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The cost of insurance is based on several factors, including health, life-style and age.  As the age of the insured rises, the cost of insurance (sometimes called the mortality charge) also rises until eventually the cost may become prohibitive.

Universal life is bulit on an annually renewable term product.  Each year the policy will be automatically renewed for another year without evidence of insurability (no medical check-up required). However, the amount charged for the annually renewable term product will increase based on the individual's attained age.  The result is a step-rate premium. As an individual grows older the step-up becomes greater and greater until eventually the cost may become prohibitive.

Out of each premium deductions may be taken for such items as taxes and expenses.  The latter are the insurance company's normal operating costs. When taken from the premium it's called a front-end load. This reduces the amount of money entering the policy for the cash value.  The remainder of the premium is then added to the policy cash value which is deposited in the insurance company's general account.

Each month charges are deducted from the cash value to pay for the costs of administration and insurance (the annually renewable term product).  These last deductions will increase each year as the policyholder grows older, consuming an ever larger portion of the cash value.

Each month, after charges are deducted from the cash value to pay for costs of administration and insurance, tax deferred interest is credited.   An insurance company show two different interest rates on an illustration: the guaranteed minimum, and the "current rate" which is based on the insurance company's investment returns, is subject to change and not guaranteed.  Cash value growth may occur as long as the amount of premiums paid (less taxes and front-end loads) plus the interest credited exceed the costs of administration and insurance. But if the premiums are not sufficient to both cover the monthly charges and allow the cash value to grow, policy lapse may become a significant concern.

The chart is divided into two sections, guaranteed and non-guaranteed.  Only the guaranteed values should be used in considerations, as these are the amounts the insurance company is contractually bound to.  Typically, the non-guaranteed values reflect current interest rates and demonstrate what the result would be if the returns were to remain constant, a highly unlikely proposition.  Still, the chart can be useful in illustrating the concept of how the policy will perform with a higher interest rate  For example: a quick review indicates that in the 20th year non-guaranteed cash values will begin to exceed premiums paid.

An insurance company reserves the right to increase the cost of insurance up to the maximum allowed in the policy. This has the effect of reducing an insurance company's liability as the pool of policyholder cash values are drained to support the price increase. For those with cash value, the option is either to terminate the insurance or increase premium payments to offset the cash value drain. For those without cash value the option is either to terminate the insurance or increase premium payments to keep the policy from lapse.  A no lapse guarantee may prevent forfeiture of the death benefit, but will do nothing to preserve cash values which will be depleted at an ever increasing pace with the combined effects of the rising cost of insurance and attained age. For the insurance company, increased premium payments is an increase in income.

For an insurance company, the amount at risk (sometimes called the insurance element) is the death benefit less the cash value. In addition to health, life-style and age factors the cost of insurance is based upon the amount at risk. Cash value in a universal life policy is absolutely vital. If the cash value has not grown quickly there may be more insurance element at risk than was projected and as a result the cost of insurance will be higher.  If the premium (less taxes and front-end loads) plus the interest credited is not enough to cover the monthly charges the cash value will be utilized to keep the policy in force. Left unchecked, the cash value may become smaller while the insurance element larger, then the cost of insurance will be higher and even more of the cash value utilized to keep the policy in force.

A no-lapse guarantee prevents policy lapse in event the cash value is insufficient to cover the costs of administration and insurance.   Even though the policy may have no cash value, as long as a designated premium is paid the policy will remain in force for the length of time the guarantee is valid, as specified in the particular policy. Thus, even though there's no cash value, the death benefit may be retained.

Early "super-funding" may position the policyholder to maximize the potential of the investment portion. Super-funding is paying the maximum permitted by law without the policy being considered a Modified Endowment Contract: (MEC loans and withdrawals are taxed less attractive than cash value life insurance policies).  By super-funding the cash value the policyholder can take maximum advantage of the tax benefits of available: tax deferred growth, income tax free withdrawals up to premium amount paid, and increased death benefits under Option 2.  The super-funded cash value can help offset increasing premium requirements of rising cost of insurance charges in later years.  It can also be used as as the policyholder sees fit: educational funding, supplemental retirement income or as other needs and wants arise.

