Such policies can fluctuate with market conditions. They invest through sub-accounts, which are mirror images of mutual funds. Losses may mean higher or more premiums to pay, or no death benefit, in a worst-case scenario.
If the market performs well, of course, variable life can be a less-expensive way to buy permanent life insurance, particularly for people who need life insurance and want an investment component. But in a prolonged down market, chances are good the variable life product will under-perform a traditional life policy.
“It all depends on the underlying choices made by the investor,” says Marvin Feldman, president and CEO of the Life and Health Insurance Foundation for Education (www.life-line.org).
Approximately 20 life insurance companies sell nearly 95% of variable premium. Among the top 10 are Hartford Life, Metropolitan Life, John Hancock, Axa Life, Prudential Life and Lincoln National. They account for slightly more than half the market, according to Larry Rybka, CEO of ValMark Securities Inc., an independent broker-dealer in Akron, Ohio.
“There are a smaller number of carriers that sell the product,” he notes,” because it requires scale, meaning you have to sell a certain amount of it to be viable for a company to manufacture it.”
A little less than 25% of the total permanent insurance market consists of variable life insurance. The first generation of VUL policies in the early 1980s subjected the consumer to the risk that if investment performance did not meet projections, the premium could go up or, if uncorrected, the policy would lapse. Since then, says Rybka, the most innovative companies have created a new generation of hybrid variable policies that incorporate premium and death benefit guarantees.
The investment component of variable universal life resides in the various sub-accounts. Life insurance companies typically offer from 40 to 60 different choices, ranging in risk from equities to fixed-income types of investment, to emerging market investments and everything in between. Some companies have their own proprietary sub-accounts. Others use a combination of their own and outside accounts to give investors more choice.
“Instead of investing in a general account, it gives the policyholder control over how the additional money is invested to grow that pot of cash,” explains Cliff Barron, variable-life line leader at Hartford Life. “The concept is you’re going to put money in today and grow that pot of cash for the future.”
Assuming that market conditions are benign, the increasing value in these sub-accounts-minus the management fees and charges-represents the policy’s cash value. “The expenses are similar to those in a traditional life policy,” says Feldman. “They include mortality charges, fees, taxes and other operating expenses. The one main additional fee you’ll find in a VUL policy is the management fee charged to the individual sub-accounts, and that fee will vary based on the type of sub-account, higher for aggressively managed accounts and lower for accounts that require less management.”
According to Hartford Life, such insurance is most appropriate for those investors with a higher risk tolerance, those who are comfortable investing in equities and in search of other tax-favored means of investing besides a 401(k) or IRA. It’s suitable as well for investors who have a death benefit need for their beneficiaries, and also a good fit for more affluent investors with estate planning needs, who may wish to pass their wealth on to their beneficiaries.
One of the knocks against the earlier-generation VUL products is that they involve a combination of investments and insurance. “Combining investments and insurance is like combining oil and water,” says Aaron Skloff, CEO of Skloff Financial Group, a wealth management firm in Berkeley Heights, N.J. “They generally result in a bad combination. Too often the investment choices are limited or, even worse, exclude key aspects of a properly diversified portfolio. Many times the investments are limited to the inferior proprietary sub-accounts from the insurance company’s lineup.”
Skloff also criticizes the way such policies are sometimes sold. “Many insurance agents illustrate double-digit rates of return within the policies, an unreasonable expectation for most policyholders. It was these aggressive expectations in the mid-late 1990’s that led many VUL policyholders to believe they could discontinue their payment premiums early. An unusually strong investment performance in the late 1990’s reverted back to the mean, and in the following decade many VUL policies imploded.”
Feldman says such criticism may be partly accurate but not totally so. Most companies, he says, may have proprietary products, but they usually include a mix of other sub-accounts representing different types of families of funds.
John Resnick, an estate planner at Resnick & Associates in Harrisburg, Pa., and host of a syndicated radio show on business moguls called Legends of Success, criticizes the cost of VUL policies. He feels mortality and expense (M & E) charges, which he says are often buried within the fine print, are too high.
“One thing that is certain,” says Resnick, “is that mortality costs with the policy are guaranteed to increase as the insured gets older. One thing that is uncertain is the performance of the side investment funds. So if you combine increased mortality charges with a less-than-expected rate of return on the investment, the policy can implode and lapse without value
While there are negatives associated with this type of policy, it must be understood that this type of insurance plan must be fully funded and managed like any other type of portfolio. If it is not meant to be paid every month and forgotten about. For something like that you are better off getting a term life policy to just cover the possibility of the death of a parental figure. The purpose of this type of policy is to plan, and invest for the future so that not only is there a death benefit to be used (eventually), but the policy can be drained to cover the expenses of any large financial obligation that may come.
Putting it all together into a plan that works for you
In order to put this all into perspective the most helpful thing we can do is get a true understanding of our financial lives. The best way to do this is to fill out a personal financial statement. Going through this process forces us to look long and hard at our financial situation and answer hard questions honestly. Because lets be truthful here, if you lie on a PFS, your really only lying to yourself and creating a real disadvantage for yourself and anyone who is trying to help you get your finances in order.
Investopedia defines a personal financial statement as:A document or spreadsheet outlining an individual’s financial position at a given point in time. A personal financial statement will typically include general information about the individual, such as name and address, along with a breakdown of their total assets and liabilities. Assets would include any account balances in checking or savings accounts, retirement account balances, trading accounts and real estate. Liabilities would cover items such as credit card balances, loans and mortgages.