Variable universal life insurance is a tricky product. There are a lot of features of this complicated product, some of them are beneficial to the consumer and some are not. Making money on a variable universal life insurance policy depends upon understanding how this insurance policy works, what to avoid when you have one, and how to put it to work for you.
A Brief Rundown Of The Features
Variable universal life insurance has an exceptional amount of features for a life insurance product, and every company has multiple products which all have different rules, limits, and add-ons called riders. The basic structure of variable universal life insurance (VUL) works as follows.
Cash Value Account
A fundamental part of every variable universal life insurance product is the cash value account. A policy owner is required to pay the premiums on a VUL either through submitting the premium due each month, or using the cash value account. The cash value account accrues through premiums paid into the policy, when premiums are paid in larger amounts than the actual cost of insurance. Any excess paid over the cost of insurance gets added to the cash value account.
Variable Subaccounts
Despite the name “cash value account” in a variable universal life insurance policy, the money accruing in the cash value account does not sit in cash at all but is invested in variable accounts. These variable subaccounts are essentially mutual funds (collections of stocks and bonds). The owner of the contract has the option of choosing between a number of funds. Typically most every asset class is represented in the fund choices.
An owner chooses an allocation prior to the money being invested, and the allocation can be changed at any time after it is invested. When money is added to the policy, it is invested into the variable subaccounts in the percentages chosen by the owner. An owner can change allocations either by changing “future allocations” which represents instructions for future money added to the policy, or they can also change the “current allocations” which represents the money already invested. They can also change both, and the two do not necessarily need to match each other.
The variable subaccounts in a VUL policy do not have “loads”, meaning that there are no charges taken by the life insurance company or fund managers when trades are made. Owners can trade policies themselves at their own discretion, or give an agent the right to trade for them in some instances. Most companies offer the owner the option of rebalancing the accounts to suit their needs.
Because the cash value account is actually invested in variable accounts (which are stock, bond and commodity investments) it will grow according to the performance of the underlying funds. If the money is invested well the return on investment can be very significant. If the money is not invested well, or if the market is very poor, the performance of the account will be poor as well.
Rising Insurance Costs
VUL policies have many different cost components, which are broken down in the policy and on the quarterly statements. For the purposes of this article, we group them all together into the total “cost of insurance”. The cost of insurance in a VUL policy is actually not level, but rises as the insured person ages (on a per dollar of coverage basis). While the cost of insurance rises, the cost is actually based upon the “net amount at risk” to the life insurance company. The net amount at risk is equal to the face amount minus the cash value (in a level face policy).
In more simple words, the cost of insurance coverage rises, but the total charges are based upon the amount at risk to the life insurance company. A higher cash value reduces the amount at risk, and therefore can reduce the cost of insurance.
How To Profit On a VUL
Now that you understand the basic features of a variable universal life insurance policy, and how the insurance charges work, here is how people actually profit from a VUL.
Funding At Higher Levels Than Cost Of Insurance
When you are given an illustration, it is projecting future costs of insurance, your return on investment, and the amount of money are you funding the policy with. Based upon your goals and budget, a premium amount is given to you. The thing that many people do not realize when they first are issued their policy is that they are not usually required to fund the policy at the illustrated premium. They could actually pay the lower cost of insurance, not accrue any money in the cash value, and the policy will stay in force.
This strategy will not make money, and will be very expensive in the long run as the cost of insurance rises. The key to successfully using a VUL policy is to fund the policy at much higher levels than the cost of insurance.
When you fund the policy at high levels you are building cash value. As you build cash value, your insurance costs drop. You also hypothetically will realize a positive return on your investment in the variable subaccounts in the long run (because the market has always risen in the long run). If your cash account grows, this further reduces the amount at risk to the insurance company, which further reduces your cost of insurance.
Funding Should Be Done Early
The earlier you can put money into your policy, and the more money you are able to put into your policy, the better your policy will perform on average. The longer the money in the variable sub accounts has to grow, the less your insurance costs will be over time, and the more compounding your account will experience.
Successful VUL policies are funded well, and funded early.
People choose variable universal life insurance because it has the potential to earn more money than other forms of permanent life insurance, while still providing the benefits of the insurance coverage. VUL policies still are treated the same as other forms of insurance for tax purposes (gains are the last money out) unless the policy is a modified endowment contract. A VUL can be a great investment, but only if you take the right steps to profit from it.
