Universal life insurance explained: how it works and who is it for

Life insurance is often introduced through a few familiar terms.

• Term life
• Whole life
• Universal life

While they may sound similar, they work quite differently and are designed for different financial needs. Some policies may focus purely on protection. Others combine protection with long-term accumulation.

As for universal life insurance, it sits somewhere between these approaches. It provides lifelong protection but also allows the policy to accumulate value over time.

Within the universal life category, there are also several variations, including indexed universal life (IUL) and variable universal life (VUL).

This article helps you understand how universal life works and how it compares with other forms of life insurance

What is universal life insurance?

Universal life insurance is a type of permanent life insurance.

Unlike term life insurance, which covers a fixed period such as 20 or 30 years, permanent life insurance is designed to provide protection for life as long as the policy remains active.

Universal life policies typically include two key components.

Protection coverage

The policy provides a death benefit, which is paid to beneficiaries if the insured person passes away.

This payout can help support family members financially by covering expenses such as living costs, debts or long-term financial responsibilities.

Cash value

Part of the premium contributes to a cash value account that may accumulate over time.

This cash value can grow depending on how the policy is structured and how the underlying crediting method works.

In some policies, the cash value may grow based on interest rates declared by the insurer. In others, the growth may be linked to financial markets.

What makes universal life insurance different?

The defining feature of universal life insurance is flexibility.

Many universal life policies allow policyholders to adjust elements of the policy over time.

This may include:

• premium payments
• death benefit levels
• how the policy’s value grows

This flexibility can allow the policy to evolve alongside changing financial needs. 

For example, someone who starts a policy in their thirties may adjust the structure later in life when their financial responsibilities change.

Understanding the different types of universal life insurance

Universal life insurance is not a single product. Instead, it refers to a category of policies that share a similar structure but differ in how the cash value grows.

Two common variations are:

• indexed universal life (IUL)
• variable universal life (VUL)

Both policies combine insurance protection with the possibility of long-term accumulation, but they approach market exposure differently.

Indexed universal life insurance (IUL)

Indexed universal life links the growth of the policy’s cash value to the performance of a market index, such as the S&P 500.

However, the policy does not invest directly in the stock market.

Instead, insurers credit interest based on the index's performance using formulas that include mechanisms designed to manage risk.

These mechanisms often include:

Floor

A floor sets a minimum credited interest rate.

If the market declines in a particular year, the credited rate may not fall below this floor. In many policies, this floor may be around 0%.

Cap

A cap sets the maximum credited interest rate.

If the market performs strongly, the credited interest may be limited by this cap.

These features are designed to balance two objectives:

• participating in market growth
• limiting downside exposure during market declines

Variable universal life insurance (VUL)

Variable universal life takes a different approach.

Instead of linking growth to a market index, VUL policies allow policyholders to allocate the policy’s cash value into investment sub-accounts.

These sub-accounts function similarly to investment funds and may invest in assets such as:

• Equities
• Bonds
• Balanced portfolios

Because the policy’s cash value is invested directly in markets, its value may rise or fall depending on investment performance.

This means VUL policies generally offer greater potential upside, but also greater exposure to market volatility.

Policyholders may also be able to adjust how their policy is invested over time.

A simple way to understand IUL and VUL

The key difference between indexed universal life and variable universal life is how they interact with financial markets.

Indexed universal life provides indirect exposure to market performance, with built-in mechanisms designed to limit downside risk.

Variable universal life provides direct exposure to financial markets through investment funds.

In simple terms:

• IUL aims to balance growth potential with downside protection.
• VUL allows full market participation but also carries greater volatility.

Example 1: When markets perform strongly

Consider a simplified example.

An indexed universal life policy links its crediting rate to a market index with:

• a 0% floor
• a 10% cap

If the market index increases by 15% in a year, the policy may credit interest up to the cap.

In this case, the credited interest would be 10%.

The policyholder participates in part of the market’s growth, but the cap limits the maximum return.

