Universal Life Insurance Cost of Insurance

The cost of insurance (COI) is something that’s important to keep in mind when considering the purchase of a universal life insurance policy. Usually the goal is to minimize it so that cash value builds as efficiently as possible (except in the case of guaranteed universal life insurance).

We’ll cover how to do this. We’ll use some similar graphs and concepts that we covered in our universal life insurance death benefit options article.

As a refresher, the cost of insurance is based on the net amount at risk. The net amount of risk is the difference between the death benefit and the cash value. So the net amount at risk is very important, because along with mortality rates, it determines your cost of insurance.

First we’ll look at a policy with a level death benefit that is funded just below the modified endowment contract (MEC) limit.

So you can easily see the net amount at risk:

This graph shows the COI in each policy year:

It remains relatively stable but eventually rises significantly. But when compared to the amount of interest credited in each year, it is very small:

Over time, the interest credited each year is significantly more than the cost of insurance.

Next we will look at a policy with a level death benefit that is funded at a much lower level than the one above:

It might take a second to sort out which line is which, but you can see that the death benefit for the more highly funded policy starts to increase sooner (it reaches the corridor limit more quickly).

The net amount at risk for the more highly funded policy is also lower while the death benefit is level. And long term, the policy that is funded at a higher level will have more cash value and death benefit.

Here is the comparison of the cost of insurance and interest credited in each year:

For the most part the cost of insurance is not drastically different. And it’s actually a little bit higher for the policy with a higher funding level in later years. This is because the corridor factors are a percentage, and when applied to a larger cash value result in a larger net amount at risk.

But the main thing to notice is that the policy with a higher funding level earns significantly more interest relative to the cost of insurance as time passes.

Next we will look at a policy with an increasing death benefit (level net amount at risk):

And the COI graph:

In this case, the net amount at risk never decreases, so the cost of insurance will not go down. In later years when mortality rates start to rise very quickly, so does the cost of insurance.

Even when compared to the interest credited, the cost of insurance is relatively high:

So, long term it might not be best to keep and increasing death benefit if cash value growth is the primary concern.

But increasing death benefits allow more premium to be paid into the policy, so in order to take advantage of the long-term COI savings of a level death benefit policy and the high funding level of an increasing death benefit policy, we could start with an increasing death benefit and then switch to a level death benefit when premiums are no long being paid:

And the interest and COI comparison:

This looks a lot like the level scenario with a high funding level. But if I put them on the same set of axes you will be able to see the difference:

The initial increasing death benefit that levels off credits significantly more interest. And the cost of insurance in later years relative to the interest credited is very low. Of course, the premiums being paid into this policy are larger than the level policy. But, the premiums end after the death benefit option is switched. With the level policy, premiums in this example are paid for life.

Even if someone doesn’t a huge amount of money to be able to fund a policy at a very high level, this is not an issue, because you can just select a small death benefit, leaving the bulk of the death benefit protection to a separate (and cheaper) term policy.

And if you do it this way, you’ll end up with a larger death benefit in the long run anyway:

Conclusion

If you are going to purchase universal life insurance with a focus on cash value accumulation, it is best to structure policies as efficiently as possible. Often they are not structured this way when they are sold. This could be due to a lack of knowledge or the unwillingness to take a reduced commission that results from doing it this way (neither one is good). If you haven’t pulled out your policy in a while, now could be a good time to take a look at it.

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