want it than Indexed Universal Life. Whole live, as opposed to IULs at least has guarantees and a fixed payment schedule. The only thing left up in the air with WL policies is the dividend ratio.  This allows whole life to truly be a policy forever.  The capricious nature of IULS and possibly VULs make them unsuitable for anyone other than most astute investors.