How Whole Life Differs from Universal Life

apple orangeComparing a Universal Life Insurance contract to a Whole Life Insurance contract is a bit like comparing apples to oranges. Though they are both classified as “permanent” life insurance products, they don’t have as much in common as you might think.

When it comes to comparing the two, it is imperative to consider this one question: How important are the contractual guarantees to you?

Universal Life policies are distinctly different from Whole Life policies. One difference being that Universal Life policies run the increased risk of lapsing at some point in the future, whereas Whole Life policies do not.

However, the key component that makes Universal Life policies much different from Whole Life policies is how the cost of the insurance is calculated.

Without getting too technical, whenever a product is released by an insurance company, a team of scientists, called “actuaries” determine how much they must charge in premium to the client in order to offer a competitive product to the market place, while still being able to be profitable.  Simply put, this is called the “cost of insurance” and this is passed on to the policy owner in the form of a premium.

Universal Life:

Simply put, buying a Universal Life policy is just like buying a new term policy each and every year.  Universal Life policies, like annually renewable term policies, become more expensive each year.

The strategy is that since these policies are “tied to the market” the returns from the market will make up for the ever increasing cost of the policy.

Whole Life:
With a whole life insurance policy, the cost of insurance is fixed for the entire lifetime of the product – based on the actuarial science used when the policy is issued.

The underlying investment strategy for these policies is driven primarily by the bond market and other conservative investments rather than the stock market.

The Risky Difference
It’s the cost of insurance that make a Universal Life policy much more likely to lapse at some point in the future than a Whole Life policy.  The increased probability of lapsing makes Universal Life polices much less likely to pay out their contractual agreements over time. 

Why do people buy Universal Life policies?

To answer this question we must look at how they are sold.  There are two main misconceptions that are often shared about Universal Life Policies which may lead a consumer to purchase them.

Misconception #1:  They are less expensive than whole life insurance

It is true that in the early years, Universal Life is generally less expensive than Whole Life.  The rationale is that the early years of “savings” will make up for the increasing cost of insurance in the later years.  Reality:  These initial “savings” don’t keep pace with the increasing cost of insurance. The insurance company will use cash value to satisfy this cost and/or the insurance company will require an increased premium from the client. If this new premium requirement is not paid, the policy will lapse.

Misconception #2:  They allow you to participate in the up-side of the market

It is true that stock market returns are used to determine the growth credited to Universal Life policies.  Reality:  If the stock market doesn’t perform as well as projected, there won’t be enough cash in the policy to support the increasing cost of insurance.  When this happens, the insurance company will come to the policy owner with an increased premium expense.  If this becomes unaffordable, the policy will be in danger of lapsing.

Misconception #3:  They will outperform the conservative investment strategy of a Whole Life policy

It is true that a Universal Life policy may offer a more aggressive investment strategy than a Whole Life policy.  Reality: Universal Life policies are consistently sold based on illustrations showing returns that are unrealistic or unsustainable.  These values are based on “Gross” numbers rather than “Net” numbers.  This means that in a down economy you could actually lose money in your contract after fees and costs are subtracted.

If you are looking for a contractual guarantee that provides guaranteed growth and protection, regardless of market conditions, a Whole Life Insurance policy is the right choice for you.

Michael Bonny

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