Universal Life Insurance Performance

What to Expect

Many policyholders buy universal life insurance for its permanent coverage, cash value and flexible options to manage payments, benefits and features. But how good is universal life insurance as a savings vehicle? How much growth can policyholders expect from the cash value of their universal life policies? What interest rates and dividend payments policyholders expect, and how does the performance of universal life compare with other places to put your money?

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Fluctuating Value and Short Term Interest Rates

The primary goal of most permanent life insurance policies’ cash value is to be a stable source of “forced savings” – every time the policyholder makes a premium payment, the cash value goes up – with growth accelerating after the first few years of the policy.

Universal life is a bit different. Compared to whole life insurance, universal life cash value can be controlled and adjusted more readily by the policyholder. With whole life, the cash value is guaranteed and cannot decrease unless the policyholder takes out a loan.

With universal life, the cash value can fluctuate much more, depending on the choices of the policyholder – for example, policyholders can decide to skip payments and allow the premiums to come out of the cash value, make extra payments to bulk up the cash value, or lower the death benefit in exchange for more cash value.

Another difference is that universal life interest rates are based on short-term interest rates and are reset each year, so interest rates on a universal life policy are often a bit lower than whole life. (Universal life policyholders are essentially “paying for convenience” – although their policies earn less interest, they have greater flexibility to change the coverage levels and features.)

It is difficult to generalize about the rates of return on a universal life policy, since so many details depend on the insurance company and the particular policy. But in general, universal life cash value will grow at around 4 percent each year – slightly less than whole life insurance. Like whole life, this is not considered a “high risk/high yield” investment – universal life cash value is not invested in the stock market or other higher risk offerings.

The goal of universal life cash value is to provide a steady source of savings for the policyholder, and it’s up to the policyholder to decide how to use that money in managing the policy – leave it to grow, or use it to pay premiums. Like whole life policies, universal life cash value also grows tax-deferred and can be used as collateral on a loan.

Some universal life policies, known as indexed universal life insurance, have their cash value interest rates tracked along with the upward movement of the stock market – often the S&P 500 or another broad market index. This type of policy gives the potential for higher growth in the policy’s cash value, while still being protected against market downturns – no matter what happens to the stock market, the interest rate is guaranteed never to fall below a pre-determined level.

Interest and Dividends

All universal life policies gain interest in their cash value. While whole life policies usually earn around 5% interest per year, universal life cash value gains about 4% annually, and is based on short-term interest rates that can go higher or lower depending on the overall economy.

In addition to the interest earned, universal life cash value can also grow due to dividend payments from the insurance company if the policy is a “participating” policy.  This means that the policyholder “participates” in sharing the results of the insurance company’s overall financial performance. Similar to being a shareholder of company stock, having a participating policy enables the policyholder to share the profits of the insurance company.

Dividends can add up to 2% (or more) to the cash value performance, depending on the decisions made by the insurance company. Dividends paid to a life insurance policy are also not considered taxable income by the IRS.

However, dividends are not guaranteed – it all depends on how profitable the insurance company is and whether the company decides to pay a dividend in any particular year or quarter. With participating policies, there is also an element of risk: if the insurance company has an unprofitable year, the interest paid to the policy’s cash value may turn out to be lower than usual.

Universal Life Offers Fewer Guarantees

Unlike whole life, which has cash value growth based on long-term fixed interest rates, universal life insurance interest rates can change from year to year. Depending on the ups and downs of these short-term interest rates, universal life policies may require the policyholder to pay additional premiums to make up for shortfalls in the accrual of the cash value – especially if the policyholder uses a flexible payment schedule or skips payments.

Despite these risks, policyholders still have certain protections. Premiums cannot exceed a certain level that is agreed to in advance by the policyholder. Even though universal life can require more involvement from the policyholder and may cause certain adjustments or extra payments along the way, many policyholders feel that the flexibility of the policy is worth the added level of attention to detail.

Universal Life vs. Other Assets – Risks and Rewards

Universal life tends to have a lower rate of return than whole life, and with a few additional risks to the policyholder – however, universal life also offers flexibility and convenience in managing the details of the policy and changing the coverage levels over time, so this lower rate of cash value growth could be considered a “convenience charge.”

Policyholders who want a slightly higher interest rate and guaranteed cash value should choose whole life insurance. Those who want the unique features and control that comes with a universal life policy should be willing to accept the lower interest rates and other risks – the flexibility is a valuable feature for these policyholders.

As compared with other asset classes like CDs, bonds and stocks, universal life cash value offers higher returns than CDs or most bonds, and has the advantage of growing tax-deferred (instead of buying CDs or bonds with after-tax dollars).

The stock market can be highly volatile, and there are no guarantees that stocks will grow in the short-term or long-term. Compared to the stock market, universal life cash value is a reasonably safe place to put money – even though there are risks with universal life that the interest rates will decrease, or that additional premium payments might be required, universal life cash value does not have huge fluctuations in value like the stock market.

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