How a Variable Life Insurance Policy Works

What is Variable Life Insurance?

A variable life insurance policy is a unique type of life insurance policy whose cash value varies depending on the performance of the underlying investments.

How Does Variable Life Insurance Work?

When insurers sell an ordinary life insurance policy, they collect premiums from the people who buy the insurance. They then invest this premium, with the promise to pay beneficiaries a given sum of money upon the policy-holder's death.
In the case of a variable life insurance, however, the policy-holder gets to allocate a part of the premium they pay towards the policy to be invested in instruments like bonds, stocks and investment funds -- typically with the aim of accruing a better rate of return on the money they put into their life insurance and provide permanent protection to their survivors (the beneficiaries) upon their (the policyholder's) death.
This permanent protection for a deceased's survivors becomes possible through variable life insurance policy, because beneficiaries have the option of continually and sustainably drawing on the returns from the underlying investments for a long time, without ever touching the principal if the policy's underlying investments continue performing well.
Furthermore, the earnings made from the investments underlying the variable life insurance policy are not taxed until the policy is surrendered and, for this reason, variable life insurance makes a good tax deferment tool.
The earnings made from the investments underlying the variable life insurance policy can actually be redirected into paying premiums for the policy and, with time, they can grow to the point where the earnings from the underlying investment are large enough to sustain the premium payments for the policy, so that the policyholder doesn't have to pay premiums any longer.

Considerations

By opting for a variable life insurance policy, a policyholder essentially also becomes an investor, with all the attendant risks.
Since the cash value (the amount that one's beneficiaries can draw upon at the policyholder's death) of a variable life insurance policy depends on the performance of underlying investments, there is a risk of the cash value dwindling significantly should the performance of the underlying investments decline greatly. With the unpredictability that capital markets often exhibit, this risk can be quite significant.
Generally though, most variable life insurance policies place a floor on the plan, which keeps it from falling below a certain amount regardless of the performance of the underlying investments.