Variable Life Insurance

What is Variable Life Insurance?

Variable life insurance is a form of life insurance that combines the characteristics of life insurance and investment. The differentiating characteristics of a variable life insurance policy include policy loans and investment options.

Variable Life Insurance – Characteristics

1. Premium

As with any life insurance policy, variable life insurance mandates the beneficiary to pay premiums into an account. This payment includes an advisory services fee, which reduces the effective premium deposited into the account. The premium then gets invested into one or more investment options, per the discretion of the policyholder. The investment options typically consist of a variety of mutual funds.

Holders may also deposit a part of the premium into a fixed account, which pays a certain rate of interest that is subject to periodic changes by the insurance company, but a guaranteed minimum is ordinarily provided.

2. Death benefit

Like any other life insurance, variable life insurance provides a death benefit. It is usually significantly larger than the net premium paid by the policyholder. By definition, a death benefit is the money received by the dependents or declared beneficiaries upon the death of the policyholder.

The death benefit is based on a face amount that is selected by the holder at the time of purchase of the policy. Usually, the death benefit includes the face amount plus either the current cash value of the account or the net contribution to the policy in the form of premium payments.

3. Policy loans

Another important characteristic of variable life insurance is policy loans. Holders may be permitted to borrow a given portion of the policy’s cash value. The benefit here is that holders are not required to pay federal taxes on the loan withdrawal, nor do they incur surrender charges.

One of the drawbacks of taking out loans, however, is that the effective cash value of the policy is reduced. That, in turn, reduces the death benefit receivable by the beneficiaries of the holder. Taking a loan against the policy also increases the probability of lapse of the policy. In case of a lapse when an outstanding loan exists, the holder may also lose their tax benefit, as the withdrawal is then considered for federal tax purposes.

4. Investment options

The policy includes a cash value account and a fixed account. The cash value account allows investments in a variety of sub-accounts. The number of sub-accounts per policy may go up as high as 50.

Variable Life Insurance – Disadvantages

• It is not an appropriate short-term savings vehicle, since it is designed to meet long-term financial objectives or provide a death benefit, or both.
• If the holder does not maintain sufficient cash value in their account to pay their policy premiums, then the policy lapses. A lapse is an effective termination without value, which means that the beneficiary is not eligible to receive any death benefit.
• The total policy fees and expenses add up to be a significant liability. Expenses associated with owning a policy typically include surrender charges and a number of fees that are deducted from the premium payments.
• Variable life insurance also comes with the inherent risk of loss of initial premium payments, which is exacerbated by the risk associated with the investment option chosen. The performance of the investment dictates the policy value and any returns earned from it. Therefore, the beneficiary must perform an in-depth review of an investment option’s prospectus before making an investment decision. Other factors, such as management fees and volatility of the fund, must also be considered.
• There is also an inherent risk of failure of the insurance company itself. All guarantees offered to the beneficiary, including the death benefit, are dependent on the financial strength of the issuing company. The company may be unable to meet its obligations in cases of financial distress.

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