What Are Units in Life Insurance and How Do They Work?
Demystify life insurance units. Learn how these investment-linked components influence your policy's value and benefits.
Life insurance serves as a financial safety net, providing a death benefit to beneficiaries upon the insured’s passing. While many policies offer straightforward coverage, certain types of life insurance incorporate a unique element known as “units.” Understanding these units is important for grasping how specific policies operate and how their value can change over time.
What Units Represent in Life Insurance
In certain life insurance policies, units represent shares of an underlying investment portfolio. Similar to owning shares in a mutual fund, each unit signifies fractional ownership of the diverse assets held within the policy’s investment component. Unit worth fluctuates based on the performance of the underlying investments.
The primary purpose of units is to link a policy’s cash value growth to market performance. They allow policyholders to participate in potential investment gains, distinguishing these policies from those with guaranteed, fixed returns. The number of units purchased or allocated to a policy directly influences the extent of this market exposure.
How Unit Value is Determined
The value of each unit is driven by the performance of underlying investment options, often called sub-accounts. These sub-accounts function much like mutual funds, offering various investment objectives such as growth, income, or a balanced approach. Policyholders choose how premiums are allocated among these sub-accounts.
Various fees and charges are deducted from sub-accounts, influencing the net asset value per unit. These deductions commonly include mortality and expense charges, administrative fees, and underlying fund expenses. Consequently, the unit value can fluctuate daily, reflecting the market performance of chosen investments and ongoing policy deductions.
Impact of Units on Policy Benefits
The fluctuating value of units directly influences both the policy’s cash value and, in some cases, the death benefit. As units increase in value due to positive investment performance, the policy’s cash value accumulates. This cash value can be accessed by the policyholder through withdrawals or loans, providing liquidity.
Changes in unit value can lead to increases or decreases in the policy’s overall value and potential death benefit. If underlying investments perform poorly, unit value can decline, potentially reducing cash value and, in some instances, impacting the death benefit. Policyholders may need to pay additional premiums to maintain coverage if cash value falls below a certain threshold due to poor investment performance.
Life Insurance Policies That Utilize Units
The concept of units is most relevant in permanent life insurance policies with an investment component. Specifically, Variable Life Insurance and Variable Universal Life Insurance policies incorporate units. These policies allow policyholders to allocate premiums into various sub-accounts, which are represented by units.
Variable Life Insurance policies feature fixed premiums, while Variable Universal Life Insurance policies offer more flexibility, allowing premium adjustments within limits. Both policy types aim to provide cash value growth by exposing it to market fluctuations through unit-based investments.