Universal life insurance offers flexibility and potential growth, but it also carries risks that can affect policy performance and long-term sustainability. Understanding these risks is essential for managing expectations and avoiding unintended policy lapse.
Interest Rate and Performance Risk
Cash value growth in universal life insurance depends on:
- Declared interest rates
- Index performance
- Investment returns (in variable policies)
If credited rates are lower than expected for extended periods, cash value growth may be insufficient to support rising policy costs.
Cost of Insurance Risk
Cost of insurance charges increase as the insured ages. Over time:
- Monthly deductions rise
- Cash value may be depleted
- Premiums may need to increase
Underestimating long-term insurance costs is a common cause of policy failure.
Funding Risk
Universal life insurance relies heavily on adequate funding. Paying only minimum premiums can:
- Limit cash value growth
- Increase reliance on future premiums
- Heighten lapse risk later in life
Early underfunding is difficult to correct later.
Market Volatility Risk
In indexed and variable universal life policies:
- Market downturns can reduce or eliminate credited growth
- Volatility can disrupt long-term projections
- Poor timing of returns can weaken policy sustainability
While some policies include downside protection, volatility still affects performance.
Policy Management Risk
Universal life insurance requires active monitoring. Failure to:
- Review annual statements
- Adjust premiums when needed
- Respond to changing performance
Can allow small issues to compound into major problems.
Loan and Withdrawal Risk
Loans and withdrawals reduce cash value and increase lapse risk if unmanaged. Accrued loan interest can accelerate policy decline.
Illustration Assumption Risk
Policy illustrations are based on assumptions that may not materialize. Overreliance on optimistic projections can lead to underfunding and disappointment.
Longevity Risk
Outliving policy assumptions increases exposure to rising insurance costs. Policies must be funded to last longer than originally projected.
Mitigating Risk
Risk can be managed by:
- Funding policies at or above target levels
- Monitoring performance regularly
- Adjusting premiums proactively
- Reducing death benefits when appropriate
Key Takeaways
Universal life insurance offers flexibility but exposes policyholders to interest rate risk, funding risk, and management risk. Understanding and actively managing these risks is essential to maintaining long-term coverage.
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