By contrast, a variable universal life policy invested in equity funds may experience growth closer to the full market performance.

In strong market conditions, VUL policies may therefore produce higher returns.

Example 2: When markets decline

Now imagine a year in which the market declines by 8%.

Because the indexed universal life policy includes a 0% floor, the credited interest rate may not fall below zero.

In this situation, the credited interest may be 0% instead of −8%.

A variable universal life policy invested in equities may experience a decline similar to the market.

This illustrates the trade-off between the two approaches.

• Indexed universal life limits downside risk but caps potential upside.
• Variable universal life allows both higher potential gains and greater potential losses.

How universal life compares with other types of life insurance

To understand universal life more clearly, it helps to see how it fits within the broader life insurance landscape.

Term life insurance

Term life insurance provides coverage for a fixed period, such as 20 or 30 years.

If the insured person passes away during the policy term, the death benefit is paid to beneficiaries.

If the policy expires while the insured person is still alive, coverage typically ends without a payout.

Because term policies focus purely on protection and do not accumulate cash value, they usually offer the highest coverage for the lowest premiums.

Whole life insurance

Whole life insurance is another form of permanent life insurance.

Like universal life, it provides lifelong protection and includes a cash value component.

However, whole life policies typically emphasise stability and guarantees.

The policy’s value usually grows through guaranteed components and bonuses declared by the insurer.

Compared with universal life policies, whole life generally offers less flexibility but more predictability.

Universal life insurance

Universal life sits between these approaches.

It provides lifelong protection like whole life insurance but allows more flexibility in how the policy is structured.

Different versions of universal life policies allow the policy’s value to grow in different ways. Some emphasise stability. Others introduce market-linked growth mechanisms.

Who may consider universal life insurance?

Universal life policies may appeal to individuals who:

• want lifelong insurance protection
• are interested in accumulating value over time
• prefer flexibility in premiums or policy structure
• are comfortable with policies that involve market-linked elements

For some individuals, universal life insurance may form part of a broader financial strategy that includes protection, savings and other investments.

Who universal life insurance may not be suitable for

Universal life policies may not be appropriate for everyone.

For example:

• Individuals who want very simple and affordable protection may prefer term life insurance.
• Those who prefer more predictable guaranteed growth components may prefer traditional whole life policies.
• Individuals who want pure investment exposure without insurance coverage may prefer financial products designed specifically for investing.

Understanding personal financial goals is therefore important when considering any insurance policy. Speak to a financial representative if you want to find out more.

Frequently asked questions

What is universal life insurance in simple terms?

Universal life insurance is a type of permanent life insurance that provides lifelong coverage and includes a cash value component that may accumulate over time.

What is the difference between universal life and whole life insurance?

Whole life insurance generally focuses on stability and guaranteed growth components.

Universal life insurance offers more flexibility and may allow the policy’s value to grow based on interest rates or market-linked mechanisms.

What is the difference between indexed universal life and variable universal life?

Indexed universal life links cash value growth to the performance of a market index using mechanisms such as caps and floors.

Variable universal life invests the policy’s cash value directly into investment funds that rise or fall with financial markets.

Is universal life insurance an investment?

Universal life insurance is primarily an insurance product designed to provide financial protection.

However, many policies include a cash value component that may accumulate over time.

Can you lose money with universal life insurance?

Depending on the policy type, the cash value may fluctuate.

For example, policies with market-linked features may experience periods of lower growth or market-related volatility.

Can you withdraw money from universal life insurance?

Some policies allow policyholders to access the accumulated cash value through withdrawals or policy loans.

However, doing so may affect the policy’s long-term value or reduce the death benefit.

Can someone have more than one life insurance policy?

Yes. Many individuals hold multiple policies.

For example, someone may have:

• a term life policy for temporary protection
• a permanent policy for lifelong coverage
• group insurance through their employer

Each policy may serve a different financial purpose.

Written by: Great Eastern Lifepedia team