One of the (many) characteristics that separate life insurance from all other types of insurance is the premium. All other types of insurance have a periodic premium that must be paid to keep the policy in force. And while all life insurance policies have an initial premium that must be paid, not all of them have ongoing premiums.
From a premium perspective, term insurance is most like all the other types in that its periodic premium must be paid for the policy to remain in force. If the premium isn’t paid, the policy lapses.
Like term insurance, whole life has a fixed premium that must be paid, at least in the early years, for the policy to remain in force. The difference is that at some point, the whole life policy will have sufficient equity to keep the policy in force even if future premiums are not paid.
Even though, through the use of dividends and/or cash values, out of pocket premiums need not be paid to keep the policy in force, a premium is still due unless the policy is “paid up.” “Paid up” is a contractual term meaning that not only are premiums not due, but the policy is structured so that it cannot even accept them.
Universal life policies, be they current assumption, variable or indexed, have flexible premiums. There is a minimum initial premium that must be paid up front to put the policy in force, but subsequent premiums will be determined by policy performance and/or objectives.
The very fact that premiums are flexible is what attracts many people to universal life policies. However, that flexibility is a double-edged sword. Paying too little or skipping premiums in the early years can create problems in the future if the markets don’t cooperate.
A prime example is current assumption universal life policies issued in the mid to late 1980s. Many, if not most, of those policies were issued with initial double digit interest crediting rates. At that level, the premium required was significantly less than the whole life premium for a comparable policy.
When interest rates began their steep decline, many of those policyholders received a capital call, i.e., a notice from the insurance company stating that a higher premium needed to be paid to prevent the policy from lapsing.
Today, regulations require illustrations depict how the policy will perform at guaranteed rates and additionally required the applicant and/or owner to sign said illustration. That won’t make the policy perform any better, and, unless explicitly explained to the applicant, won’t be of much help either (but it will indemnify the insurance company against future lawsuits).
The bottom line is that it is in your best interest to fully understand the premium and potential changes to it before procuring a policy. Failure to do so could potentially create problems for everyone involved, including the beneficiaries.