A growing number of affluent families are taking out Universal Life Insurance (SVU) as part of their estate planning and structuring. Due to the high amounts insured, universal life insurance is also known as “jumbo life insurance” or “jumbo universal life”.
Simply put, universal life insurance is a life insurance policy that provides very high death coverage , both in percentage terms (often more than 300% of the premium paid, e.g. you pay a $3 million premium and beneficiaries receive $9 million or more at death) and in absolute numbers (sometimes more than $90 million), hence the term “jumbo life insurance”.
What sets universal life insurance apart from other life insurance products is the combination of high death coverage and an accrual plan: the value of the policy increases over the years, with a guaranteed interest rate.
What is universal life insurance?
Universal life insurance is a type of life insurance that offers very high death coverage. This is combined with a savings component; most of the premium paid by the policyholder is invested by the insurer to provide an accumulation of monetary values (every policy will have a Policy Value) that can be viewed by the policyholder as an alternative asset class, similar to a savings or investment product.
Universal life insurance policies are mainly used:
- as a liquidity planning tool in the event of death (estate planning);
- to offset inheritance taxes on, for example, foreign property (tax planning); eg. UK inheritance tax (40%) will apply to the value of property located in London at the time of the owner’s death;
- for complex estate planning with many family members (inheritance planning); that is, to create liquidity in the context of family business succession to benefit non-active family members or to pay off existing debt without the need to liquidate businesses or investments;
- to provide family security – protecting the family’s lifestyle in the event of a tragic loss (wealth planning);
- to avoid the probate process ; or
- as an attractive investment alternative (diversification)
Within the scope of life insurance, universal life insurance is the exact opposite of private placement life insurance (PPLI). A jumbo life policy has very high death coverage, while a private placement life insurance policy offers minimal death coverage.
How does universal life insurance work?
traditional life insurance
In traditional life insurance, the premium is based on a predetermined level of insurance coverage. If the insured event occurs, then the agreed coverage is paid. If the insured event does not occur, or if the insured stops paying the premium, then the sum of all premiums paid up to that point is forfeited. Therefore, premiums are policyholder cost only unless the insured event occurs.
universal life insurance
The premium paid for a universal life insurance policy is best defined as a deposit. A substantial cash payment (“deposit”) is made to the insurer to obtain the universal life insurance policy and the policyholder immediately receives the agreed insurance coverage, for example, a premium of US$3 million is paid and beneficiaries receive US$9 million when the policyholder dies*. In addition, the universal life insurance insurance company annually credits interest (guaranteed) on this “deposit” by the insured person. The insurer calls this deposit the Policy Value (Cash Value). This consists of the total premium paid by the policyholder, minus insurance costs and other costs such as insurer and broker fees.
* The tax consequences of life insurance are different in each country.
The investment component of universal life insurance
Therefore, unlike the traditional life insurance described above, the premium paid is not lost. A universal life insurance insurer is able to offer interest on the Policy Value (Cash Value) by pooling all deposits (from all policyholders) into their own general investment account and putting them into conservative fixed income investments (investments vary slightly from one insurer to another).
Due to the long-term nature of investments, insurers are able to pay a relatively high interest rate compared to the mid-market rate. They also commit to paying a guaranteed minimum interest rate, so universal life insurance works as an investment for the policyholder. The policy value (cash value) will generally increase and, after a few years, exceed the premium paid (see graph).
Universal life insurance policy
The universal life insurance policy can be based on different currencies, but it is usually expressed in dollars. The policyholder has the flexibility to finance the insurance, with the option of making a lump sum deposit (single payment) or paying annually (multiple payments) over a number of years.
The policy itself is also highly flexible. Death cover and beneficiaries may be revised and modified as the insured party’s circumstances change throughout their lifetime. The insured may increase their premium(s) in the future.
The insured has full access to the savings component (Policy Value) of the policy, which can be increased, decreased and pledged if necessary. Full or partial withdrawals can be made at any time: the policyholder can withdraw funds from the universal life insurance policy – to meet a liquidity need, or to make a profit when the policy value is increasing more than the policyholder needs.
When taking out a universal life insurance policy, it is necessary to decide who will be the beneficiary(ies) of that policy. This beneficiary need not necessarily be an individual, it can also be a structure such as a trust . After taking out the policy, it is possible to change the provisions relating to beneficiaries (changes may be made in response to changes in family circumstances or because it is necessary due to a move to a foreign jurisdiction ).
The insurance risk
Due to the high-risk component (death coverage) of the SVU , wealthy families wishing to take out insurance must undergo a rigorous evaluation. This includes a medical evaluation and a financial evaluation. Interested individuals should undergo a medical evaluation at an approved clinic. Policy terms are offered based on the actuarial risk assessed in this process. It may also mean that persons residing in certain jurisdictions, or of a certain age or constitution, may not be offered any terms; or just less attractive terms.
Financing the universal life insurance premium
Given that the policy has a Policy Value when redeemed (the Cash Surrender Value – CSV), it is possible to obtain a loan to finance a considerable portion of the premium. The guarantee for this loan will be constituted by the insurance policy issued. It is also possible to get a loan later. Due to the conservative way of investing of insurers, some private banks are willing to fund the premium up to 85-90% of the Redemption Value, which is comparable to approximately 75-85% of the premium itself. However, it is necessary to consider that the loan must be paid to the bank before the insured or beneficiary can benefit from any policy distribution.
This possibility creates many additional estate planning options for affluent families, especially for those who have many assets but lack liquidity. By financing the policy, these families are able to obtain much higher death coverage.