15 Advantages of Variable and Variable Universal Life Insurance

Understanding the advantages of universal life insurance helps consumers make the most educated decision. Here are the 15 major advantages that should be considered when considering universal life:

  1. Policyowners have control over how premiums and cash values are invested. They generally may allocate their investments as desired among a variety of mutual fund-type investment accounts.
  2. Insurers permit switches or transfers between funds at least once and usually more times per year, usually with no charge.
  3. Switches or transfers between funds are tax-free.
  4. Cash values of VL and VUL policies are more secure in the event of insurer insolvency than cash values of other types of policies. Assets backing VL and VUL policies are in separate, segregated accounts from the general investment portfolio of the insurer. Also, insurers base cash values on the market value of the assets in the separate accounts. Therefore, cash values are readily available in the event of insurer insolvency. In contrast because insurers do not adjust cash values in other types of policies to the market value of the assets in the insurer’s general portfolio, in the event of insolvency, the general portfolio may not have sufficient assets to cover cash values.
  5. Earnings on the assets underlying the policy cash values accumulate tax-free or tax deferred, depending, respectively, on whether the policy pays distributions of gains as death benefits or as lifetime benefits as a result of cash value withdrawals or payments under a nonforfeiture option.
  6. VL provides some measure of automatic increases in death benefits that may keep pace with inflation. Death benefits of VL policies are tied to changes in the underlying value of the assets backing the policy. Because the rate of return assumed when setting the guaranteed minimum death benefit is relatively low, death benefits generally should trend upward and provide some measure of inflation protection.
  7. A VUL policyowner has wide discretion or flexibility in selecting the timing and amount of premium payments. Provided that there is enough cash value to cover mortality and other account charges, the policyowner may even skip premium payments. In contrast with other types of policies, skipping premiums does not result in the creation of policy loans.
  8. VUL permits the policyowner to change the level of death benefits. Insurance companies permit decreases in the death benefit at virtually any time. However, policyowners who reduce death benefits within the first seven years of issue may face adverse tax consequences under the modified endowment contract (MEC) rules. Insurers generally permit increases in face amount, subject to evidence of insurability. Increases in the death benefit also may subject the policy to a new test period under the MEC rules.
  9. VUL policies are transparent. Annual reports break out and report each of the policy elements separately. This unbundling allows the policyowner to specifically identify and track premiums, death benefits, interest credits, mortality charges, expenses, and cash values and to check projections against actual performance over time.
  10. Most VUL policies offer three death benefit patterns, two original patterns called “Option A” (or I) and “Option B” (or II), as well as a more recent pattern called “Option C” (or III).

Option A, similar to a traditional whole life policy, offers a fixed or level death benefit. As cash values grow larger, the net amount at risk, the pure insurance, is reduced to keep the total death benefit constant (unless the cash value grows to an amount where the insurer must increase death benefit to avoid classification as a MEC).

Option B operates in a manner similar to the death benefit one would receive from a traditional whole life policy with a term insurance rider equal to the current cash value. Under option B, the death benefit at any time is equal to a specified level of pure insurance plus the policy’s cash value at the time of death. Therefore, the death benefit increases as the cash value grows.

Option C provides a Return of Premium (ROP) feature that increases the death benefit by the cumulative premiums. Some ROP options also provide for an interest factor that will increase the cumulative premiums by a specified interest rate. This option has become more popular as a result of premium financing and the need to maintain a level death benefit for the insured net of the amount that is owed to a lender.

  1. Some companies offer cost of living riders to VUL Option A policies that, without evidence of insurability, automatically increase the policy death benefit periodically by the increase in the CPI. The increasing death benefit associated with option B generally makes the need for a cost of living rider under this option moot.
  2. In contrast with most traditional whole life policies, many VUL policies use back-end loads rather than front-end loads to recover the initial policy expenses. Consequently, most or all of the policyowner’s initial premiums go into cash values subject, of course, to regular annual expense and mortality charges. Therefore, cash values tend to build up more quickly than with traditional whole life policies.
  3. Policyowners can borrow policy cash values at a low net cost. Although policyowners must pay interest on policy loans, the insurer credits the cash value backing the loan with an interest rate that is usually slightly lower than that paid by the policyowner on the loan. Consequently, the actual net borrowing rate is less than the stated policy loan rate.
  4. In most VUL, policies policyowners may withdraw a substantial portion of their cash value without surrendering the policy. However, if policyowners withdraw money, the insurer often reduces the pure life insurance portion of the death benefit by the amount of the withdrawal. In addition, withdrawals may be subject to income tax. (See the following discussion under “Tax Implications”.)
  5. Life insurance proceeds are not part of the probate estate unless the estate is named as the beneficiary of the policy. Therefore, the policyowner can have the proceeds paid to the beneficiary without the expense, delay, or uncertainty caused by administration of the estate.
Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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