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4 – UNIVERSAL LIFE INSURANCE

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4.1 Transparency Through Unbundling

With term insurance and guaranteed whole life insurance, the main pricing elements are bundled together. These include:

  • Cost of Insurance (COI)
  • Investments
  • Expenses

Because they are bundled, the policyholder usually cannot see how premiums are allocated.

🔍 Universal Life (UL) insurance is different.
It uses unbundling, meaning these components are separate but connected. This creates more transparency and flexibility.

The three key components are:

  • 🛡️ Cost of Insurance (COI)
  • 💼 Expenses
  • 📈 Investment component

Separating these encourages policyholders to actively monitor their policy. Ignoring rising COI or poor investment performance can lead to policy lapse.

💡 How Money Flows in a UL Policy

  • 💰 Premiums are deposited into the investment account
  • 📈 Investment returns are added to the account
  • 🧾 COI and expenses are deducted from the account
  • 🛡️ Death benefit is provided through the policy contract
  • 🔄 Policyholders may withdraw, partially surrender, or borrow from the account (if available)

UL policies clearly show:

  • How COI is deducted
  • How expenses are charged
  • What investment returns are credited

This transparency helps policyholders understand how charges and returns affect the cash value (CV).

📌 Cash Value (CV)
= Value of the investment account

📌 Cash Surrender Value (CSV)
= CV minus any surrender charges (if applicable)

4.1.1 Cost of Insurance (COI) 🛡️

COI represents the insurer’s cost of providing the death benefit and is also called a mortality charge.

In a UL policy:

  • COI is deducted from the investment account
  • The policyholder can see these charges
  • Policyholders may choose how COI is structured (covered later)

4.1.2 Expenses 💼

Insurers deduct expenses from the investment account. These may include:

  • Selling and distribution costs
  • Underwriting and policy issue costs
  • Claims processing
  • Insurer taxes

Charges may be:

  • A percentage of premiums, or
  • A flat monthly fee

UL policies are flexible but often have higher administrative costs than other permanent insurance types.

4.1.3 Investment 📈

UL combines insurance and investing.

How it works:

  • Premiums go into the investment account
  • Part covers COI and expenses
  • The remainder builds cash value

Policyholders have flexibility in:

  • Choosing investments
  • Changing investments over time

Potential benefit:

  • 📊 Investment growth may be tax-sheltered

Investment performance is reflected in the policy’s cash value, giving policyholders a clearer view of results.

📌 Investment growth is tax-free as long as limits under the Income Tax Act are respected.

4.1.4 Premium Tax 🧾

Even though UL payments are sometimes called deposits, they are treated as premiums.

Each premium payment includes:

  • 🏛️ Provincial/territorial premium tax (typically 2–4%)
  • The rest goes into the investment account

The tax applies to the entire premium, not just the insurance portion.

✨ Key Takeaway

Universal Life offers:

  • 🔍 Transparency
  • 🔄 Flexibility
  • 📈 Investment potential

But it requires:

  • Active monitoring
  • Understanding of charges and performance

4.2 Flexibility for the Policyholder

Universal Life (UL) insurance is one of the most flexible forms of life insurance. It can be customized both:

  • 🕒 At the time of purchase
  • 🔄 After the policy is already active

Flexibility appears in:

  • 💰 Timing and amount of premiums
  • 🛡️ Face amount
  • 👥 Life/lives insured
  • 🧮 Cost of Insurance (COI)
  • 📈 Investments

4.2.1 Timing and Amount of Premiums 💰

UL allows policyholders to decide how much and when to pay premiums (within limits).

Premiums are deposited into the investment account.

Policyholders can pay:

  • Minimum premium
  • Maximum premium
  • Any amount in-between

📌 Minimum Premium

  • Covers premium tax, COI, and expenses
  • Keeps policy in force to age 100
  • Does not build cash value

➡️ Called a minimally funded UL policy

📌 Higher Premiums
Paying more than the minimum helps:

  • Build cash value
  • Benefit from tax-sheltered growth

Extra payments can be made:

  • At issue
  • Through future payments
  • Via lump sums

📌 Maximum Premium

  • Limited to maintain tax-exempt status
    ➡️ Called a maximum-funded UL policy

📌 Premium Flexibility
Policyholders may:

  • Reduce premiums
  • Stop premiums temporarily

As long as the investment account can cover COI and expenses.

