Why do Universal Life Insurance Policies lapse even though I’m paying my premium?

Universal Life Insurance policies are flexible premium products that allow the policy holder to choose within a window of highest and lowest premium for a certain death benefit. The most common occurrence with these types of policies is the client funds the policy at the minimum amount. This happens for one of two reasons most commonly; first reason for this is because the policy holder chooses to pay the least amount of premium now with plans of increasing it "when money or income increases" and the second reason for this is due to the insurance agent telling the policy holder that they only need to fund the policy at that amount and "everything will be ok."

To understand this completely, it is necessary to understand the inner-workings of the policy. In a Universal Life policy, the cost of insurance increases as you get older - but you don't see it on your statement. Let's take an example of $10,000 per year premium. The first year the cost of insurance may only be $2,000 and the remaining $8,000 goes into a "side account" which usually follows an index such as the S&P 500. In the second year, the policy owner contributes the same premium of $10,000 and the cost of insurance rises to $2,500. Now the remaining amount that goes into the side account is only $7,500. This trend continues, but at a slightly faster rate. When we fast forward to 15 years later, the policy owner contributes the same $10,000 to the policy and the cost of insurance is now $10,000 which means that all of the premium went to cover the cost of insurance and none of it went into the side account. Finally, in the following year the cost of insurance will be higher than the premium and the additional cost of insurance will be deducted from the side account.

The theory behind this policy is that the side account will grow sufficiently to be able to continue to supplement the premiums paid in the later years of the policy. These policies, of the permanent type of life insurance, are the most commonly lapsed policy because as the cost of insurance continues to increase, the policy owner may not be aware of how much the cost of insurance has truly grown nor do they understand how much is coming out of their side account until it may be too late.

If you have one of these policies, it is crucially important to review them regularly to make sure that you are funding them properly. There are a great deal of these policies out there as they have been popular products for life insurance agents to sell due to the appealing premium to death benefit ratio.