Variable Universal Life Insurance: What are the Variables in VUL?
During the decade of the 1970s, the fast-changing social and economic environments were potentially making whole life insurance policies as a tool that was becoming irrelevant to the needs of the changing culture.
People with foresight such as G.R. Dinney were addressing this issue with fervor.
The problem was that inflationary rates in the 1970s were on average 7.25% as expressed in the consumer price index at the time. By the end of 1979, the inflation rate was 13.29%.
This was making whole life insurance a non-viable product because it was not able to keep pace with inflation in cash value buildup.
Couple that with whole life insurance policy owners that were taking more loans out against their policy this created serious cash crunch for whole life carriers. In addition, with more and more women participating in the workforce, increased consumer intelligence about life insurance and security products was in demand and needed.
This created the need for an interest-bearing product that would tend to keep pace with inflationary forces and to keep the insurance industry solvent with their share of investment dollars by individuals.
This is the genesis of the universal life policy.
During the 1980s, these products in the life insurance industry matured into fixed flexible and variable insurance premium payments. This became one of the variables.
The details of Universal Life will be addressed in another article, but if not for the foundation of the universal life first; the idea of Variable Universal life insurance may not have been born. It was in the middle of the decade of the 1980s that whole life mutual companies were paying out over 13%, while the Universal policies were earning about 7.5% on average.
Keep in mind that the universal life policies were issued with fewer guarantees than the whole life policies while the S&P 500 at the time was averaging over three years 15%.
If there is anyone dependent on your income – parents, children, relatives – you need life insurance.
– Suze Orman
As many policyholders were now considering cashing out their whole life policies and just buying term life insurance so they could invest in the market in the form of mutual funds, the insurance industry created the Variable Universal life insurance (VUL).
Variable Universal Life insurance (VUL) has two more big variables in addition to the flexible or variable premiums.
1. The first is that the cash value buildup was separated out from the insurance carrier’s general ledger into a sub-account.
2. Secondly, they created a mutual fund like sub-accounts by hiring sub-account managers in which the policyholder could now create a diversified risk assessed account to theoretically grow their cash value by potentially outpacing inflation with market returns.
This shifted the managing of the cash value from the insurance carriers to that of the policy owner depending on the sub-account managers contracted with the insurance carriers to meet or exceed inflation.
The idea was to keep pace with market returns.
Strangely, one could think of it as a diversified investment of mutual like sub-accounts surrounded by an insurance wrapper. This created a huge variable in the insurance industry.
Graphically it could be described as follows:
As you can see from the graph variable universal life insurance created a product that was truly a securities product that now needed to be managed. It was no longer a product that could be said to get it, set it, pays for it and forgets it as with whole life insurance.
This in tandem with the idea of financial planning becoming more in vogue to the average American resulted in insurance agents needing to become securities licensed. Conversely, security licensed representatives now needed to acquire an insurance license.
So here are some of the variables that were now part of this product in the insurance industry.
- Some of the guarantees of whole life insurance were eliminated
- The idea of flexible or variable premium payments was introduced
- The growth potential was seen as being better than the dividend or interest payments to the cash value
- Management of the sub-accounts required
- Risk tolerance analysis for the policyholder
- High-quality sub-account managers vetted by the insurance carrier
- A vast array of asset classes needed for a diversified portfolio
- The need to manage this portfolio was now needed
- Strong advisor and policy owner relationship required
- Internal cost of insurance increased
- Hidden or not so clear sub-account fees affected returns
- The potential for lower or negative market returns could challenge cash value past growth returns
Each insurance carrier participating in Variable Universal life insurance all boasted that they have the best and highest quality fund managers.
This was the insurance industry’s answer to “buy term insurance and invest the difference.”
Historically, term life insurance has always been very profitable for the insurance industry as most policies went past the term and the insured never died. It was pure insurance. Term life insurance is explained in this article.
Because they were losing market share to the securities industry as consumers were cashing in their whole life insurance policies and buying term and investing the difference ( or not), they were forced to make a change.
It was almost like the mantra if you cannot beat them, join them.
That is exactly what the insurance industry did, sort of! Of course, the problem of implosion came into being as well. When selling variable universal life insurance policies, it was incumbent on the agent to show that past performance does not guarantee future performance.
However, the actual selling of these products gave lip service to that statement, as illustrations used past performance figures that were in many cases overinflated and used to show potential future returns.
In an article published by Think Advisor that in 2008, 250,000 Variable and Universal policies lapsed by people 65 and over totaling more than $57 Billion in face value. This is not even taking into consideration VUL policies that lapsed by people under age 65. This is significant as this asset was important to people during retirement and approaching the twilight of one’s life.
One could blame the systemic black swan event of 2008. It could happen again! Did we learn anything from this? One has to take pause and be concerned.
So what can we conclude?
It does not make Variable Universal life insurance a lousy product.
It merely means it is just one life insurance product that needs to be handled with great care and personal and advisor management.
Innovation in the insurance industry will always be necessary, so consider the VUL as just one variable that could fit in with a properly planned out insurance and investment retirement plan.