The Definition for Variable Universal Life Insurance
Variable universal life insurance is a specific kind of universal life insurance. Variable universal life, or "VUL" as it is called, offers substantial control over policy cash values. These types of policies have come to be known as "investment life insurance" or "investment policies" used to supplement an individual's retirement income. But before you buy a VUL policy, it may be helpful to know what a variable universal life insurance policy is.
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The Death Benefit
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A variable universal life insurance policy offers a choice of two kinds of death benefits. Option A offers a level death benefit that does not increase over time. The face amount of insurance is purchased at the beginning of the policy, and cash value builds up against the value of the death benefit. This allows the total cost of insurance to decrease over time as long as the cash value continues to grow inside the policy because the "net amount at risk" decreases over time as the policy cash value builds up. The actual cost per thousand dollars of insurance is increasing as you get older, but the cash values effectively replace the death benefit you are purchasing. For example, if the cost per thousand of insurance is $5 and increasing as you grow older, and you are purchasing $250,000 of insurance, the mortality costs would be $1,250, and would grow over time. Under Option A, as the cash value increases, the amount of insurance you are purchasing decreases. So, even though the mortality costs per $1,000 of insurance are rising, the amount of insurance you are purchasing is decreasing, which has a net effect of making the insurance policy less expensive over time. Option B is an increasing death benefit. The death benefit or "net amount at risk" stays level and the cash value builds on top of the death benefit. Cash value is added to the death benefit instead of building up against it. This causes the death benefit to increase with each premium payment. Consequently, the cost per $1,000 of insurance also rises. The goal with Option B is to have the cash values grow to generate sufficient interest to offset the cost of insurance.
The Cash Value
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The cash value is often referred to in the insurance industry as "the pot of money." It represents a true savings component and although it is tied to the death benefit (you cannot have the savings component apart from the death benefit), you can add to and withdraw money from the account directly. All premium payments are deposited directly into the cash value of the policy prior to any charges or interest being credited to the policy. The premiums themselves are flexible, meaning that no set premium amount is due, per se. As long as there is enough cash value in the policy to cover the costs of the policy, the policy will stay in force. Some VUL policies will have a guaranteed required premium for the first five years, however, to keep the policy in force.
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Policy Charges
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Policy charges are deducted from the policy at the end of the month. These charges go to pay the administration of the policy, the mortality charges (the cost of the death benefit), and the commissions to the agent selling the policy.
The Sub-accounts
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The sub-accounts (mutual funds) are the investment accounts that you invest in. You can direct any portion of the cash values into the mutual fund sub-accounts, or leave the money in a general account that earns money market rates. Your cash values can generally be switched among sub-accounts at no charge, although this will depend on the policy and the issuing insurance company.
Considerations
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A VUL carries a significant amount of investment risk because it is investing in mutual funds, which can cause the policy cash value and death benefit to decrease to the point of policy lapse if the mutual funds perform poorly. This can become especially problematic since policy charges never stop. Actual mortality charges, in particular, always increase over time (in terms of cost per $1,000 of insurance) because the older you are, the more likely you are to die. This can be somewhat confusing, because while the cost per $1,000 increases due to increased mortality risk, the actual cost of maintaining the policy could decrease over time under the Option A death benefit provided that the cash values are increasing and thus reducing the "net amount at risk" for the insurance company. In effect, the cost per thousand of insurance (the unit cost) increases as the amount of death benefit you are purchasing decreases. The risk is that if, under Option A, the cash values do not accumulate as expected, then the policy could lapse as the cost per $1,000 of insurance increases and the policy owner is unable to decrease the "net amount at risk" (the amount of death benefit the policy owner is purchasing). The risk under Option B is that the cash values will be significant enough and will not generate sufficient interest earnings to hold down the rising cost of insurance.
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