Understanding Universal Life Insurance

I recently read a post on 2million's blog about how he recently purchased Group Universal Life (GUL) insurance through his employer. There is a lot to address from his post and I considered waiting until we have had the time to explore insurance in general and discuss the basics of life insurance. Rather than wait, I decided we should jump right in and look at Universal Life (UL) and the choice he made.

The best way to understand all Universal Life is with this picture:

Ul_sink Since I am not a skilled artist, I'll tell you that this is a cross section of a sink. In this analogy, we will represent money with water. As you pay your UL premiums (the faucet on the left) the sink begins to fill. The depth of the water in the sink is your cash value. Notice that the insurance company adds water to your sink too by paying interest on your cash value.

In a level death benefit UL, the actual amount of insurance is the policy face amount less the cash value. For example, if you have a $100,000 policy and $10,000 cash value, the amount of insurance provided is $90,000. When the insured dies, the policy pays $100,000 but $10,000 of that simply came from your cash value.

There are two drops which drain out of the sink every month (regardless of how often you pay your premium). We must keep water in the sink or the policy will lapse. The first drop is the cost of insurance or the premium for the mortality risk you may die in that month. The younger you are, the lower the cost of insurance is per $1000. The older (or unhealthy) you are the higher the cost of insurance is per $1000. The whole idea of Universal Life is that you build your cash value which reduces your amount of insurance so the cost of insurance is reasonable when you are older. In our example above we only have to pay the cost of insurance on $90,000 … not $100,000. The second drop is the policy fee which is the insurance company's income.

Now on to 2million's case… As a diabetic he may or may not have an insurability issue depending on the severity, treatment, and prognosis of his disease. Let's assume that he would have problems buying insurance. In that case he is smart to purchase all the insurance he can without answering health questions. Especially a product such as Universal Life which he can probably keep if he ever leaves his employer.

My only concern has to do with the amount of premium he is planning on paying. It looks like he is only adding enough water to the sink to cover the costs of insurance and the policy fee. There is no problem with that as long as you consider this a term insurance policy and understand that the premiums will need to increase as you get older and the cost of insurance increases. Did you notice that the premium faucet has a valve? Another feature of Universal Life is that you control the premium. He may want to consider asking the insurance company to calculate the level amount of premium that would be required to keep the policy in force for the time period he intends to keep it.

Whew! There was a lot to cover in this post. Thanks for reading it all the way through.

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