Variable Universal Life has become an important product for financial and estate planners, in addition to the family and business use of life insurance products. At the very least, it is worth of a full Chapter in this text.
Combining some of the unique features of both Universal and Variable Life, Variable Universal Life insurance permits:
These policies are subject to the same securities regulation as Variable Life policies. Fees, policy loans and surrenders are also subject to the equivalent provisions in Variable and Universal Life policies.
This product has been quite successful as by 1995, VUL had captured 15% of all new U.S. premiums, a rather substantial increase since the 1980’s. From 1995 to 2000, sales results went from 15% to 44%. However, with the stock market taking a dive, in the second quarter of 2001, VUL premiums declined for the first time in 23 quarters and have been flat ever since. For the first quarter of 2002, the policy count was off 24% from the first quarter of 2001.
However, even with the news that variable sales are down, according to LIMRA VUL is the number one life insurance product sold on annualized premiums, with a 31% market share (down only 3% from 2000), compared to Whole Life which is 26% and up 2%, Universal Life at 21% and up 4%, term life at 20% and down 2%, and Variable Life at 2%, down 1 %.
The pricing of Variable Universal Life can be very complex as it actually consists of many parts, and these parts are different than in a puzzle because they can fit together in several ways. The professional must be aware of all of the various parts and have the expertise to put them together in a comprehensive, but understandable, presentation. Competitive pricing is very important when choosing a VUL product, and the largest expense is the cost of insurance (COI) which is taken from the contract fund each month, as discussed earlier.
A random check of VULs presently offered by the principal writers of these products, reflect that with the preferred mortality charges of many companies, at age 65 for instance, these charges ranged from $6 to $8 annually per thousand, but there were some as high as $25.
Front-load charges vary from company to company but premium taxes (3 ½% to 4%) are pretty standard. Other charges, such as supplemental benefits, administration and premium waiver charges do not seem to vary very much. There is much more competition for term riders among the companies.
The mortality and expense (M&E) charge can be tied to the client’s cash value but generally is an indirect expense and is taken from the gross rate of return. While some policies charge as much as 90 basis points for M&E, others use a reducing scale that can eventually be as low as 20 bps.
CONSUMER APPLICATION
Barry has a VUL with $200,000 in a sub-account. This particular account earned 9% gross for the year. The policy charged 90 bps for M&E, which effectively then reduced the return to 8.1%, or an expense charge of $1,800.
Barry discovers that with another company, the M&E charge reduces to 20 bps. This would result in a charge of only $400. It was also pointed out to Barry that these charges “come off the top” and means that there is less cash value to be invested each year, resulting is a substantial loss in later years.
In spite of the downward spiral of VUL sales in early 2002, financial analysts predict that VUL will climb back up and sales will move up. Many feel that this is a good time to recommend VUL products to those who recognize that it is a flexible long-term investment which has substantial tax advantages, plus it also has a death benefit. This reasoning is based upon several factors, including:
To start with, the asset values that were assumed just a few years ago, for planning purposes, are probably lower today with the result that investment portfolios cannot compete with life insurance, in any of its forms, as the value of the portfolio is an unknown. Variable Life, and in particular, Variable Universal Life, not only provide the investment performance, but also provides diversification, tremendous flexibility, and a guaranteed death benefit that will be there, regardless of what the market does.
It is readily acknowledged that fixed investments can offset market volatility, but fixed investments generally do not produce satisfactory results in time of inflation. The history of equities over a long period of time proves that the likelihood of losses diminishes while the likelihood of gain increase. VUL can perform better than other investments because even during times of poor market performance, a good advisor can help the policyowner get past the fear of short-term losses and put them in a better position when the market increases.
The guaranteed death benefits is not affected by poor market conditions, and even if death occurs when the market is weak, the life insurance proceeds provide the beneficiaries with the means to ride out the market cycle and allow them to hold onto their other investment holdings.