4.2.1.1 Insufficient Account Value ⚠️

A UL policy stays active only if the investment account can cover deductions.

Low cash value may result from:

  • Minimal funding
  • Withdrawals
  • Reduced or stopped premiums
  • Poor or negative investment returns

➡️ This increases lapse risk.

4.2.1.2 Modal Factors for UL Policies 🧾

Unlike term and whole life:

  • UL usually does not charge modal factors
  • Payments are simply divided across the year

➡️ No extra cost for spreading payments.

4.2.2 Face Amount 🛡️

The face amount is selected at policy start.

Policyholders can:

  • ➕ Increase coverage
  • ➖ Decrease coverage

📌 Increasing Coverage

  • Requires evidence of insurability
  • Unless a guaranteed insurability rider exists

Increasing face amount:

  • Raises COI deductions
  • Reduces money available for investment
    ➡️ May require higher premiums

📌 Decreasing Coverage

  • Lowers COI deductions
  • Leaves more for investment
    ➡️ Can increase cash value growth

4.2.3 Life/Lives Insured 👥

One UL policy can cover:

  • Single life
  • Joint lives
  • Sometimes multiple lives (depends on insurer)

Some policies allow:

  • Adding a life insured
  • Substituting a life insured

➡️ Evidence of insurability is required.

✨ Key Takeaway

UL flexibility allows policyholders to:

  • Adjust premiums
  • Modify coverage
  • Customize investments
  • Adapt coverage to life changes

But flexibility also requires:

  • Active monitoring
  • Smart funding decisions

4.3 Pricing the Insurance Component

In Universal Life (UL) insurance, the cost of insurance (COI) is deducted from the policy’s investment account. Understanding how this pricing works is key to managing the policy effectively.

COI deductions reflect:

  • 📌 Net Amount at Risk (NAAR)
  • 📌 Yearly Renewable Term (YRT)
  • 📌 Level Cost of Insurance (LCOI)
  • 📌 Choice between YRT and LCOI
  • 📌 Guaranteed vs. adjustable mortality charges

4.3.1 Net Amount at Risk (NAAR) 🧮

The insurer’s risk is that death occurs earlier than expected.

Insurers rely on:

  • Mortality statistics
  • Underwriting assessments
  • Investment returns on pooled premiums

If death occurs prematurely:

  • Fewer premiums are collected
  • Less investment growth is earned
    ➡️ Higher cost to insurer

📌 NAAR Definition

The Net Amount at Risk (NAAR) is the portion of the death benefit that is truly at risk for the insurer.

Formula:

NAAR = Death Benefit − COI

✔ Death benefit may exceed original face amount depending on policy structure.

4.3.2 Yearly Renewable Term (YRT) 📈

YRT is like one-year term insurance that renews annually.

COI is based on:

  • Age
  • Probability of death that year
  • NAAR

COI is expressed per $1,000 of NAAR.

📌 Key Feature

  • Cost increases each year with age
  • Similar to increasing term insurance

➡️ Lower cost early on
➡️ Can become expensive later
➡️ May erode cash value if not offset by:

  • Higher premiums
  • Strong investment returns

4.3.3 Level Cost of Insurance (LCOI) ⚖️

LCOI mirrors Term-to-100 pricing.

📌 Key Feature

  • Cost per $1,000 remains level
  • Does not rise with age

✔ Higher COI in early years
✔ Lower COI in later years
✔ Helps preserve cash value long-term

4.3.4 Choosing Between YRT and LCOI 🔍

Both methods suit different goals.

