Variable Universal Life (VUL)

Variable universal life is permanent life insurance built on the universal life chassis, with the policy value invested in separate-account subaccounts chosen by the owner rather than credited at a rate the insurer declares. NAIC's Glossary of Insurance Terms defines it as a product that "combines the flexible premium features of universal life with the component of variable life in which excess credited to the cash value of the account depends on investment results of separate accounts," and adds that "the policyholder selects the accounts into which the premium payments are to be made." Everything universal life does with a running account, this product does with a running account whose balance moves with securities markets.

The naming is worth pinning down, because the market and the regulators use different words and a reader searching one will not find the other. Consumers, agents and insurers say variable universal life, or VUL. The Securities and Exchange Commission regulates the class under a broader label: 17 CFR 230.498A(a) defines a "Variable Life Insurance Contract" as "a life insurance contract, issued by an Insurance Company, that provides for death benefits and cash values that may vary with the investment performance of any separate account." That definition reaches scheduled-premium variable life as well, so it is wider than the market term. NAIC's glossary keeps both, carrying "Variable Life Insurance" and "Variable Universal Life" as separate entries.

The securities layer is what separates this product from the rest of the family, and it is not a technicality. A variable universal life contract is registered with the SEC. The registration form is Form N-6, which under 17 CFR 239.17c is the "registration statement for separate accounts organized as unit investment trusts that offer variable life insurance policies." The buyer receives a prospectus rather than the sales illustration and policy summary that govern a non-variable policy, and the person selling it needs a securities registration in addition to a state insurance license. The same split exists on the annuity side of the business, between a fixed indexed annuity and a variable annuity, and in both cases the classification decides who may sell the contract and what the buyer is handed at the point of sale.

Two NAIC model regulations carve it out, which is where the disclosure difference comes from. The Universal Life Insurance Model Regulation applies to all individual universal life policies except variable universal life. The Life Insurance Disclosure Model Regulation, which is the source of the policy summary and the buyer's guide a purchaser normally receives, states at section 3.B(5) that it does not apply to "variable life insurance under which the amount or duration of the life insurance varies according to the investment experience of a separate account." So the state insurance disclosure regime steps back and the federal securities disclosure regime steps in. Neither of those model regulations is federal law, and each state adopts them with its own variations, but the pattern of the carve-out is consistent.

The absence of a floor is the whole risk, and it is the exact inverse of an indexed policy. Indexed universal life credits a share of an index's rise subject to a cap, and credits zero rather than a loss when the index falls. A variable policy has neither limit: a strong year in the subaccounts is credited in full, and a bad year is debited in full. What both products share is that the cost of insurance and the expense and rider charges are deducted from the account every month regardless. In a falling market that combination compounds against the owner, because the charges are taken from a shrinking base and the cost of insurance itself rises with the insured's attained age. A contract that was funded on the assumption of a particular return can therefore reach a point where the account no longer covers the monthly deductions, and the coverage lapses unless the owner puts in more money or reduces the death benefit.

The consequence for how the product is evaluated. A prospectus discloses the subaccount expenses, the mortality and expense charges, and the surrender schedule, and an illustration projects the policy forward at assumed rates. The projection is not a guarantee and the assumed rate is the single input that most changes the answer, so the useful exercise is to ask for the same illustration at a materially lower assumed return and read what happens to the premium required to keep the policy in force.

Premium goes into the contract, an expense load comes off the top, and what remains is allocated among the subaccounts the owner has chosen. Each month the insurer deducts the cost of insurance for the current death benefit and the contract's other charges from the account. Whatever is left rides the subaccounts. The death benefit is generally the face amount, though many contracts offer an alternative option under which the account value is added to it. The owner may usually change the allocation among subaccounts, vary the premium, and adjust the death benefit, subject to the contract's own limits and, for an increase, new evidence of insurability.

A hypothetical, to show what having no floor costs. Suppose a policy holds $50,000 of account value at the start of a year and the contract's charges, including the cost of insurance, total $250 a month, or $3,000 for the year. The subaccounts lose 20 percent over that year. Taking the charges first, the account has $47,000 exposed to the market, and a 20 percent decline on $47,000 is $9,400. The account ends the year at $37,600, a fall of $12,400 on a market decline of 20 percent. An indexed policy with a zero floor and the same $3,000 of charges would have ended at $47,000 in the same market. The figures are invented for the arithmetic, and a real contract deducts monthly rather than annually, so the exact result differs; what the comparison shows is that the charges are additive to the market loss rather than absorbed by it.

The same arithmetic run forward is why these contracts need monitoring rather than filing away. Two or three years like the one above, early in a policy that was funded to a projection, can leave the account too thin to carry the monthly deductions a decade later, at an age when adding money is harder and the cost of insurance is higher.

Pros

• The owner controls the investment allocation and receives the full return of the subaccounts chosen, without a cap or a participation rate skimming the upside.
• The account grows without current income tax while it stays inside the contract, and the death benefit is generally received free of income tax.
• Premium and death benefit are adjustable after issue, the same flexibility the universal life chassis gives any policy built on it.
• Registration brings a prospectus, which discloses subaccount expenses and contract charges in a standardized form rather than leaving them to a sales illustration.

Cons

• There is no floor. A losing year in the subaccounts is debited in full, and the contract's charges come out on top of it.
• The failure mode is lapse rather than a smaller balance: an account drained by poor returns and rising cost of insurance stops supporting the coverage, which is the worst possible outcome for a policy bought for protection.
• It requires ongoing attention to the allocation, the funding level and the annual report, over decades.
• Insurance charges sit on top of subaccount expenses, so the same funds inside a policy carry a cost that the same funds in an ordinary investment account do not.
• Premiums are large relative to term coverage, and sales compensation on life insurance is typically calculated as a percentage of premium, so the compensation on the sale scales with the size of the contract.