In order to be considered for preferential tax treatment as insurance, one of two tests must be passed, the Cash Value Accumulation Test or the Guideline Premium / Corridor Test.  Thje choice of which test to use must be made at policy inception and can't be changed later.

Options are available if the policy fails the Cash Value Accumulation or Guideline Premium / Corridor Test ...

There are many different premiums.  Each premium has a different impact on the performance of the policy.

Building cash value may be thought of as similar to building equity in a home.  Out of each payment deductions may be taken for such items as principle and interest.  As the loan is paid down the equity is built up.  For universal life insurance, out of each payment deductions are taken expenses.  Then, a portion of the premium is credited to the cash value.  Just like equity in a home can be accessed, so too can the equity in universal life insurance be accessed.  The cash value may be available through loans, partial withdrawals or policy surrender.  Also, financial institutions usually will accept the cash value of life insurance as collateral.

Loans may be payable either in advance or in arrears.  When payable in advance, a check for the amount of the loan is drawn, less the first year's interest charge (hence payable in advance). Thereafter interest is charged at the beginning of each year that the loan remains outstanding.   When interest is payable in arrears, a check for the full amount of the loan is drawn and interest is charged at the end of the year (hence payable in arrears). Thereafter interest is charged at the end of each year that the loan remains outstanding.  Interest accrues daily. Any unpaid when due is added to the outstanding balance of the loan to accrue and compound. Left unchecked, this may result in the loan exceeding the cash value. In such a case funds will be required to avoid policy termination and potential tax consequences.

Loans may be taken up to the surrender value, (cash value minus any surrender charges), less a deduction for the costs of administration and insurance as detailed in the policy.  Usually, there are no expenses and no front-end loads (service charges)  for re-payments.  The loan interest rate and structure is identified in the policy.  Typically, an insurance company will offer a better rate than can be obtained through commercial lending sources.  The insurance industry is unique in the common use of interest crediting.  When a policyholder takes a loan the insurance company charges interest, but at the same time interest is credited to the full cash value, including the amount borrowed.  The difference between the interest rate charged and the interest rate credited is called the spread: it is the net interest cost to the policyholder.  Often the spread is 1% or less.

Some universal life policies may have provision for a zero interest loan, commonly known as a "wash loan".  The interest rate charged is matched with an equal interest rate credited on the full cash value, again, including the amount the policyholder has borrowed.  When structured correctly, a zero percent loan allows for the cash value of the policy to be used as a source of supplemental retirement income.  The money is drawn out as loans over a period of time.  Loans do not have to be repaid but instead can be paid out of the death benefit. Be aware though, outstanding loans may reduce the death benefit, and further, if not structured, correctly serious tax consequences may occur.  Consult an accountant well versed in the use of wash loans before engaging this strategy.

Partial withdrawals (sometimes called partial surrenders) may be taken up to the surrender value, with minimum distributions depending on the specific insurance company and policy. Under Death Benefit Option 1, the face amount of the policy will be reduced by the withdrawal amount.  The face amount of the policy remains the same under Option 2, but the the total death benefit amount reduced by the amount withdrawn.  No repayment of the withdrawal is required. However, if the policyholder chooses to place the amount withdrawn back into the policy, front-end loads may be charged.

Policy surrenders may be taken up to the surrender value, less any back-end loads, depending on the specific insurance company and policy.  Typically, surrender charges decline as the policy is held longer.  Policy surrenders may be considered similar to selling a house.  When the owner sells a house s/he receives the equity value after all other charges are paid.In a standard universal life product, when a the owner surrenders a policy s/he receives the surrender value after all other charges are paid.

Some insurance companies offer three, but typically two death benefit options are offered.

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