Pitfalls to Look Out for When Buying a Life Insurance Policy: Why Universal Life is a Good Idea if You want Flexibility

The topic of life insurance, although an extremely useful idea in itself, often earns pejorative status in everyday conversations. Many of you have had former high school classmates or family members try and approach you on the topic of life insurance in a less than professional manner; they are often very pushy in their approach and don't take the time to properly analyze your needs.  The one solution fits all approach often with the buyer ending up with a policy which is not properly suited towards his or her family's needs. The wrong policy can cost you thousands and leave your family strangled for cash when they need it most.

So, is there any easier way to get this issue of life insurance issue handled conveniently and to your benefit? My advice is to read up on the basics of life insurance and get a feel for your needs and determine what's best for you even before you begin dealing with a broker. This can by a daunting task for many, but the good news is that this article will get the ball rolling.

First of all, we need to assess what are the basic life insurance types: Term, Whole and Universal life insurance. Term life insurance is by far the easiest policy to understand and it's considered to by many to be the purest form of life insurance. The advantage of Term coverage is that it's very inexpensive: the downside is the cost escalates dramatically as you get older.

Whole life insurance provides peace of mind by delivering permanent coverage at a guaranteed rate. The downside is these policies have a much higher initial premium. If you opt for this type of life insurance, decide if you want a participating or non-participating policy. The first option provides an annual dividend, which can provide an increasing cash value and death benefit while staying in line with inflation. Non participating policies are less expensive but generally provide a level rather than escalating death benefit. You should also check whether the policy has a quick-pay option, which allows you to pay up the policy in 10, 15 or 20 years if you wish.

Universal life insurance provides a mix of the two coverages. This coverage is considered to be most flexible form of life insurance; you can vary your monthly deposit, choose a level or increasing death benefit options.

To illustrate the basic concept behind this policy, picture a crate. In this crate, you put a certain amount of money that you give to the insurance company. They then deduct the monthly insurance and administration costs and the surplus is invested in an account of your choosing. Many insurance companies offer guaranteed minimum interest rates (usually around 3-4 %) but it can be higher.

Now this policy is not without risks, many universal life policies have an escalating insurance costs in order to maximize the policies cash value build up in the early years. If the policy does not grow at your anticipated rate of return you could be left with an empty crate and no insurance. This type of policy is often geared towards high income earners who are looking to defer tax and already have their financial house in order.

As for other general advice related to life insurance policies, make sure you check up on the available riders and benefits. The one and single most important thing to have in mind is to work with an independent broker. Insurance policies vary dramatically from company to company and you really need an unbiased opinion.

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  1. Jeff_Y 01/22/2011 at 3:49 am

    Can you please elaborate “many universal life policies have an escalating insurance costs in order to maximize the policies cash value build up in the early years”?

    This sounds very alarming

  2. LSM Insurance 01/22/2011 at 3:32 pm

    Thanks for the note Jeff. Universale Life insurance policies generally have two cost of insurance structures 1) Inceasing cost of Insurance structures – the cost starts off low but increases as the insured ages 2) Level cost of insurance – the cost starts off higher but remains levelfor the insureds lifetime.

  3. B 03/05/2011 at 8:30 pm

    Last year I bought a universal policy. I am 30 and have 2 young daughters, no mortgage or any real assets. I have a car worth less than 5K and the only debt I have is Student Loans, about 30K. I`m living with family and pay no rent until I can afford to move out. I was paying over $150 a month and wasn`t working. Until now after school had finished. I have just started work and wanted to know if I should keep the universal or get term. Im in good health, non-smoker. It had almost been a year since I had that policy and I just cancelled it. I read up on universal and it didn`t make sense for me and my situation. At the time when I signed up for it, I was on student loans and not working. My life will eventually get more financially stable…what should I do.

  4. LSM Insurance 03/06/2011 at 10:16 am

    Thanks B. It sounds like you were sold the wrong plan. You would likely be much better of with a Term policy with is renewable and convertible. Regards,

  5. P.S 02/02/2012 at 11:49 pm

    I am aged over 55 and have mortgage load of over 100k bought UL policy by last 2 years with a perspective of potential help at old age and casual support to lessen mortgage load.

    Upon checking annual report, the deposition or Rate of return was not promising and your example of crate, which may go empty with no return at the end sounded me alarming and moreover by category I am not financially sound but rather subsistence.

    What is your advice on a economical,less risky approach with guaranteed return.

  6. LSM Insurance 02/03/2012 at 12:48 pm

    Thanks for the note. You should be able to change the investment option on your existing policy to a more secure investment option like a GIC or equivalent if you are not comfortable with the current risk level. This can generally be done at no charge.

    If you do switch plans be sure to verify the potential surrender charges.

  7. Jerry 07/22/2014 at 12:41 am

    I think one of the biggest pitfalls is 2 year waiting period on no medical plans most people don’t know thy’re there and how it works

  8. LSM Insurance 07/22/2014 at 5:47 am

    Thanks Jerry. You make a good point and many people who apply for Guaranteed Issue or Simplified Issue plans with a 2 year waiting period would be able to qualify for a traditionally fully underwritten life insurance policy with no waiting period.

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