Quora Answer: How Do I Decide between Whole Life & Universal Life Insurance Policy?

The following is my answer to a Quora question: “How do I decide between a whole life insurance and a universal life insurance policy?” 

A whole life insurance policy, as its name suggests, covers you for your “whole life”, from the time of inception.  In most instances, the coverage ceases at age 100 years.  Depending on the policy contract, the coverage may extend to disability and critical illness, and there may be special provisions for accidental death.  The regular payment may be until coverage ceases, or it may be a limited pay. 

Whole life insurance polices have a non-participating fund aspect, where the insurer invests, less distribution cost, the premiums for a higher return, and puts some of that gain back into the policy.  This increases the value of the policy, and it has a surrender benefit that may, in time, be much more than premiums paid.  This allows the plan to function as a rudimentary financial instrument.  This means, in addition to the stated coverage, there is some financial flexibility.  The increase in policy value is not immediately liable for tax. 

The limitation is that this policy may be expensive.  The premiums are level, and this expense may impact the policy owner when he retires, or at any time his earning capacity drops.  The benefits are fixed upon inception, although there may be a period where the policy owner may request some variation.  Downgrades of coverage may be possible, but increase in coverage as net worth grows is not really an option for a policy incepted for a long period. 

Generally, whole life plan premiums are calculated based on a fixed quantum, based on life expectancy and mortality charges.  That amount is divided by the life expectancy less age at inception.  This means the annualised policy premiums are cheaper the younger you are when the policy is incepted, since that cost is amortised over a longer period.  Additional critical illness coverage is substantially expensive due to the high mortality charges. 

A universal life insurance policy is an adjustable life insurance policy, because it is more flexible.  The policy structure allows you to increase or reduce coverage depending on your financial capacity, with the attendant increase or decrease in premiums.  There is an investment account, which pay be a participating or non-participating plan, into which some of the premiums are paid into.  The interest generated, once it has reached a critical amount, can be used to fund the policy itself.  This also allows you to adjust the coverage, which may be subject to further medical examination.  This option to adjust your coverage throughout the policy life is very useful for business owners, and high net worth individuals.  The nature of these policies mean that in the event of adverse financial circumstances, payment may be stopped for a while. 

Both types of life policies have options for premium holidays and policy loans.  However, the universal life policy is more geared towards it since a premium holiday on whole life policy has a greater impact on coverage and policy value due to the great differences in premium.  Universal life policies are geared toward mass affluent and above, and the coverage and attendant premiums tend to be higher.  The primary concern pertaining to a universal life policy is its exposure to interest rates, which are dependent on market conditions.  They have a major impact on the policy value. 

Considering which one is better for you depends on many factors, from your coverage needs, your investment horizon, your age at entry, your budget, and how you want to structure the policy as part of your personal or company portfolio.  You need to sit with a financial advisor and discuss which of the above features best fit your needs.