Even the method of premium payment lends to good investment strategy, as by paying a steady inflow of premiums, this creates a “dollar-cost averaging” situation which in itself is a very effective investment strategy. This averaging strategy uses a set amount of money that is invested at regular intervals regardless if the market is up or down. If the market is down, the premiums buys more shares and thereby can lower the average cost per share over a long period. Down markets actually represent buying opportunities, and with the steady inflow of premiums, the investor-policyowner doesn’t even need to worry about market timing.
The wide variety of investment vehicles available to a VUL policyowner can reduce the volatility of the market. By offering investment objectives, plus fixed amount and money market choices, it can mimic fixed or index-based plans, or even offer a truly diversified investment product.
Further, while clients exchange mutual funds, go from one to another, there almost always is a sales charge and taxes incurred. With a VUL, such internal exchanges are free from sales charges and taxes. The flexibility of the VUL is unsurpassed.
It is frequently pointed out by those professionals who concentrate on VUL plans, that one merely has to imagine recommending to a client that they must liquidate stocks and mutual funds and incur large losses in the process, to satisfy their beneficiaries needs for cash at death.
Variable Universal Life insurance policies are referred to by a number of alternate terms, including Universal Variable, Flexible‑premium Variable and (just plain) Universal Life.
According to a survey performed by LIMRA, over the past year the percentage increase in the average VUL premium rose 21%, to $6,252 per policy. During this same period of time, term life premiums have decreased while Whole Life premiums remained constant. (In case of a memory lapse, please be reminded that in a variable product, such as VUL and Variable Life products, an increase in average premium shows that more persons are using these products for investments – a good thing.)
CONSUMER APPLICATION
Darrell and Janet are in their mid-30’s and have two children, ages 3 and 5. They own their home, have lower than typical consumer debt. Darrell makes $45,000 per year and Janet makes $35,000. According to a needs analysis, it is agreed by the prospects and the agent that they really need an additional $250,000.
They have certain priorities, including college funding for their children, and their personal retirement secondary. They have the typical problem that so many couples with children seem to have, with saving and investing. They both have 401(k) plans where they work and they both contribute 3% of their income to the plans, which is the maximum.
A Variable Universal Life policy can provide the build-up of cash values for college funds, and then later provide supplemental retirement income. Suggestions to this couple in using their VUL for their own particular purposes, would include:
CONSUMER APPLICATION
John and Mary are in their mid-40’s, two children age 14 and 17, own their home and both have good jobs. John needs around $500,000 in life insurance and Mary needs about $525,000 of life insurance. They both want to retire in 20 years and they want their children to go to college. They have 401(k) plans, but they would be insufficient to allow them to meet their needs. Their principal needs are to obtain more life insurance and achieve their retirement goals.
CONSUMER APPLICATION
Waldo is age 49, with a good job. His wife, Dru, is a homemaker. Waldo makes $80,000 per year. They have 2 children, 18 and 20. A needs analysis indicates that even though Dru could have a little more insurance on her life, the principal concern is for Dru as Waldo is underinsured by $225,000, and that amount would help their children with their remaining college expenses and would liquidate their debts. Waldo has some group and personal Term Insurance.
It could be recommended that they purchase a $100,000 VUL policy which they over-fund to potentially reduce the premium payment period. He could also take out a Term policy for $125,000.
NOTE: Variable Life for Non-qualified benefit plans is discussed in Chapter Eight, entitled “Retirement Plans.”
Six of the life insurance companies producing a majority of the Variable Life and Variable Universal Life plans. As discussed, the provisions of the various plans vary greatly. One of the VUL policies is quite new and is shown as its provisions are different than most.
. Co. A Co. B Co. C .
#Riders available 6 5 6
Minimum issue $ 25,000 75,000-250,000 (by age) 50,000
Target/Gross Prem.$:
Age 25 6.39 5.77 6.78
Age 35 9.00 7.80 9.22
Age 45 16.00 11.60 17.40
Age 55 24.25 19.10 30.92
Minimum prem. none lower than target Appl. for 1 yr
Curr. rate fixed acct.(%) 5.5 6.4 6.25
Guar. Int. Rate Fix.act.(%) 3 4 4
(Highest/lowest (%):)
Subaccount ann.rate 7.83/ -33.99 2.8/ -23.93 -10.95/-28.85
Invest. Advisory fee 1.00/.39 .90/.40 .88/.37
Fund Operating Exp. .095/.01 1.1/.03 .32/.01
Premium loading % of prem. varies 3.6 to 7.6 2.9 6.35
No. of funds offered 31 28 33
M&E – Yrs 1-10 (%) .65 .25 .45
11-20 .15 0 0
20+ 0 0 0
Pol.Loan Int.rate (%) 8 5 3.25
Total Surr. Chg.-1st yr varies per cent of target premium level 120 mo.
