Variable Universal Life: Evolving To Solve A Variety Of Client Needs
Variable universal life insurance is a dynamic product that has evolved over the decades to provide a variety of client solutions.
What sets VUL apart from other permanent life insurance products is the investment component, where the cash value is placed in subaccounts managed by professional money managers. Most VUL products have between 50 and 100 subaccount investment options to choose from. This allows a custom portfolio to be built within the insurance wrapper.
When you look in the rearview mirror, many advisors and clients were hurt by the way VUL was designed, marketed and sold in the past. Take the late 1990s as an example. The industry was not funding policies adequately, there were no protections in place and agents were illustrating VUL north of 10% annualized. I think we all know what happened, and it was a major black eye for the VUL industry. Ever since then, most have steered clear of the product.
Today, a maximum of 7% gross is the adopted standard for illustrating VUL, with many broker-dealers placing further internal restrictions closer to 6% gross. As with many historical examples, crisis breeds innovation and the industry has tried to learn from that mistake. That particular market downturn led to the introduction and standard practice of no-lapse guarantees or NLG being applied to the contracts for a period of time, or even for the life of the contract, regardless of subaccount performance.
VUL is sold in two primary ways today: either in an over-funded, accumulation design with a limited NLG, or in a lifetime NLG protection design. The lifetime NLG protection design is the most popular use of VUL and is the one I’ll cover first.
In 2013, a market price disparity occurred as a result of actuarial guideline 38, or AG 38. That guideline mandated higher reserve requirements for many permanent policies sold by insurance companies. Guaranteed universal life was one of the products negatively impacted as a result. The added liability for this requirement was worked into the repricing of the contracts, which increased the cost of this type of policy across the industry.
AG 38 had little to no impact on VUL. Around this time, one carrier in particular had a lifetime no-lapse guaranteed VUL on the books that, instantaneously, offered a cheaper alternative to traditional GUL. The VUL product offered the same lifetime guarantees as GUL, but with a lower cost structure. This allowed for a client to purchase more death benefit per premium dollar, regardless of their underwriting class, when compared side-by-side to GUL. Additionally, the lifetime NLG VUL offered potential cash value growth in later years within the policy for the client to access for supplemental income, for example, that a GUL doesn’t provide.
GUL Versus VUL
Let’s take a “five-pay” example from Lincoln Financial where the client will pay an annual premium for five years. For a male client, age 65, with a standard non-tobacco underwriting class looking for $1 million in guaranteed death benefit coverage, the premium for their GUL is $109,584. For Lincoln’s corresponding NLG VUL it worked out to be $89,736 annually. That is a premium difference of $99,240 over five years for the same $1 million in guaranteed coverage. Additionally, the VUL contact, assuming 7% net return, had a surrender value, or cash value amount of $826,090 in policy year 20 (client age 85).
That cash value figure is based on the hypothetical illustration that is by no means guaranteed. What it really translates to is added flexibility for the client for various uses, including more value for a 1035 exchange down the road if need be. This GUL to NLG VUL price disparity is greatest for 1035 dump-ins and short-pay scenarios, and less so for a level premium design.
Over the past five years, this lifetime no-lapse VUL sale has made up more than 80% of total VUL sales among our brokerage general agency partners and their agents. It is an easy gap to bridge from the traditional guaranteed life insurance sale for most point-of-sale agents, while providing the peace of mind and flexibility that advisors and clients demand. This is what we would call a “protection” design for clients over age 50 with a particular focus on death benefit.
There is another type of VUL sale that focuses on cash value as opposed to death benefit, called an “accumulation” design.
Within the confines of the IRS tax code for life insurance, premium dollars can be allocated between two general areas: cash value and death benefit. Outside of the up-front costs, the major ongoing cost throughout the life of the policy is cost of insurance, or COI. That cost is determined by a client’s age, health, and the insurance company’s net amount at risk. The net amount at risk is really the difference between the policy cash value and death benefit, which is what the insurance company is on the hook for if the client dies.
For an accumulation design, we take the protection model described earlier and we flip it on its head. Instead of looking for a defined death benefit, we are looking for the absolute minimum death benefit per premium dollar to qualify for life insurance, thus maximizing cash value for investment.
This model works the best when we can also minimize COI, which reduces cost drag on the policy. We are already minimizing net amount at risk, so the other factors of client age and health come into play.
The younger and healthier the client, the lower the COI will generally be. This could be a great product for high-income clients between the ages of 25 and 60 who are looking to place investments within the tax-advantaged wrapper of life insurance. The death benefit is tax-free to beneficiaries. In addition, withdrawals and loans from the life insurance cash value are, in most cases, free from income tax. With after-tax money going in, tax-deferred investment growth and then subsequent tax-free income, this model begins to look a lot like a Roth IRA alternative for clients who can no longer qualify for it.
A Question Of Cost
At that point, it really becomes a question of what cost the client wants to assume: either the cost of taxation or the cost of insurance. If their COI is less than their COT, it would be better to assume the cost of insurance and eliminate the cost of taxation. However, if a client’s COI is high, due to health reasons, for example, then it may not be the better deal. In that situation, a nonqualified investment-only variable annuity may be an alternative. An IOVA doesn’t offer the same tax advantages, but still maintains tax-deferred growth and isn’t subject to medical underwriting.
A client’s health is really the pivot point between a life and annuity sale for accumulation purposes. The single biggest misconception about life insurance is the perceived cost. Over the life of the client, an overfunded VUL design for a healthy individual is actually comparable in cost to a variable annuity product, while offering superior value on an after-tax basis for income. To take it a step further, in a large degree of variable annuities, the first distribution ends up being a death benefit, which is a taxable event to beneficiaries. Whereas, in a life product, the death benefit is a tax-free transfer.
In any VUL sale, the client is subject to medical underwriting. Outside of perceived cost, this is the single biggest deterrent for financial advisors and clients alike when considering life insurance. Over the past five years, with Big Data, predicative analytics, electronic medical files and access to information, insurance carriers have begun offering accelerated underwriting programs that take the typical underwriting sales cycle from 30-60 days to 10-15 days. As you might imagine, there are parameters on what qualifies for accelerated underwriting. Accelerated underwriting is usually reserved for clients with no major medical conditions, between ages 25 and 60, and up to a maximum of $1 million face amount (death benefit).
With these parameters as an example, a 35-year-old with a standard non-tobacco rating could invest in a five-pay VUL of around $30,000 a year while still sitting below that $1 million face amount threshold. We’ve been told independently by chief underwriters of two major insurance carriers that the next expansion of the program will be to push the $1 million face amount to a higher level, but they don’t see the age limit being expanded above 60 anytime soon.
The consensus among industry professionals is that accelerated underwriting is the future of permanent life insurance sales, and creates a more transactional experience for both consumers and advisors. As VUL and other cash value life insurance products become transactional, it sets the stage for mass-market appeal. We believe it will be a gradual shift from a point-of-sale distribution model, to a traditional wholesale model. We also believe that someday VUL will be as transactional as dropping a variable annuity ticket for a client for either a protection or accumulation design.
There are other ancillary uses for VUL beyond the scope of this article — including business applications, private placement and the combination of chronic illness and long-term care riders. But it is clear that VUL deserves deeper consideration among financial planners and clients.