Universal life insurance

Universal life insurance is a type of contract, mainly widespread in North American and Asian markets, that combines death protection and a savings component, with great flexibility: the policyholder can adjust premiums and the level of guaranteed capital within limits, the accumulated savings capitalising at a rate credited by the insurer or indexed to supports. This flexibility distinguishes it from classic whole-life insurance with fixed premiums and capital. Some indexed variants make the return depend on the performance of stock indices, with floor and cap mechanisms. For the insurer, these contracts carry long-term guarantees whose valuation is sensitive to interest rates and policyholder lapse behaviour, creating a risk complex to model and hedge. A long period of low rates weakened some portfolios whose minimum credited-rate guarantees had become costly. For the analyst, these products illustrate the interaction between financial guarantees, policyholder behaviour and interest-rate risk in life insurance.

A universal life contract with a guaranteed minimum credited rate becomes costly for the insurer when market rates fall lastingly below that minimum.

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