Renewal 0 after 10 yrs varies 0 after 120 mo
Partial Surr. Chg. 10% 1st yr varies none allowed yr1-$25 later
COI Yr 1/Yr 10
Age 25 .26/.50 .56/.63 .65/.70
Age 35 .24/.86 .68/.78 .60/1.20
Age 45 .54/2.29 1.01/1.83 .79/2.20
Age 55.90/5.62 2.01/4.23 2.78/5.85
Age 65 2.56/13.03 7.60/10.78 6.18/13.36
Restrictions on
Transfers 18 free per yr. 12 free per yr, 20 fund max.,
$25 thereafter 2 –fixed accts
. Co. D Co. E Co. F .
#Riders available 7 6 7
Minimum issue $ 50,000 100,000 50,000-250,000
Target/Gross Prem. $:
Age 25 6.74 .29 6.15
Age 35 9.91 .40 8.97
Age 45 15.34 .63 13.80
Age 55 25.01 1.05 22.60
Minimum prem. lower than target (see aboveG) lower than target
Curr. rate fixed acct.(%) 6.05 5.8 6
Guar. Int. Rate Fix.act.(%) 3 4 3
(Highest/lowest:%)
Subaccount ann.rate 1.63/ -24.96 7.8/ -29.7 new
Invest. Advisory fee .65/.10 .84/.33 new
Fund Operating Exp. .20/0 .02/.01 new
Premium loading (%) of prem.2,75 –1.25 6.6 yr 1-10, 3.6 after new
No. of funds offered 27 44 43
M&E – Yrs 1-10 (%) .50 .90 60bps
11-20 .50 .90 25bps
20+ .50 .20 15bps
Pol.Loan Int.rate 6% - variable 5% fixed 3-3.5%
Total Surr. Chg.-1st yr 50% of total prem. declining-15 year 45% level
Renewal graded to 0 in 15 yrs. varies 45% to 0 in 10 yrs
Partial Surr. Chg. $25 of 2% declining 10yr proportional 10yr
COI Yr 1/Yr 10 (preferred)
Age 25 .077/1.05 not available .1013/.0370
Age 35 .083/.182 not available .1127/.0559
Age 45 .154/.382 not available .2213/.1564
Age 55 .323/.979 not available .5213/.4228
Age 65 .862/2.83 not available 1.4087/.9808
Restrictions on
Transfers Min. $500 or balance, 24 free per year Unlimited -
free 12 trnfs per yr from sub-accounts $25 after 12
trnfs per year.
As anyone in the life insurance and annuity business knows by now, the estate tax laws have been changed so that the estate tax (aka “Death Tax”) will be phased out by 2010. There has been some concern among estate and financial planners as to whether this tax will be reenacted in 2011, as some believe is possible. Many insurers who offer Variable Universal Life have recently introduced estate tax repeal riders that provide clients with additional flexibility should the estate tax be repealed. These riders usually allow policyholders to surrender their policies without charge if there is no federal estate taxes in 2011.
When Interest rates rose sharply in the United States a few years ago, one of the earliest new products insurers responded with was interest‑sensitive Whole Life insurance. Other names for this type of policy are excess interest and current assumption Whole Life. This type of insurance is "sensitive” to current interest rates in the marketplace as reflected in various elements of the policies.
Interest‑sensitive policies typically have a minimum guaranteed cash value based upon a minimum guaranteed interest rate, but all policies of this type have some factors that are not guaranteed. The specific features differ among insurers.
