The subject of variable life insurance brings to mind a fake “Saturday Night Live” commercial for a product called Shimmer. In the spoof, Dan Aykroyd and Gilda Radner play a married couple arguing about whether Shimmer is a floor wax or a dessert topping; they ultimately agree it’s both.
Variable life insurance is a hybrid that, like Shimmer, serves two distinct purposes.
Variable life is different from other types of insurance, which are exclusively regulated at the state level. Thanks to the very robust investment portion of this product, it is subject to federal investment regulations.
That means insurance agents who want to sell this product must not only be licensed by their home state, they must also become federally registered brokers. Registered securities brokers must pass a rigorous exam administered by the National Association of Securities Dealers.
Good Times, Bad Times
Variable life policies resemble their more conventional cousin, the universal life policy, in that they are composed of two parts — the insurance and the investment fund. But the similarity ends there.
Unlike a universal life policy, you as the policyholder have a great deal of latitude in choosing where your premiums are invested. Typically, the choices range from stocks and bonds to mutual funds. Because these are securities-based investments, regulations require that you receive a prospectus before investing. The reason is that, like all securities investments, there is the possibility of total loss.
Since this is a hybrid insurance-and-investment product rather than a fixed premium, there is a pre-established range of premium payments. You can choose the payments so long as they fall between the minimum and maximum allowable amounts. The minimum premiums are intended to cover most or all of the insurance costs.
The flexible premiums allow you to grow your cash value at your own pace, so the more you pump in, the faster it grows. That is, unless your investments are performing poorly –in which case your cash value will decrease. When your investments are performing well, you also have the option to use the interest and dividends to pay a portion or all of your insurance premium.
Cash value in a variable life policy accumulates on a tax-deferred basis, which includes dividends and interest, until it’s withdrawn from the policy, with the exception of loans.
Variable life policyholders, like whole life policyholders, can borrow against the cash value without having to pay taxes on the gains.
That means, unlike traditional investments, you could borrow indefinitely without having to pay capital-gains taxes. The very serious downside to this strategy is that, if the loan ever equals the policy’s cash value, the policy will lapse and the taxes on the income will come due all at once. This can happen if the value of investments in the policy suddenly decreases due to poor market conditions.
As the policyholder, you have the ability to change your investment mix at any time. For example, you can move from a stock-heavy portfolio to a bond-heavy portfolio at will. Like any other investment account, the risks and rewards of those choices are yours alone.
There are usually fees and expenses associated with these transactions, and their amounts can vary from one insurer to another, so it is important to understand how much they are and how they will affect your cash value.
These policies do not come with investment advice or advisors and there are few, if any, protections against losses. You are personally responsible for understanding what you’re investing in and what the potential risks are.
It is important to remember that variable life insurance policies are more than just investments; they are life insurance policies, and if they are your primary source of life insurance you must weigh the risks of losing coverage against the gains from investments. Many insurance professionals, including me, do not recommend variable life insurance policies as a primary source of life insurance coverage due to their volatile nature.