The Rate of Return on Universal Life Insurance

Abstract

Universal life insurance is one of the newest products in the industry. It has been heavily promoted and has been acclaimed as an alternative to direct investment in the financial markets by policyholders. Because the policyholder purchases both term insurance protection and an investment stream, it is useful to compare the rate of return on this package to the alternative of buying term protection in the open market and investing in the financial markets on an individual basis. This article carries out the comparison by assessing internal rates of return on a large sample of universal life policies and comparing them to the current interest rates quoted by the companies. Under the assumptions made, the investor benefits from buying term insurance and investing premium residuals directly rather than purchasing a universal life policy. Further, this article examines the reasons underlying this result and concludes that in a vast majority of cases the annual loading and expense charges attendant to the universal life contract make it inferior to an open market insurance and investment strategy, assuming the open market strategy returns can, over time, approach the current interest rates quoted by the issuers of universal life insurance.