Some interest‑ sensitive Whole Life policies have adjustable or indeterminate premiums, which means the premium changes as interest rates change. At the onset of the policy, a premium amount is set by the insurer based upon the interest rate it expects to earn, which is called the current rate. The current rate is guaranteed only for a short period any longer than a year.
Usually once a year, the insurer reviews the rate in light of the insurance company's financial experience and current market interest rates. The Insurer then adjusts the policy premium, so the policyowner pays either:
Policies with indeterminate premiums must stipulate a maximum premium amount that will apply no matter how poor the insurer's earnings are. This guarantee protects the policyowner against ever having to pay more than the specified maximum premium.
Rather than requiring increased premium payments, some policies allow a reduction in the death benefit if the policyowner prefers. In times of poor performance, however, the death benefit could be greatly reduced, threatening the life insurance protection. On the other hand, insurers do not typically allow policyowners to raise the death benefit in lieu of paying a lower premium because this action would put the insurer in the position of providing greater coverage without evidence that the insured's health has remained stable.
An interest‑sensitive Whole Life policy may have a fixed premium instead of an indeterminate premium, with the "interest‑ sensitivity" applying to transactions in the policy's cash values. In this is the case, varying rates of interest will be credited to the cash value as interest rates fluctuate, rather than changing the premium amount.
Interest‑sensitive Whole Life policy provisions concerning loans, surrenders and withdrawals are similar to the provisions for other policies discussed. More specific information about typical life insurance policy provisions appears later in this text.
With the introduction of “interest-sensitive” and Universal Life policies which allow the Cash Values to grow at a rate based upon the level of interest paid on investments or cost-of-living indices, the exchange of older fixed-interest Whole Life policies for the “newer” generation of policies, has become very popular. It is important that such exchange falls under the IRS Code Section 1035, which allows for a tax-free exchange. The IRS establishes certain criteria for a policy exchange to fall within Section 1035 and if the exchange does not meet these requirements, the gain is treated as ordinary income and is taxed. These requirements are:
If there were a loan against the policy, this would be a routine exchange and there are no complications if the new policy has an equivalent loan against it. However, it usually is the case that the new policy does not have a loan against it, in which case, the IRS may determine that that it is a taxable gain and subject to income taxes.
CONSUMER APPLICATION
Arthur has an older Whole Life insurance policy with a face amount of $100,000. He had borrowed against it for college costs and presently the policy has a policy loan outstanding of $25,000.
If Arthur should die without paying off the policy loan, the beneficiary would receive $75,000.
Arthur’s insurance agent suggested that he exchange the policy for a Universal Life Insurance policy. For the same amount of premiums that he is presently paying, Arthur can have a $100,000 face amount policy without a policy loan.
He exchanges the policy for a Universal Life Insurance policy. For the same amount of premiums that he is presently paying, Arthur can have a $100,000 face amount policy without a policy loan. Obviously, Arthur has gained on this exchange. This is called a “boot” in Internal Revenue parlance.
The IRS Code states that if other property were received as part of an otherwise tax-free exchange, any gain contained in the exchanged property must be recognized up to the fair market value of the “boot.” The loan that disappeared in this transaction is the “boot.”
According to the IRS Code, the receipt of boot will first result in a reduction of the policyholder’s basis in the new policy, and the gain will be taxable only if the “fair market value” exceeds the basis in the exchanged policy.
Arthur’s basis is the total amount of premiums that he has paid into his old policy; in this case he had paid a total of $20,000 in premium. This leaves a total “boot” of $5,000. Therefore, Arthur would have to pay tax on an ordinary income basis on the $5,000.
Arthur’s agent had a couple of solutions:
The Cash Value that is transferred into the new policy may violate the cash value accumulation or guideline premium/cash value corridor for life insurance policies. The agent would have to submit this information to his home office to see if this would be a taxable distribution. (This is a technical calculation and outside of the purview of this discussion),]
Also, Arthur could end up with not enough face amount to take care of his needs. He may have to purchase other insurance to make up the difference.
