Understanding Variable Universal Life Insurance


Variable Universal Life Insurance or VUL is a flexible form of universal life insurance.

Universal Life works as follows:

* A sum insured is selected by the insured. This is the amount of life cover that will be available on the death of the insured.

* The premium is set so as to cover not only the cost of the life cover, but also an investment amount.

* The client has the option to select the size of premium from a given range for a specific sum insured.

* As the investment grows, the amount of risk cover decreases. The amount covered is made up of the risk cover plus the investment amount.

* Expenses are deducted from the premium before investment takes place. The cost of life cover is calculated monthly based on the statistical probability of death.

Variable Universal Life provides additional flexibility.

* The client may select and vary the funds to which investments are made.

* The client may vary the premium from month to month. Once there are sufficient funds in the investment portfolio, the risk cover may be paid directly from the investment portion.

A hypothetical example will illustrate the features of a VUP policy.

Celia Capolla is the main bread winner in her household. She is 33 years old, and requires a sum of $1 to protect her family in the event of her untimely death. Celia is able to select a monthly premium from a range that suits her. From a minimum of $350 to a maximum of $5,000 per month (these are hypothetical figures for illustration only).

The minimum premium covers the risk of $280 leaving just $70 to go towards investment and expenses. The maximum premium of $5,000 will cover the $280 risk leaving $4720 to go towards investment and expenses.

The minimum option will cover the life cover but will probably require regular premium top-ups to cover the risk.

The maximum option will minimise the cost of the risk benefit over the long run, and over time will provide a much better cash payout. Celia has selected the maximum premium for the initial period.

For simplicity, expenses have been excluded from the following calculations.

* Month 1. Celia’s policy is charged $280 for $1m life cover. $4,720 is available for investment into a fund of her choice. Celia has chosen a spread of high return, high risk investment funds.

* Month 2. The value of the investment is $4600. Celia’s account is charged $279.10 for life cover of $994,400.

* Month 3. The investment is now worth $10,000. The cost of risk cover is $278 for cover of $980,000.

* Month 4. The investment portion is now worth $14,800. Celia has had a birthday and the cost of life cover rises! The risk cover is $283 for the month.

* Month 5. Celia opts for the minimum premium for the month. She pays only $350. Her fast growing investment is now valued at $15,000, and $282.70 is charged for life cover.

By the end of the first year the investment portion has reached a value of $78,000. The amount of life cover required is now $922,000 costing just $259.

Once the value of the investment portion reaches $1m, the risk element falls away entirely and the entire premium is used for investment. The end result is that the cash value of the policy is more than the original sum insured.

A VUL policy provides the option to pay higher of lower premiums as long as there are sufficient funds in the investment portion to cover the cost of the outstanding risk.

There may be some tax benefits associated with VUP policies. This may vary from country to country but the general rule is that there is no tax payable on the cash value of the investment if kept for a minimum period.

The main disadvantages of VUL are:

* The expenses charged which diminish the value of the investments. Commission is usually the biggest drain on the policy, particularly in the first year.

* Having selected a number of volatile funds, Celia experiences huge growth for a number of years but a sudden turn in the markets turn and overnight the value of the investment portfolio drops by almost 50%.

* The investment value has also diminished after electing the no-premium option for a number of months.

If the broker will agree to longer term ‘As-and-When’ instead of upfront commission, this could be of great benefit in maximising the investment.

The main alternative to VUL is a simple term insurance policy (perhaps reducing term) coupled with a separate investment. The main criteria in this decision would be to weigh up the higher costs associated with life insurance against the tax benefits of having a VUL policy.