📌 YRT Works Best When:

  • Client wants higher short-term fund values
  • Focus is on early cash value growth

📌 LCOI Works Best When:

  • Client wants long-term stability
  • Goal is lifelong value preservation
  • Prefers predictable costs

📌 Switching Rules

  • Some policies allow YRT → LCOI switch
  • Rates based on age at switch
  • Usually cannot switch back to YRT

4.3.5 Guaranteed vs. Adjustable COI 🛡️

COI schedules may be:

✔ Guaranteed

  • Fixed for life
  • Predictable and stable

✔ Adjustable

  • Insurer can modify rates
  • Reflects actual mortality, expenses, returns

➡️ Adjustable COI adds uncertainty for policyholders.

Agents must clarify which applies.

4.3.5.1 Open-Ended or Restricted Increases ⚠️

If COI is adjustable:

📌 Open-ended increases

  • No clear cap
  • Higher risk to policyholder

📌 Restricted increases

  • Limited to a set percentage or dollar amount
  • More protection for policyholder

Most policies use restricted increases.

✨ Key Takeaway

UL pricing requires balance:

  • YRT = cheaper early, costly later
  • LCOI = higher early, stable later
  • Guaranteed COI = predictability
  • Adjustable COI = flexibility with risk

Smart planning helps preserve cash value and prevent lapses.

4.4 Death Benefit Options

A Universal Life (UL) policy allows the policyholder to choose how the death benefit is structured. This choice directly affects:

  • 📌 Net Amount at Risk (NAAR)
  • 📌 Cost of Insurance (COI)
  • 📌 Investment growth inside the policy

Selecting the right option helps align the policy with long-term financial goals and beneficiary needs.

4.4.1 Level Death Benefit ⚖️

This is the simplest and lowest-cost option.

The beneficiary receives either:

  • ✔ The original face amount, OR
  • ✔ The account value if it exceeds the face amount (depends on policy design)

📌 How it works

  • Extra premiums can grow the investment account
  • Investment performance influences results
  • For many years, only the face amount is paid
  • Account value contributes later if it grows large enough

✅ Best suited for

  • Clients wanting affordable protection
  • Those satisfied with a guaranteed minimum benefit
  • Clients comfortable relying on investment performance for upside

4.4.2 Level Death Benefit Plus Account Value 📈

Here, the beneficiary receives:

Face Amount + Investment Account Value

The insurer commits to paying both from the start.

📌 Key features

  • NAAR remains level
  • COI is higher than basic level option
  • COI deductions reduce account growth unless premiums are increased
  • Full account value passes to beneficiaries tax-free

✅ Best suited for

  • Clients expecting growing insurance needs
  • Strong investors
  • Those funding the policy with larger premiums

4.4.3 Level Death Benefit Plus Cumulative Premiums 💰

This option pays:

Face Amount + Total Premiums Paid (gross premiums)

It effectively refunds premiums at death.

📌 Important points

  • Often the most expensive option
  • Protects against losing premiums in early years
  • Lower NAAR can reduce COI
  • Lower COI can help the account grow faster

⚠️ If account value exceeds face amount + premiums paid, the excess stays with the insurer.

✅ Best suited for

  • Clients maximizing funding
  • Those wanting premium protection in early years
  • Clients focused on value recovery

4.4.4 Indexed Death Benefit 📊

The death benefit increases with inflation.

It may be:

  • Linked to inflation indexes (like CPI), OR
  • Set at a chosen annual increase (commonly 1%–8%)

📌 Key features

  • Death benefit grows over time
  • Protects purchasing power
  • NAAR is not level
  • COI may increase as benefit rises

✅ Best suited for

  • Long-term planners
  • Clients concerned about inflation
  • Those wanting increasing protection

✨ Key Takeaway

Death benefit options shape both:

  • Protection outcomes
  • Investment performance

General impact:

  • ⚖️ Level = lowest cost
  • 📈 Face + Account Value = growth focused
  • 💰 Face + Premiums = premium protection
  • 📊 Indexed = inflation protection

Choosing wisely helps balance cost, growth, and long-term security.

4.5 Investment Components

The investment side of Universal Life (UL) insurance is one of its biggest differentiators from other life insurance types. It gives policyholders control and flexibility, but it also requires attention and ongoing management.

