What is Unbundled Life Insurance Policy

An unbundled life insurance policy is a type of financial protection plan that provides cash to beneficiaries upon the policyholder's death. A unbundled life insurance policy contains a savings and investment component that the policyholder can use during his or her lifetime or pass on to beneficiaries. This does not expire when the policyholder reaches a certain age; and that allows the policyholder to adjust the amount and timing of premium payments and the amount of the death benefit while the policy is in force. Unbundled life insurance is another word for universal life insurance.

BREAKING DOWN Unbundled Life Insurance Policy

Both whole and universal/unbundled life insurance are types of permanent life insurance that have a cash value component, in which a portion of each premium payment is saved and invested on the policyholder's behalf. The other portion of the premium goes toward administrative expenses and the death benefit.

However, there is an important difference between these two types of policies. With whole life insurance, the premiums and death benefit are fixed when the policy is purchased. With universal/unbundled life insurance, the premiums and death benefit can be changed during the life of the policy. This can be a desirable feature if the policyholder's needs change.

The universal/unbundled policy also clearly discloses the policy's administrative fees - also called underwriting and sales expense charges - to the policyholder, whereas a whole life policy does not. Thus, in addition to providing flexibility, universal/unbundled life insurance allows the policyholder to see exactly where his or her premium payments are going.

Elements of Unbundled Life Insurance

  • Surrender charges: If a policyholder surrenders an unbundled life insurance policy early, the life insurer may charge a surrender fee, which can be substantial in the earlier years.
  • Partial withdrawals: Most unbundled life policies include withdrawal provisions that enable the policyholder to take a portion of the cash value without surrendering the policy. The withdrawal can reduce the death benefit.  As long as the policy continues to qualify as a life insurance contract, withdrawals can be tax free until they exceed the cost basis of the policy.
  • Policy loans:  Most unbundled life policies allow policyholders to borrow from accumulated cash value. The insurer charges interest at a rate that is typically below prevailing interest rates. If the loan is not repaid, the death benefit will be reduced as well as the cash value of the account, if surrendered early.
  • Surrender options: If a policy is surrendered, the policyholder can choose to receive the cash value from several options. The cash value, less any surrender charges, can be paid directly to the policyholder. It can also come in the form of a paid-up life insurance policy at a reduced amount. Or, it could come in the form of a paid-up term policy with the same death benefit amount as the original policy.