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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Discussion
Very interesting article. I find it interesting that there is no mention of the impact of "tax free" loans and withdrawals -- often the major emphasis from agents in pitches for these types of policies -- and the author focuses on life insurance, in fact, being life insurance. So that does beg the age old question -- would a policy holder have been better off buying term or more conventional whole life insurance and avoiding the risk associated with variable life. On a personal note, I do own one of these types of polices, albeit much, much smaller than the example given. Although I have not been terribly happy with cash values performance, I have tried to make "lemonade out of lemons" by taking loans for purposes such as IRA contributions and premiums on other insurance policies while monitoring the account to make sure it is adequate to maintain the policy (I do pay back the loans).
posted over 2 years ago by Ken from Georgia
I don't understand. Why would anyone ever buy universal life insurance?
Term insurance costs a tiny fraction of what universal costs (for identical coverage), and if I invest the difference that I've saved, I'll make WAY more money than the policy ever will.
Plus, under some policies, your benefitiaries don't even get to keep the "cash value" when you die. The insurance company just pockets it!
posted over 2 years ago by Ryan from Washington
I am still struggling to understand this product years after someone first tried to sell it to me. My view is that for most people, including myself, life insurance products should be straigtfoward and provide a high degree of certainty in both payments and proceeds. That is certainly not the case here. There are tax advantages, but after commissions to the insurance agent and management fees on a limited number of investment fund choices, I'm doubtful that those tax advantages make it worthwhile. As for the guaranteed variable universal life premium product, I would rather by a 10 to 20 year level premium term policy and a deferred annuity policy, each from different companies. At least you know what you are getting and you can obtain the coverages at the lowest price.
posted 3 months ago by J Altenburg from New Jersey
@J Altenburg- You are not limited on investment choices. My wife and I are using the cash value in our life insurance for multiple investments: rental properties, purchasing a small business, and soon we will be using it to invest in a hotel project. Each of these investments is returning over 10%, which is a leveraged return, so cash-on-cash return is almost 100 percent. I'll get back to you on the hotel once it is operating.
posted 2 months ago by John Kollhoff from Kansas
