Understanding universal life insurance policies

How do universal life insurance policies work?

Universal life insurance policies are bundled products, meaning you get insurance protection and an investment return.

Investment returns are based on the rates declared periodically by your insurer (known as “crediting rate”) and can be changed at the insurer’s discretion. However, the insurer cannot decrease it beyond the minimum crediting rate which can be set at 0%.

Universal life insurance policies are different from typical whole life insurance policies. Unlike most life insurance policies, after the inception of universal life insurance policies, you have the option of adjusting the sum assured and the cash value of your policy.

Note: Sum assured is what your insurer pays your beneficiaries when you die. Your insurer can choose whether to cover you for a higher sum assured based on additional risk assessment.

Cash value, also known as surrender value, is what you will get back if you cancel your policy. You may pay more premiums at any time to increase the cash value of the policy.

What are the key features?

Universal life policies are typically marketed as a tool for leaving a substantial inheritance to your loved ones after your death. In return, your insurer collects a large upfront lump-sum premium that can run into seven figures. These are known as protection-oriented universal life policies.

You should only consider buying a universal life policy if you have the means to pay the premium without borrowing. This is to avoid losing insurance coverage.

Your financial adviser may ask if you would like to take a loan from a financial institution to pay for the large sum of premiums – known as premium financing. Think twice before taking this up.

There are also other types of universal life insurance policies, which focus on wealth accumulation thus offering lower protection benefits with lower premium outlay. These are known as savings-oriented universal life policies.

Note: Do you have the means to repay your premium financing loan consistently (both principal and interest), including when interest rates rise?

If you take up premium financing but fail to make your loan repayments, you may lose your insurance coverage as the financial institution who lent the money (“lending FI”) can surrender your policy to the insurance company to get back what you owe them.

Another scenario to be mindful of is that your lending FI may ask you to fork out a lump sum to pay off the loan in full or partially. This could happen if the lending FI deems you or your insurer to be less credit-worthy. This could also happen when the investment returns of your policy decline such that the cash value of your policy becomes lower than your loan amount. Can you find the money at short notice?

The bottomline: If you lose your insurance coverage as a result, how big of an impact will it be for you or your loved ones?

Consider these points very carefully before you take up premium financing.

What you should be aware of before buying

Fees

You will have to pay fees at various points after buying a universal life insurance policy.

These include:

• Premium charge – Your insurer may deduct a percentage from your premium payment for its expenses, such as distribution and administration costs for offering the product

• Insurance charge – Some insurers charge a recurring fee for insurance coverage, and the amount usually increases with your age

• Administration charge – You may have to pay administrative costs to your insurer

• Partial withdrawal charge – Your insurer may charge a fee if you withdraw part of the amount you have accumulated in the cash value of your policy. The sum assured of your policy may also be reduced as a result

• Surrender charge – If you withdraw everything in the cash value of your policy, you are effectively terminating the policy and insurance coverage ends. Your insurer may also charge a fee for that

Tip: Insurance and administration charges are typically deducted from your policy’s cash value on a monthly or annual basis.

Check your policy contract for the frequency and amount of deduction.

Tip: Your insurer can revise the charges but will need to notify you. Check with your insurer on the notice period that will be given.

For details on how various charges affect the cash value of your policy, refer to the policy illustration provided to you when you purchase the policy.

Possible lapse

There is the possibility that the cash value of your policy gets lower and lower. For instance, the investment returns turn out to be much lower than expected while fees add up.

When the cash value gets to zero, your policy lapses, unless you pay additional premiums.

You should refer to your policy illustration for possible lapse scenarios and review the cash value of your policy regularly. Insurers will typically make available periodic statements updating you of the cash value of your policy and notify you when your policy is about to lapse.

Policy term

Some universal life policies can be terminated by the insurer, after a notice period. In such a case, you will get back the accumulated cash value in your policy.

What is the difference between a universal life insurance policy and other life insurance policies?