Variable universal life insurance: weighing the pros and cons

Advisors differ on the ideal age for a buyer. Shannon looks for high-earning professionals in the "thirtyish" age range who have maxed out other retirement savings options and have a life insurance need.

In contrast, Cahill says older clients can benefit from VULs. He cites the example of a hypothetical buyer, age 63, who plans to work for another seven years and can afford to invest several hundred thousand dollars annually in the contract while he's still working.

Kazinec reports placing VULs successfully with clients ranging in age from their twenties to their fifties. Younger clients can increase premiums in later years based on catch-up provisions allowed under the MEC rules, he points out. "It's a carry forward, which is a great tool for younger folks to use with potential increases in income and bonuses and lump sums and inheritances in the future," Kakinec says. 

VUL provides additional planning benefits. In many states, life insurance contracts' cash surrender value is exempt from creditors, which can benefit clients at risk of being sued. However, Cahill maintains that the most important factor is the policy's impact on the client's wealth.

"What I look at is, is my after-tax cash surrender value higher in the life insurance policy at the end of seven years or is it going to be higher if that (premium) goes directly into the mutual funds assuming, a blended tax rate on the funds of 30 percent?" asks Cahill. "If it's going to be higher in the cash surrender value on a projected basis, then of course [I buy the VUL policy] because I'm saving on taxes." 

The costs 

The after-tax comparison requires considering VUL's costs and critics point to these fees as a significant drawback to VUL. The terminology can differ among insurers but policy fees and charges for VUL products are generally comprised of a premium load, administrative charge, cost of insurance, charges for optional riders and benefits, and in some cases, an asset based mortality and expense charge, Miscolta says. Also, the underlying insurance dedicated funds incur fund operating expenses, but these expenses are reflected in the daily unit value of each variable subaccount.  

Charges such as cost of insurance, coverage charges, and certain optional riders are based on a person's age, gender, health status and/or occupational hazards, so it is very difficult to cite an average or approximate range, he explains. The best way to determine how changes influence policy charges is for an individual to obtain a personalized hypothetical illustration that shows how the VUL policy operates. 

Cutting through the complexity 

As the list of fees indicates, VULs have multiple moving parts. Consequently, advisors risk overwhelming clients with details and policy options. Kazinec shows clients the interaction between subaccounts' rates of return and premium funding levels by presenting multiple possible outcomes. 

"I'm always showing them different rates of return and different funding schedules so they get an understanding of minimum-type funding, target-type funding and maximum IRS funding," he says. "If you did that, based on the same rates of return, here's how [the illustration] looks."  

The exercise is not just a sales technique; it's also an approach for minimizing potential compliance problems and clients' later claims that they didn't understand something about the contract. 

Advisors need to be certain the client understands the product, he says, "So you don't get surprises later. It's all about doing the job right upfront so you don't have complaints down the road." 

Cahill similarly spends ample time going through the illustrations. Every VUL carrier provides a cost sheet that usually details the premium, the purpose of the premium loads, the various costs of insurance, mortality and expense charges, policy fees, and taxes.

After reviewing those items, he shows the client internal rate of return calculations for both cash surrender value and the life insurance value (at the client's death) to determine a policy's potential after-tax financial return on the premiums paid. With that information, he can then compare the results to investing in a mutual fund or another taxable account.

He cites an example using a seven-pay proposal. Assuming a reasonable expected return on the policy's cash value and a suitable mutual fund, he compares the projected returns at the end of the seven years. If the outcome on the VUL is better than the taxable fund's outcome, it's worth considering the VUL, he says.  

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