For more than 100 years, whole life insurance has provided an indomitable pillar of stability for millions of policyholders who depend on it for savings and protection. But the 1980s saw the advent of other types of cash-value life insurance, such as universal life, which offers greater flexibility and choice for consumers. Variable universal policies appeared a few years later with the lure of allowing policyholders to reap the gains of the stock and bond markets. The question has since arisen: Which type of policy offers the best protection for the money, and have cash-value policies rendered traditional whole life insurance obsolete?

Whole vs. Universal vs. Variable Universal Life

Whole life insurance is easily the most conservative type of permanent life-insurance policy available. It pays regular dividends, has a guaranteed cash value that pays interest and grows tax-deferred, and allows policyholders to purchase additional paid-up insurance with their dividends, if they wish.

Universal life (UL) is much more flexible. It allows for variable premiums. The cash value often pays interest using a tiered schedule, in which the bottom layer of funds earns one rate, the next layer earns another and so on. Modern universal policies now offer indexing features that provide some portion of growth in the stock market with no risk of principal. These relatively recent innovations have caused some vendors to proclaim that whole life coverage has become irrelevant, because UL policies can supposedly outperform whole life products in every aspect.

Variable universal life (VUL) insurance is the newest kid on the block, a hybrid vehicle that combines the flexible terms of a UL policy with the sub-account options offered in variable annuities. It is one of the most-complex financial products on the market today, with myriad fees that typically reduce the returns posted by the mutual-fund sub accounts by a substantial margin.

Of course, all three types of cash-value policies stand in contrast to term insurance, which provides a much larger death benefit at a lower cost – but only for the specified term, at which point it will lapse if it is not renewed. People who are concerned that they could become medically uninsurable in their later years and need to count on a guaranteed death benefit should purchase permanent protection from a cash-value policy.

A 2009 study by LIMRA, a worldwide research trade association for the financial services industry, showed that UL insurance is by far the most popular type of life coverage in America; just over 40% of all policies in force at that time were in this category. Whole and term life each constituted about a quarter of the market, while VUL policies came in a distant last, making up a mere 9% of the market.

Catching Up

Although UL policies are still generally regarded as more flexible, whole life insurance has adopted many of the innovations first introduced in universal and VUL products. Many whole life products now provide riders for critical and chronic illness, living benefits and waiver of premiums for disability. The term riders now offered in many whole life policies also allow them to provide additional death benefits in the same way that UL policyholders can increase their policy's face value by paying additional or higher premiums. The popularity of VUL policies declined during the bear market in 2000, as their cash values frequently became depleted from market losses and many policyholders were forced either to pour substantial additional funds into their policies to keep them in force or to let them lapse.

The Interest-Rate Factor

UL policies were the darling of the insurance industry when they first appeared in the 1980s, as they were able to substantially outperform whole-life policies due to credit methods that were (and are) based on current interest rates. These vehicles performed excellently at first because interest rates at that time were so high.

The current interest-rate environment has substantially eroded the appeal of straight UL policies that pay only interest with no other crediting methods, such as market indexing. Furthermore, many older UL policies have provisions written in the fine print of their contracts that allow insurance companies to reduce the policy's cash value if the projections of market performance on which the policy was based do not pan out. This has largely been the case in both the stock and bond markets. By contrast, carriers have invested whole life premiums very conservatively, which is why traditional mutual life-insurance companies owned by their policyholders suffered minimal damage through both the Great Depression and the Great Recession.

Which Is Right for You?

As with any choice of financial products or services, consumers must determine what they want out of their life insurance to select an appropriate product. The most risk-averse will probably be happiest with the guarantees provided by whole life policies. Although the promised returns are fairly modest, they can be counted on at almost all times, providing an asset virtually unaffected by market conditions.

Those who are more aggressive may be wise to look at an indexed UL policy with income-benefit riders or other guarantees that still give them the chance to get ahead during market-growth periods. UL may make more sense when interest rates are low and the markets have experienced a recent major downturn because policyholders will benefit from higher interest payments when rates start to rise again. Most financial advisers now steer all but the most sophisticated clients away from VUL products, as other vehicles can provide similar returns with less risk.

The Bottom Line

Although UL and VUL policies will likely continue to retain their market share, current market conditions have given whole life policies a new chance to shine. A guaranteed death benefit and cash value, coupled with added riders and benefits, have made them more attractive to conservative consumers, who also prize having access to tax-free loans against the policy's cash value than they can get from their variable or universal cousins. For more information on whole and universal life insurance, consult your insurance agent or financial adviser.

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