Variable Universal Life: Astute Management Required
by Peter Katt
Variable universal life is a complex and difficult to manage life insurance asset. This column describes the issues, but purchasing such a policy requires astute guidance.
Variable universal life allows policyholders to control how their policies’ premiums are invested. Policyholders choose from a preset set of various sub-accounts, which are mutual funds. Due to the higher expenses, most variable universal life buyers select equity-based funds. Though this does provide the opportunity for higher returns, variable universal life policies invested in equities will have investment results that are volatile and unpredictable—with occasional dramatic cash value losses. This plays havoc with trying to select a premium schedule to follow.
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This is an important distinction to pay attention to. Whole life and universal life policy premiums are mostly invested by the insurance company in investment-grade bonds held for yield. Therefore, investment results for whole and universal life policies will change relatively slowly and are backed by a minimum guarantee, which means the cash values can never take a loss. (However, the cash values can go down when policy expenses exceed the crediting amount.) In contrast, the cash values associated with variable universal life policies can suffer dramatic losses.
Variable Universal Life Risks
Variable universal life has often been treated as just a better-performing version of whole or universal life, even though the inherent investment volatility of the equity exposure makes it a very different kind of life insurance. The major reason why the unique risks are not understood is due to variable universal life illustrations. Agents and buyers get their primary understanding about life insurance by viewing illustrations provided by the insurance company. Illustrations show how a policy is designed to perform based on the premiums, insurance costs and constant investment yields. This presentation creates the illusion of certainty. However, the investment volatility of the equities funding a variable universal life policy can produce large losses in a very short period of time—with no guarantee that subsequent gains will offset the losses any time soon. There is also the additional possibility that a policyholder will exit the equity funds near the bottom of the market, thereby removing any participation in a stock market recovery. These possibilities simply cannot be seen by viewing variable universal life illustrations.
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