Investment components include:

  • 📌 Net premiums
  • 📌 Tax deferral
  • 📌 Investment choices
  • 📌 Impact of returns on policy viability

4.5.1 Net Premiums 💰

When a premium is deposited into a UL policy:

Net premium = Gross premium − premium tax − COI − expenses

The net premium is what actually gets invested.

✔ If COI decreases, more money becomes available for investment
✔ If premiums stay the same and COI rises, less is invested

4.5.1.1 Exemption Test 🛡️

UL policies can grow in a tax-sheltered environment, but only within limits.

✔ The insurer applies an exemption test to keep the policy tax-exempt
✔ Deposits above the allowed limit go into a non-exempt side fund
✔ Income in the side fund is taxable annually

➡️ Staying within limits preserves tax advantages.

4.5.2 Tax Deferral 📈

Investment income inside the policy:

✔ Is not taxed when earned
✔ Is reinvested fully
✔ Benefits from compounding growth

Tax is generally deferred until surrender.

➡️ If the death benefit includes the account value, growth may pass tax-free to beneficiaries.

4.5.3 Investment Choices 🧩

UL policies offer multiple investment options, unlike many other permanent policies where the insurer controls investments.

✔ Premiums can be split across investments
✔ Diversification reduces risk
✔ Allocation can be changed over time
✔ Requires investment knowledge

4.5.3.1 Daily Interest Accounts (DIAs) 🏦

✔ Earn interest daily
✔ Often tied to short-term benchmarks (e.g., treasury bills)
✔ Principal protected
✔ Minimum return = 0%

Low risk, stable option.

4.5.3.2 Guaranteed Investment Accounts (GIAs) 📜

Similar to GICs:

✔ Fixed terms (1–20 years)
✔ Guaranteed principal
✔ Minimum return often linked to bond benchmarks from the Government of Canada
✔ Early withdrawal may trigger penalties

Good for stability-focused investors.

4.5.3.3 Index Fund Investments 📊

✔ Returns tied to market indexes
✔ No guarantees
✔ Value can rise or fall
✔ Possible negative returns
✔ May include management fees

Suitable for growth-oriented investors comfortable with risk.

4.5.3.4 Mutual Fund Investments 🌍

✔ Returns based on mutual fund performance
✔ Wide asset mix options
✔ Canadian, U.S., global exposure
✔ No guarantees on principal or returns
✔ Management fees apply

Higher potential growth with higher risk.

4.5.4 Impact of Investment Returns on Policy Viability ⚖️

UL components are interconnected.

If COI rises:
➡️ More money is withdrawn
➡️ Investment growth slows

If returns are low or negative:
➡️ Account value declines
➡️ Risk of policy lapse increases

✔ Solutions:

  • Increase premiums
  • Improve investment performance
  • Rebalance strategy

4.5.4.1 Policy Illustrations 📑

UL policies include illustrations showing projections for:

  • Premiums
  • COI
  • Account value
  • Cash surrender value
  • Death benefit

⚠️ Important points:

✔ Illustrations are not guarantees
✔ Small return changes can greatly affect results
✔ Usually shown at multiple return scenarios
✔ Policyholders must acknowledge limitations

✨ Key Takeaway

UL investment success depends on:

✔ Balanced funding
✔ Smart investment choices
✔ Monitoring performance
✔ Adjusting when needed

UL offers flexibility and growth potential — but requires active oversight to keep the policy healthy over time.

4.6 Investment Account

The investment account (also called the accumulating fund) is a core feature of a Universal Life (UL) policy. It holds invested premiums and can provide several valuable non-forfeiture benefits.

It can be used for:

  • 💰 Surrendering the policy
  • 💰 Policy withdrawals
  • 💰 Premium offsets
  • 💰 Policy loans
  • 💰 Collateral for third-party loans
  • 💰 Leveraging
  • 💰 Distribution upon death

4.6.1 Surrendering the Policy 📤

If coverage is no longer needed, the policyholder can surrender the policy.

