Universal life (UL) is one of the most controversial life insurance products. Although some advisors swear by UL as an effective financial planning tool for many clients, others view it as a highly risky product that has potential to go sour, with devastating consequences for clients.
Now, the UL product market is undergoing drastic changes. Sustained low interest rates and changes to the tax rules have forced carriers to raise premiums, tweak product features and, in some cases, withdraw their UL offerings altogether.
The changes have some UL proponents less enthusiastic about the product. However, advisors such as Trevor Parry, president of TRP Strategic Consulting and partner at Pension Acuity Partners in Toronto, say that in some circumstances, UL continues to be a great option for clients.
"UL has a diminished role," says Parry, "but I think there's still a marketplace for it. It's just a question of affordability."
UL combines permanent life insurance with a tax-sheltered investment account. Unlike whole life (WL) insurance, which has consistent premiums and guaranteed cash value accumulation, UL unbundles the insurance coverage and the investment account, providing clients with flexible premium payments and a variety of investment options.
Recent changes to the exempt test, which governs the amount of tax-exempt cash that clients can hold in permanent life insurance policies, have reduced the amount of tax-exempt investment space within UL policies. The new rules also prevent clients from funding a policy aggressively within the first year or two in which the policy is in force.
In response, life insurers across the country have revamped their UL products to adapt to the new tax framework. The result is fewer UL products on the marketplace as well as fewer features available on the products that remain.
"Some of the product offerings have been pulled back or simplified," says Asher Tward, vice president of estate planning with TriDelta Financial Partners Inc. in Toronto, "but there are still plenty of products being offered."
Most insurers have also raised premiums on their UL offerings in recent months, as sustained low interest rates have continued to squeeze these products' profitability. This builds on a string of price hikes that have driven up the cost of UL considerably in the past few years.
"Pricing, year-after-year, continues to be less competitive," says Tward. Nonetheless, he says UL is still feasible for some clients looking for permanent life insurance coverage.
"It's still effective," he says. "It's been so beaten [up] in terms of pricing and options over the years, that it's amazing it's still a very viable option."
Once interest rates rise, Tward adds, insurers will likely gain the flexibility they need to reduce premiums and, potentially, enhance product features.
"We've seen the worst of it," he says. "As rates normalize, that should bring costs down for these products."
However, for some advisors, such as Robert Porter, insurance advisor and owner of Crusader Insurance & Financial in Mississauga, Ont., UL is not a product they would consider for their clients — regardless of the price.
Porter says he avoids UL as he's seen many clients run into problems with the product. Specifically, clients are often not clear on how the product works when they buy it, he says; and in cases in which the investments in the policy don't perform as expected, the policy can end up lapsing.
"I've never sold UL," Porter says, "and I've just become so disillusioned with what I've seen among clients who have been sold UL."
As such, Porter prefers products such as WL, which have guarantees.
But when UL is used in the right circumstances, it can be an effective product, says Harold Geller, associate lawyer with law firm McBride Bond Christian LLP in Ottawa. Still, he notes that it's vital for clients to fully understand how the product works and the risks involved.
"It can be a very good product," he says. "But, the devil is in the details."
Geller has seen a growing amount of litigation activity involving clients who bought UL based on a false impression of how the product works. Many of the problems have stemmed from UL policies with annual renewable term (ART) cost of insurance, in which the premiums increase over time, as opposed to level cost of insurance, in which the premiums remain the same over the life of the policy.
Some clients who bought ART policies in the past were shown illustrations projecting annual returns of 10% or more in the investments in the policy, which could theoretically offset the cost of the increasing premiums over time. When markets didn't perform that well, though, many of those clients were left without sufficient funds in their policies to pay the premiums and maintain the coverage.
"UL has caused an enormous amount of problems for people who understood that by investing through insurance, they get, in effect, free life insurance," Geller says. "On a short-term basis, ART is brilliant, because it offers low rates of insurance. But if you're going to live, it's a disaster, because the amount you pay per year goes up as per your age, to the point at which it's completely unaffordable to any reasonable person."
Up next: The role for universal life.