April 10, 2009

Good example of a bad Universal Insurance purchase

The other day on the Suze Orman show a woman called in to ask a question about her Variable Universal Life Insurance policy. Variable Universal life policies are a cash value life insurance policy that has the option to invest in different investment vehicles such as mutual funds or bond funds. The performance of the investment has some risks due to the volatility of the investments. There are some common criticisms of Variable Universal Life policies: high costs, limited investment choices and policy expenses can increase.

Here are the details on the woman's policy given on the show:
$300,000 Death benefit
$100 / month premium
60% fees
$13,500 total investment over 5 years
$6,725 cash value

So she had paid the premium for 5 years and spent $13,500. They said the premium was $100 a month which would be $6,000 for 5 years so I'm guessing that she put extra money in and/or there were other fees. They didn't explain how the 60% fees worked or what the fees were for. This is the information given in the show so I'm taking it at face value. Plus they didn't say anything at all about how she had allocated her investments within the policy. She may or may not have made risky choices for the investments. In any case she had spent $13,500 over 5 years and had $6,725 value built up.

Lets compare that to buying a term policy for $300,000 coverage:

A healthy woman in her 30's can get a 20 year term policy with $300,000 coverage for under $200 a year. If the woman had bought such a term policy and simply put her money in a bank account with 1% interest then she'd have over $12,750 in the account. Thats about $5,975 more than the cash value of the universal policy.
Or what if you were a little more risky with it and put your extra cash into a S&P500 index ETF once a year? Even with the plunge in the value of the stock market you'd still be ahead with over $8,500 in stock left.

Lets sum up:
Option 1: Variable Universal life policy = $6,775 in cash value after 5 years
Option 2: Term life + save the rest in a simple savings account = $12,750 in cash value after 5 years
Option 3: Term life + invest the rest in S&P 500 ETF fund = $8,500 in cash value

Clearly in this case the choice to buy the Variable Universal Life policy was not a good one. She would have done better simply buying term and investing the rest in the S&P500, even with the recent drastic plunge in the S&P.

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