✔ The policy ends
✔ Investments are converted to cash
✔ Payout = account value − surrender charges

Surrender charges:

  • Usually apply in the first 10 years
  • Gradually decline over time
  • Never exceed the account value
  • No charge if no cash value exists

4.6.2 Policy Withdrawals (Partial Surrender) 💵

Funds can be withdrawn from the investment account.

✔ Reduces account growth
✔ May affect long-term policy viability
✔ May create taxable income
✔ Insurers often set minimum withdrawals
✔ Maximum = cash surrender value
✔ Charges may apply

➡️ Frequent withdrawals can increase lapse risk.

4.6.3 Premium Offsets 🔄

UL policies can eventually self-fund.

✔ Investment growth can cover COI and expenses
✔ Policyholder may stop paying premiums
✔ Policy stays in force if account value is sufficient

➡️ Requires strong funding and good investment performance.

4.6.4 Policy Loans 🏦

Loans can be taken against policy value.

✔ Typically 50–90% of cash value
✔ Interest rate set at loan time
✔ No required repayment schedule

Important effects:

  • Loan + interest reduces death benefit
  • May create taxable income
  • Investment funds remain inside policy

➡️ Loan interest may exceed investment returns.

4.6.5 Collateral for Third-Party Loans 📑

The policy’s cash value can be used as loan collateral with a lender.

✔ Avoids taxable disposition
✔ Full cash value remains invested
✔ Growth stays tax-sheltered
✔ Lender may require income/assets proof

➡️ Repayment terms depend on the lender.

4.6.6 Leveraging ⚖️

Leveraging means borrowing to invest.

✔ Loans use CSV or death benefit as collateral
✔ Success requires returns > borrowing cost

Risks:

  • Poor returns
  • Rising loan interest
  • Reduced CSV or death benefit
  • Possible forced surrender
  • Potential tax consequences

✔ Loan interest may be tax-deductible if funds produce investment income.

➡️ Leveraging requires careful monitoring.

4.6.7 Distribution Upon Death 🛡️

How the investment account affects payout depends on the death benefit option:

Level Death Benefit

  • Usually pays original face amount
  • Sometimes pays excess account value above face amount

Level Death Benefit + Account Value

  • Pays face amount + full account value

Level Death Benefit + Cumulative Premiums

  • Pays face amount + total premiums paid
  • Excess account value kept by insurer

Indexed Death Benefit

  • Pays indexed face amount
  • Excess account value kept by insurer

✨ Key Takeaway

The UL investment account offers flexibility and access to funds, but:

✔ Withdrawals and loans affect growth
✔ Poor management can cause lapse
✔ Strong funding and monitoring are essential

4.7 Advantages and Disadvantages of Universal Life (UL) Insurance

Universal Life (UL) insurance combines life insurance protection + investment flexibility. It offers powerful features, but also requires active involvement from the policyholder.

Here are the key pros and cons to understand.

✅ Advantages

💡 Transparency

  • UL clearly shows cost of insurance (COI), expenses, and investment performance
  • Policyholder can monitor how money flows in the policy

💡 Premium Flexibility

  • Policyholder can increase, decrease, or temporarily suspend premiums
  • As long as the investment account can cover COI and expenses

💡 Investment Choice

  • Access to various investment options
  • Ability to adjust investment mix over time

💡 Funding Flexibility

  • Premiums can be paid within allowable limits
  • Helps align policy with changing financial situations

💡 Tax Advantages

  • Investment growth is tax-deferred
  • Can support tax-efficient retirement income planning

⚠️ Disadvantages

⚠️ Complexity

  • UL policies can be difficult to understand
  • Requires financial understanding and attention

⚠️ Active Monitoring Required

  • Policyholder must track:
    • Investment performance
    • Account value
    • COI charges
    • Premium adequacy

⚠️ Investment Risk

  • Poor investment returns can reduce cash value
  • May increase risk of policy lapse

⚠️ Premium Tax

  • Entire premium is subject to premium tax

⚠️ Knowledge Requirement

  • Policyholder benefits most with investment knowledge
  • Poor decisions can weaken policy performance

✨ Quick Insight

UL insurance works best for individuals who:

✔ Want flexibility
✔ Are comfortable with investments
✔ Are willing to actively manage their policy
✔ Have long-term financial goals

It may be less suitable for someone seeking a simple, hands-off policy.

