The role for universal life

UL combines permanent life insurance coverage with a tax-exempt investment account in which clients can choose from a variety of different investment options.

Many advisors gravitate toward participating whole life (WL) for their clients’ permanent life insurance needs as it provides guaranteed cash value accumulation, level premiums and the opportunity for policyholders to earn annual dividends from the insurer. However, those benefits come at a cost.

“Everyone loves the guarantees of a par policy … but it’s expensive,” says Trevor Parry, president of TRP Strategic Consulting and partner at Pension Acuity Partners in Toronto. “Sometimes people can’t swallow that huge premium.”

Although the cost of UL has increased during the past few years — mainly as a result of low interest rates — it remains a more affordable permanent coverage option for clients compared to par. It also offers more flexibility, as clients can adjust their payments over time by increasing or decreasing the amount they contribute to the investment account within the policy.

That flexibility is crucial for some clients, such as business owners whose costs and income may be unpredictable, says Parry.

“A good number of business owners have cash flow changes — pretty substantial ones — and they need the coverage,” he says. “At the end of the day, it comes down to flexibility for the client.”

UL also allows clients to choose their own investments, unlike WL, for which the insurance company pools and invests the premiums conservatively.

“Some people want to be more aggressive in the investment component,” Parry says. “That’s where UL makes sense.”

Recent tax changes reduced the amount of cash that clients can hold in a UL policy on a tax-exempt basis. However, these policies are still attractive from a tax-planning perspective, Tward says.

“Tax sheltering limits are still generous inside of UL policies,” he notes.

However, advisors need to be cautious when it comes to UL. As the product is risky and complex, it’s not suitable for a majority of individuals seeking life insurance coverage, according to Harold Geller, associate lawyer with law firm McBride Bond Christian LLP in Ottawa.

“These are incredibly sophisticated products,” he says. “For very sophisticated individuals, UL can be a very prudent investment. When that product is taken out to the masses, harm occurs.”

Geller has encountered many clients who have bought UL policies without a thorough understanding of how the product worked and have since found that it has failed to perform as expected. That can lead to legal trouble for advisors who sold those policies.

The product needs to be considered as part of a client’s broader financial plan, Tward says: “Every situation has to be evaluated based on the need, and a full analysis has to be run.”

Clients who want to limit their exposure to risk, Tward says, can opt for UL with level cost of insurance or a limited pay option so that their premiums are predictable. They can also choose low-risk investment options within the policy, such as guaranteed investment certificates.

“That way,” he says, “people know what they are getting and they aren’t relying on variability.”

However, Robert Porter, insurance advisor and owner of Crusader Insurance & Financial in Mississauga, Ont., says clients are far safer to buy a par policy.

Specifically, Porter says he has witnessed scenarios in which clients bought UL products under the impression that they would only have to make a limited number of payments to fully pay up the policy, only to find out later that additional payments would be necessary to keep the policy in force.

“UL can go wrong because it’s not guaranteed,” he says.

This is the second article in a three-part series on universal life insurance.

Up next: Mistakes to avoid with universal life.