How
a Variable Universal Life Policy Works
Variable universal life (VUL) insurance works very similar
to traditional universal life insurance with the exception
that a variable policy allows an individual to allocate
excess premium payments to investment accounts similar
to mutual funds. A variable universal life policy has a
fixed interest rate component as well as several investment
account options that offer the potential for higher returns.
However, along with the potential for higher returns comes
the risk of loss of cash value which may negatively affect
the life insurance protection over the long run. (1)
VUL Policy Costs
As with most universal life policies, when the VUL policyholder makes a premium payment, the insurance company first deducts a premium load. The premium load is a combination of a premium expense charge plus a premium tax charge and can range anywhere from 3-7% of the total premium depending on the insurance company. After the premium load is deducted, the balance of the premium payment is deposited into the accumulation account. The accumulation account earns fixed interest at a current prevailing rate with a minimum guaranteed rate of generally 2-3% annually. On each monthly policy anniversary, deductions are taken from the accumulation account for administration charges, expense charges, and costs for insurance including riders. For more information on policy features and costs with universal life insurance, see "How a Universal Life Insurance Policy Works".
VUL Premium Payments
VUL insurance premiums are flexible and may be increased or decreased depending on the policy owner’s objectives. The policy owner has the option of paying the minimum premium required to cover policy costs or pay a higher premium to grow cash values. As long as there is sufficient cash value in the policy, premiums may even be temporarily discontinued. If the cash value is insufficient to cover policy costs and insurance charges, the policy premium must be increased. If the premium payment does not cover policy expenses and insurance charges, and there is no cash value available to meet these costs, the policy will lapse. With VUL policies, investment performance can have a huge impact on policy premium requirements.
VUL Sub Account Choices
Each variable universal life policy offers abroad variety
of sub accounts with different asset mixes from which
to choose. Most policies have 10-20 account options
that include varying degrees of risk. Furthermore,
policy owners can manage their cash values and investment
choices by switching allocations among the equity fund
accounts at their discretion. Because most of these
sub account funds are professionally managed, VUL policies
have significant operating costs and management fees.
Similar to mutual funds, these fees and expenses are
assessed against the separate accounts and will vary
based on the type of fund.
VUL Investment Experience
The performance of a variable universal life policy is
directly related to the investment returns of the underlying
separate account funds or the fixed account if cash values
are allocated there. There are no cash value guarantees
for the separate account funds. If cash values are reduced
by poor investment returns, additional premium payments
will likely be required to maintain the insurance protection.
If premium payments are not increased, the policy may
lapse due to poor performance.
Variable universal life insurance policies are for sophisticated
investors only. Before considering a VUL you must understand
the volatility of the equities markets and make sure
the policy is suitable for your needs. With VUL, when
the investment sub accounts are rising, the insurance
policy generally performs very well. However, if the
investments perform poorly, the life insurance policy
performs poorly and may impact the long term status of
the policy.
Access to Policy Cash Values
Variable universal life insurance treats surrenders,
withdrawals and policy loans in the same fashion as traditional
universal life policies. To see a specific explanation
of how these features can be used to access policy cash
values see, "How
a Universal Life Insurance Policy Works": Surrender Charges,
Withdrawals and Policy Loans.
Additionally, VUL policies offer all of the tax advantages
of permanent life insurance. For more information on
taxes and life insurance see, "Life
Insurance Tax Advantages".
VUL Transfers Risk
Variable universal life policies transfer policy risk
of cash value growth from the insurance company to the
policy owner. With VUL’s, the policy holder will
be ultimately responsible for selecting the equity funds
that grow the cash value. If the funds achieve good returns,
a VUL policy may significantly outperform traditional
permanent insurance policies. However, if the equity
funds lose value, policy cash value can be exhausted
leaving no funds available to pay insurance costs and
policy expenses.
Variable universal life is considered a security under
federal law and is subject to the regulations of the
Securities and Exchange Commission (SEC) and the National
Association of Securities Dealers (NASD). They may be
presented for sale by licensed representatives only.
A prospectus describing the complete policy must be provided
by the licensed representative when selling variable
universal life insurance.
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