Rethinking Variable Universal Life
Advisors and consumers often think of variable universal life (VUL) as just an equity-linked product. But for many, VUL is much more than that.
This article seeks to encourage a rethinking of VUL as a unique life insurance product that provides control, flexibility and transparency in a low cost product chassis, while providing the potential for enhanced returns through access to equity investment allocations.
VUL has been primarily defined as an equity-linked product, and historical industry VUL sales tend to follow stock market results—VUL sales are up when the stock market performs well and vice versa. However, it is interesting to see the lasting impact of the 2008 financial crisis: even as subsequent stock market returns (e.g., S&P 500) have been positive, VUL sales have continued to decline. (Eight percent VUL sales distribution in 2013, compared to a high of 36 percent in 2000—see Historical VUL Sales Distribution Versus S&P 500 Returns).
VUL sales for the ultra-affluent, as measured by M Financial Group sales, tend to follow stock market results to a lesser degree than industry sales. VUL remains the product of choice for the ultra-affluent, with a 43 percent sales distribution in 2013. Advisors to the ultra-affluent—and consequently, the ultra-affluent themselves—are more aware of the other attractive attributes of VUL, which will be covered in this article.
Relative to other types of life insurance, VUL affords the policyowner utmost control. VUL policyowners can allocate the cash value among numerous available investment options. Contrast this to other product types, such as whole life (WL) and universal life (UL), where only one investment option is available (the general account), which is managed by the insurance company.
Some may argue that UL and WL avoid the investment risk of VUL, but this is not the case. There is investment risk with WL and UL (e.g., declining dividend interest rates and crediting rates) and the carrier maintains investment control. With VUL, policyowners can determine the amount Historical VUL Sales Distribution Versus S&P 500 Returns
Source: LIMRA Technical Supplement – U.S. Individual Life Insurance Sales of investment risk based on their specific financial situation and objectives, while having the opportunity to benefit directly from their decisions.
In a dynamic investment environment, flexibility is an advantage. UL products only offer the general account, and indexed UL (IUL) products offer indexed accounts and the general
Most are aware that VUL offers the potential for enhanced returns through access to equity mutual funds. While historical results do not predict future performance, they can provide perspective. See S&P 500 historical returns to the right, where long-term (20 years or more) annual returns are in the 10 percent range. Also note the recovery since the 2008 financial crisis, with the annual return over the last five years in excess of 15 percent.
But the advantages of VUL go beyond access to the equity markets. The strength of VUL can also be seen in three areas: control, flexibility and transparency in a low-cost product chassis.
Historical S&P 500 (with Dividends) Compound Annual Growth Rates Through December 31, 2014
Source: Yahoo Finance
account. VUL is unique in that it offers maximum flexibility with access to all three available investment account options: 1) general account, 2) indexed account and 3) separate account.
- The general account is managed by the insurance company, where typically more than 80 percent of the portfolio distribution is investment grade bonds and mortgages. The general account provides a crediting rate based on portfolio returns with book value accounting (less volatility) and provides protection with a guaranteed minimum crediting rate floor (e.g., 2 percent).
- Indexed accounts provide crediting rates based on equity returns (e.g., S&P 500), subject to a participation rate (e.g., 100 percent), a cap rate (e.g., 12 percent), and a floor (e.g., 0 percent).
- The separate account can offer numerous investment choices, including bond and stock mutual funds. These accounts allow the policyowner exposure to financial markets in an amount and risk level at their discretion. Combining these investments options with #1 and #2 above may generate higher returns with acceptable risks.
Most VUL products today offer separate account and general account options, with more and more VUL products also offering indexed accounts. The VUL products offering all three investment options enable the policyowner optimal flexibility so that allocation adjustments can be made as market conditions—and personal objectives and needs—shift.
Within the separate account, VUL is the only product to provide transparency of the underlying asset allocation and results—there is no“black box.” Investments are directed by the policyowner and market values are reported and credited to the policy cash value.
The initial VUL products introduced in the 1980s were expensive and came with high product charges. This reputation still lingers, but the reality is VUL products offered today have charges that are comparable to UL (i.e., not necessarily more expensive). As a result, VUL does not necessarily require a high return in order to compete with other products. Depending on the product, VUL may only require a 4.5 to 5.5 percent return to compete with UL, and still offers an upside performance opportunity with potentially higher returns from the underlying investments.
BREADTH OF INVESTMENT OFFERINGS (EQUITIES AND FIXED INCOME)
In addition to investment flexibility, today’s most sophisticated VUL products offer a wide range of investment alternatives. Some of the more popular VUL products feature more than 80 subaccounts managed by investment firms such as Vanguard,
- Rowe Price, Dimensional Fund Advisors and other respected firms.
A common fallacy when discussing VUL is to associate the investment risk to equity financial markets only. This is not the case as a VUL policy’s cash value can be allocated among equity and fixed income options, not unlike a typical 401(k) plan. For example, a policyowner can implement a balanced allocation with 60 percent equity exposure and 40 percent fixed income exposure to take advantage of long-term equity returns while reducing volatility with fixed income investments. Fixed income exposure can generally be obtained via bond subaccounts or direct investment in the carrier’s general portfolio via allocation to the general account.
Many VUL products also offer investment choices commonly found in 401(k) plans for those who may be uncomfortable managing asset allocations:
- Portfolio optimization asset allocation models ranging from conservative (e.g., 20/80 stock/bond allocation) to more aggressive (80/20 stock/bond allocation);
- Life Cycle funds, which automatically reallocate to more conservative investments as the policyowner reaches retirement.
Many VUL products also offer automatic portfolio rebalancing to provide ongoing targeted diversification.
MANAGEMENT OF VUL
As with any investment, VUL policies must be managed appropriately and consistently to maximize long-term benefits. Important issues to consider and manage include premium funding, investment allocation and policy performance. It is recommended (and common) to assume what may be considered a conservative growth rate assumption, such as 5 or 6 percent, and fund the policy accordingly. If actual investment performance exceeds the assumed rate, future premiums could be reduced or even eliminated. Performance of a financial investment—both equity and fixed income—will vary over time. It is important to review the investment selections regularly (e.g., semi-annually) and adjust as needed based on an agreed-upon investment philosophy. Actual investment performance in a VUL policy will directly impact policy performance. This impact—both positive and negative—should be monitored at least annually. This does not necessarily mean that action should be taken every year, but the policyowner should understand how investment returns are impacting policy performance so that he/she will be ready to take action when needed.
VUL is much more than an equity-linked product. In the interest of your clients, take some time to rethink VUL as the only product type to offer control, flexibility, transparency and low cost designed to address their needs and objectives.