4.8 Comparing Universal Life (UL) and Whole Life

Universal Life (UL) and Whole Life are both permanent life insurance, but they differ in how premiums, investments, and policy management work. Understanding these differences helps in selecting the right strategy for long-term protection.

🔍 Cost of Insurance (COI) & Expenses

Universal Life (UL)
✔ COI and expenses are deducted from the investment account
✔ Policyholder can choose YRT or LCOI costing
✔ Missed premium does NOT trigger a loan
✔ Policy may lapse if account value becomes insufficient (after grace period)

Whole Life
✔ COI and expenses come from policy reserves
✔ Not transparent to policyholder
✔ No COI choice
✔ Missed premium triggers automatic premium loan (APL)
✔ Policy lapses only when CSV reaches zero (after grace period)

💰 Premiums

Universal Life (UL)
✔ Flexible premiums
✔ Can increase, decrease, or skip (within limits)
✔ Must maintain enough account value

Whole Life
✔ Typically level premiums for life
✔ Predictable and structured

🎁 Dividends

Universal Life (UL)
❌ No policy dividends

Whole Life
✔ May pay dividends (for participating policies)
✔ Dividends can be used in multiple ways (e.g., PUA, cash, premium reduction)

🛡️ Death Benefit

Universal Life (UL)
✔ Multiple death benefit options
✔ Can include:

  • Face amount only
  • Face + account value
  • Face + cumulative premiums
    ✔ Flexible but affects COI

Whole Life
✔ Death benefit generally known in advance
✔ Can increase through Paid-Up Additions (PUAs)

📆 Modal Factors

Universal Life (UL)
✔ Modal factors generally not applied

Whole Life
✔ Modal factors apply if paying monthly, quarterly, etc.

📈 Investment Control

Universal Life (UL)
✔ Policyholder chooses investments
✔ Requires investment knowledge
✔ Higher involvement and monitoring

Whole Life
✔ Insurance company manages investments
✔ No action required from policyholder
✔ Simpler and hands-off

✨ Quick Comparison Insight

Universal Life suits those who:
✔ Want flexibility
✔ Are comfortable managing investments
✔ Prefer customizable coverage

Whole Life suits those who:
✔ Want guarantees and stability
✔ Prefer simplicity
✔ Value predictable premiums and benefits

4.9 Using Universal Life (UL) Insurance

Universal Life (UL) insurance is best suited for individuals who want lifelong coverage plus investment growth inside one policy. It is especially useful for people comfortable with financial planning and long-term strategies.

UL works well when protection and tax-advantaged investing are both priorities.

4.9.1 Maxed Out RRSP and TFSA 💰

UL insurance can be attractive for individuals who have already maximized their RRSP and TFSA contributions, particularly those in higher tax brackets.

✔ Investment growth inside UL is tax-deferred
✔ Policy can hold significant funds (within limits)
✔ Death benefit is generally paid tax-free to beneficiaries
✔ Useful for long-term wealth transfer planning

👉 In this situation, UL acts as an additional tax-advantaged accumulation tool.

4.9.2 Tax-Free Retirement Income 🏦

A UL policy can support retirement strategies.

✔ Policy cash value can be used as collateral for loans
✔ Loan proceeds can provide tax-free retirement income
✔ Investment value remains inside the policy growing tax-deferred

⚠️ This strategy requires careful planning and monitoring to avoid policy lapse or excessive debt.

✨ Quick Insight

UL insurance is most suitable for someone who:

✔ Has long-term insurance needs
✔ Is comfortable managing investments
✔ Wants tax-efficient growth opportunities
✔ Has already used traditional registered plans

It may be less suitable for someone seeking a simple, low-maintenance policy.

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