Universal Life Insurance and Why Policies Lapse

Universal life (UL) is a type of permanent life insurance with flexible premiums and an account value that earns interest. Each month, the policy deducts the cost of insurance and fees from that account. As long as the account value can cover those charges, the policy stays in force.

The problem: the cost of insurance rises with age. If the account earns less than projected, or premiums are set too low, the account can run out decades after purchase, often when the insured is elderly and replacement coverage is unaffordable or unavailable.

The short version

• Premiums go into an account; charges for insurance and expenses come out.
• The cost of insurance is based on the amount at risk and the insured's age, so it rises over time.
• If interest credited is lower than illustrated, the account grows more slowly and may not keep up with charges.
• No-lapse guarantee riders, available on some policies, can keep coverage in force if specific premium requirements are met.
• Reviewing an in-force illustration periodically shows whether the policy is on track.

How the account works

A simplified model

To show the mechanics, here is a hypothetical, simplified policy: a $250,000 death benefit bought at age 45, with a level premium of $2,400 a year, a 6% premium load, $120 a year in fees, and a cost of insurance that rises with age. We vary only the interest credited.

The same premium that looks adequate at 5.5% leads to a lapse in the late 80s at 3%. Many UL policies sold when interest rates were higher were illustrated at rates that later proved too optimistic.

Warning signs

• The in-force illustration shows the policy lapsing before your target age at current rates.
• Account value is declining even though you're paying the planned premium.
• You reduced or skipped premiums after purchase.
• You've taken loans or withdrawals from the policy.

Options if a policy is underfunded

• Increase premiums to the level the illustration says is needed.
• Reduce the death benefit to lower the cost of insurance.
• Use a no-lapse guarantee, if the policy has one, by meeting its premium requirements.
• Exchange to another policy, carefully: new policies can bring new charges, contestability, and underwriting; see contestability period.
• Let it go or sell it, in some situations, after professional review.

Variants

• Guaranteed universal life emphasizes a guaranteed death benefit to a specified age, with little cash value.
• Indexed universal life credits interest based on an index, subject to caps and floors.
• Variable universal life invests in sub-accounts and can lose value.

The takeaway

Universal life can work well when funded adequately, but its flexibility puts the burden on the owner. Rising insurance costs late in life can drain an underfunded account. Request an in-force illustration every few years, compare it with your goals, and adjust premiums or coverage early rather than late.