Five of the most unpleasant words a life insurance salesman or executive can hear are: ''Buy term, invest the difference.'' Over the last decade or so, those words helped move millions of dollars out of the insurance industry's most widely used and most profitable product, the whole life policy, and into less profitable term policies.
To help counter this trend, a few insurance companies invented a product called ''universal life'' about three years ago. For most of the time since, universal life had a rather uncertain existence, running afoul of the Internal Revenue Service, which questioned some of its tax shelter aspects, and being disdained by many insurance industry critics, who said it was still not as good as ''buy term, invest the difference,'' even though it was supposed to do almost exactly that within one policy.
Today, however, with the help of last year's Tax Equity and Fiscal Responsibility Act (TEFRA) and fierce competition in the insurance business, universal life products are emerging that compare favorably with many conservative investments and provide a respectable rate of return for money not actually being used to pay premiums.
Basically, universal life is a policy combining death-benefit protection with a cash value account. The cash value is supposed to earn interest rates competitive with what a person could get in an outside investment. The cost of the insurance provided by the policy is deducted monthly from the policy's cash value.
One of universal life's most attractive features is its flexibility. It allows policyholders to increase or decrease the size of premium payments, depending on their financial needs and available cash. Premium payments can even be suspended for a short time, as long as there is enough money in the cash value fund. Protection can also be decreased by the policyholder, or increased, as long as there is proof of increased insurability. Any of these changes can be made without rewriting the policy.
This kind of flexibility is particularly helpful to young families who may find themselves hard-pressed for cash. Later, as income rises, they can boost premium payments to increase cash value, perhaps to build up a college fund.
Universal life is also cheaper. For the same whole life coverage that might cost $1,200 a year in premiums, you can get universal life for about $400. Comparable term coverage would be $200, but there is no cash value accumulation or investment feature.
A universal life policy is also helpful to people who like the idea of buying term insurance and investing the difference elsewhere but lack the confidence or experience to manage their own investments, or simply do not have the time or ambition to do so.
Until TEFRA, there were some doubts about the taxation of earnings in universal life policies. But TEFRA gave universal life the same tax break whole life gets, that is, earnings accumulate tax-free in a policyholder's account during his lifetime. With that question cleared up, the number of companies offering universal life policies nearly doubled, and today there are some 140 policies to choose from.
But not all these new policies offer a rate of return on their ''side fund'' that is truly competitive with the type of investment likely to be used by those investing on their own.
Three of the best policies in this regard, says James H. Hunt, director of the National Insurance Consumer Organization (NICO) and a former insurance commissioner in Vermont, are offered by USAA Life Insurance Company, Transamerica Assurance Corp., and Interstate Assurance Company of Des Moines. San Antonio-based USAA Life is a subsidiary of United States Automobile Association, which provides auto and homeowner coverage to current and former commissioned officers in the armed services. The life insurance company does not have this restriction.
For a male nonsmoker, age 40, NICO found the USAA Life policy would have an annual rate of return of 13.4 percent if the policy was held five years. It would have a 13 percent rate of return in 10 years; 12.8 percent for 15 years; and 12.6 percent for 20 years. These rates of return were based on USAA's current interest rate of 12 percent.
One reason these returns are so good, the study points out, is the expenses are quite low - 3 percent of each premium, plus a first-year-only charge of $50. And, except for a $25 fee, there is no other charge or penalty for partial withdrawals or even cancellation of the policy.
The NICO study also notes rates of return are not real interest rates: They are hypothetical estimates of investment returns in the cash value portion of the policies. These estimates depend on the existence of that 12 percent interest rate. But even if the interest offered was reduced, the rate of return would not be cut nearly as much.
Rates of return may not be the only criteria you want to use in buying a universal life policy, however. It's often said life insurance is ''sold, not bought.'' But it should be bought, that is, purchased, because the consumer has made up his own mind about a product. And to make an effective purchase of universal life will require some research into several products. Some companies may have better service; one particular policy's combination of premiums, return , and restrictions may work better for you; or, you may still be better off buying term and investing the ''side fund'' on your own.
(Much of this research has been done by NICO, a nonprofit consumer group specializing in insurance. Its booklet, ''How to Save Money on Life Insurance,'' is available for $6.25 by writing to National Insurance Consumer Organization, 344 Commerce Street, Alexandria, Va. 22314.)
So, with the introduction of more competitive policies and the clearing up of the tax issue by TEFRA, many of the more troublesome obstacles to universal life seem to have been overcome. This leaves the consumer with a choice of products that finally are doing what they were meant to do: provide flexibility, a tax shelter, and a reasonable return on the investment portion.
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