Variable Life Insurance
Variable Life Insurance refers to two types of cash value life insurance which alter the nature of the contract by placing the cash accumulation in the insurance company’s “Separate Account”, which is a Management Investment Company regulated by the Securities & Exchange Commission (SEC) under the Investment Company Act of 1940. The cash accumulation may be designated to and distributed among a number of “sub accounts” that closely resemble mutual funds, but are slightly different. The Separate Account and its sub accounts invest policy cash accumulations in the stock and bond markets, where it may be subject to market risk, business risk, interest rate risk, inflation risk, and, if invested in foreign securities, government/political risk, and currency risk.
As a security, variable insurance contracts, including variable annuities, must also be registered with the SEC, and licensed life insurance agents must also be securities licensed in order to transact these forms of insurance. Because stock and bond investing is subject to market risk — the day-to-day rise and fall in prices of securities, also called “volatility” — while the insurance company makes the promise of paying the death benefit according to all of the terms and provisions of the contract, it does not assume any of the risk of loss of principal or declining cash accumulation.
That risk is borne 100% by the policy-owner, who must pay attention to the performance of the separate account on a regular basis, making adjustments to and reallocating portfolio assets . . . managing the policy for the best possible rate of return, which, in some years, could mean trying to minimize losses, because a profit is not possible due to a general market decline — such might have been the case with most variable insurance contracts in the bear market of 2008-2009, when most investors saw their portfolio values decline by up to 40% or more.
The two types of Variable Life Insurance are Variable Whole Life (simply “Variable Life”), and Variable Universal Life Insurance (“VUL”). There are significant differences between the two.
Variable Life is designed with a fixed premium. It has no interest rate guarantee, but it does offer the possibility of a minimum guaranteed death benefit (“MGDB”). A small portion of the fixed monthly premium goes into the insurance company’s General Account to fund the MGDB, which is also a small amount of insurance, usually in the range of $25,000 to $100,000, even though the policy face amount might be $500,000 to $1,000,000 or more. After sales charges (“loads”), administrative expenses, and any state premium taxes are deducted, the balance of the premium payment goes into the Separate Account to purchase “accumulation units” in the various sub accounts selected. There, the funds are subject to mortality and expense charge (“M & E”), fund management expenses, and other investment expenses. .
Securities laws prevent sales charge from being excessive, but there are no limitations on administrative expenses and other policy charges. As a result, to cover its cost of “policy acquisition” (agent commissions, underwriting expenses, other general administrative expenses), administrative charges in the first one or two years tend to be very high, significantly reducing the amount of money that actually goes into the investment component of the contract.