Arthur was rather disturbed over all of the “technicalities” that had arisen, however the agent pointed out to him that he still would be better off, as his old policy allowed his cash value to grow only at 3% per year, and by allowing his cash value to grow at the present interest rates, and to grow tax-free, plus the advantages that he would have by using a more “modern” type of policy in his estate planning, he is still “way ahead of the game.”
Table of Policy Features
This table summarizes many of the primary features of the life insurance policies:
Table of Policy Features
Cash Value/ Securities
Type Death Benefit Premiums Interest Rate Regulation
Whole life or Fixed ‑ Level Guaranteed rate No
Limited Pay Life ‑ Relatively high Relatively low
Universal Life ‑ Adjustable by ‑ Relatively high, Low guaranteed No
policyowner within but flexible rate plus variable
specified limits ‑ May be raised, excess rate, not
‑ Two options lowered or skipped guaranteed
available (current
interest rate)
Variable Life ‑ Variable ‑ Level ‑ Variable rate Yes
‑ Guaranteed ‑ Relatively high ‑ Not guaranteed
minimum benefit ‑ Policyowner's risk
Variable ‑ Variable Relatively high, ‑ Variable rate Yes
Universal Life ‑ Adjustable but flexible ‑ Not guaranteed
‑ Guaranteed May be skipped ‑ policyowners risk
minimum benefit
Interest‑ Fixed, but subject ‑ Relatively high ‑ May vary No
Sensitive to change in ‑ May be fixed or ‑ Current rate
Whole Life certain situations indeterminate guaranteed for
‑ Maximum specified short periods
Term Fixed ‑ Relatively low None No
initially
-Increase as insured ages,
upon renewal
CHAPTER 4 – STUDY QUESTIONS
1. Under present tax laws the cash value growth of a Variable Universal Life is
A. taxed each ear, the same as a savings account.
B. tax deferred until the future unless more money is withdrawn than deposited.
C. treated as capital gains and taxed accordingly.
2. The greatest expense incurred, by the insurer, for a Variable Universal Life policy is
A. commissions paid.
B. underwriting and policy.
C. cost of term insurance.
3. The basic difference between a Variable Life and a Variable Universal Life is
A. the Variable Universal Life is not regulated by NASD or SEC.
B. generally the premiums paid into a Variable Life are level and into a Variable Universal Life and be flexible.
C. the Variable Life has a guaranteed death benefit and the Variable Universal Life does not.
4. Variable Universal Life insurance provides
A. flexibility.
B. for a fixed monthly premium.
C. for a separate account with a guarantee return.
5. Estate tax Repeal Rider is
A. a rider on Family policies that covers estate taxes that family members might have to pay.
B. a rider on a 20 year Decreasing Term policy that allows the owner to reinstate the policy after 20 years.
C. use in the event the estate tax is phased out by 2010.
6. Interest sensitive Whole Life policies
A. provide for a current rate of interest throughout the life of the policy.
B. are also known as excess interest and current assumption “Whole Life”.
C. do not have a minimum guaranteed cash value.
7. One of the requirements for a 1035 exchange is
A. to exchange a Term policy for an Annuity.
B. to exchange an Annuity for another Annuity.
C. to exchange a Whole Life policy for a Term policy.
8. The Variable Universal Life policy is recommended to sell in either a “Bull” or a “Bear” market because
A. the financial backbone of the Variable Universal Life policy is “Junk Bonds” and since their performance is guaranteed it is a good buy.
B. the fluctuations of the stock market do not have any influence on the Variable Universal Life policy.
C. the fluctuations of the stock market can work to the benefit of the owner.
9. Some interest sensitive Whole Life policies have “indeterminate premiums” which means
A. the premium amount is set by the insurer at onset of the policy based on expected earnings.
B. the insurer sends a policy notice once a year and charges the owner a rate that re-flects an interest rate and profit.
C. the death benefit changes as the insurer earns more or less interest.
10. One of the benefits of a Variable Universal Life policy is
A. a fixed rate of return.
B. the guaranteed death benefit is not affected by poor stock market performance.
C. a guaranteed separate account.
ANSWERS TO CHAPTER FOUR REVIEW QUESTIONS
1B 2C 3B 4A 5C 6B 7B 8C 9A 10B