Avoiding a Variable Universal Life Insurance Implosion

Avoiding a Variable Universal Life Insurance Implosion


Most people purchase life insurance to protect their family when they passed away. Unlike term, universal or whole life insurance, where there is no financial market risk component, Variable Universal Life insurance (VULI) is subject to financial market risk.  Combining something that is intended to be the safest financial instrument (life insurance) with risky investments (stocks and bonds) can be a recipe for disaster.
 
Over the course of the last decade, insurance agents marketed and sold VULI policies with projections of 8%-12% returns on your investments inside the policy.  Many agents did not stress the inherent risks of these types of policies – including the risk of the policy becoming worthless during and even after difficult financial market returns. 
 
The Solution – Defuse the Implosion.  Just a quick background on VULI and how it works.  VULI is designed to provide a life insurance benefit for the insured’s entire life, like whole life insurance.  Unlike whole life insurance, where cash values are invested at a fixed rate, VULI cash values are subject to financial market risk.  If the values decline, as they have over the last two years, there may not be enough cash value to offset the annual life insurance premiums.  This would require the insured to pay additional premiums or watch the policy implode (translation: the insurance company cancels the policy). 
 
The Nuts and Bolts of a VULI Policy.  Although often marketed as a retirement plan, VULI is simply stated…permanent life insurance.  The insured can invest the cash value inside of the policy into one or more sub-accounts.  Similar to mutual funds, sub-accounts invest in stocks, bonds and other risky investments.  Although any gains and interest inside the policy are tax free, there are some important concerning aspects of these policies.  These include a host of fees: 1) premium expense charges, 2) policy fees, 3) mortality and expense (M&E) charges, 4) surrender charges, 5) increasing life insurance costs, and 6) additional rider fees.
 
Defusing the Implosion.  The first step in defusing the implosion is obtaining a current prospectus that provides an overview of the policy.  Next, obtain an in force illustration of the VULI policy, ideally every two to three years.  It is at this is the time when the insurance agent’s marketing pitch is reconciled with reality.  Based on the conservative assumption the insured can gleam key data about the sickness or health of the policy.  The insured may soon realize he has a time bomb ready to implode.
 
After careful review, the insured should determine: 1) which sub-account changes should or should not be made, 2) what additional contributions may be required, 3) if the insured wants the policy to implode, 4) if the policy should be exchanged to another insurance carrier or another type of policy.
 
Making an Exchange.  Fortunately, section 1035 of the Internal Revenue Code permits an insured to make a tax free exchange of a VULI policy to another insurance contract that is considered a “like kind exchange”.  There are a number of ways the insured can trip this up, so he should work closely with each carrier throughout this process.
 
Action Steps.  The insured should find out if the VULI policy is a ticking time bomb and analyze all the data of the policy to determine if it is the best solution for his goals.  Unless the insured is extremely comfortable reviewing an extensive set of tables provided with an in force illustration, he should work with a licensed insurance agent that has in depth analytical skills - ideally a CFA. 
 
Aaron Skloff, Accredited Investment Fiduciary (AIF), Chartered Financial Analyst (CFA), Master of Business Administration (MBA) is CEO of Skloff Financial Group, a Registered Investment Advisory firm based in Berkeley Heights, NJ.  He can be contacted at www.skloff.com or 908-464-3060.