Variable Life Insurance

Life Insurance Basics

Before diving into variable life insurance specifically, it is important to understand the basic types of life insurance and how variable life fits into the broader landscape. Life insurance products are designed to provide a death benefit to beneficiaries upon the death of the insured person. The two fundamental categories are term life insurance and permanent (cash value) life insurance.

Term Life Insurance

Term life insurance provides coverage for a specific period (the "term"), such as 10, 20, or 30 years. If the insured person dies during the term, the beneficiary receives the death benefit. If the insured survives the term, the coverage expires with no value. Term life is the simplest and least expensive form of life insurance. It is purely a death benefit with no investment or cash value component. Term life is NOT a security and does not require a securities license to sell.

Whole Life Insurance

Whole life insurance provides permanent coverage for the insured's entire lifetime, as long as premiums are paid. It has two components: a death benefit and a cash value component. The cash value grows at a guaranteed rate set by the insurance company, and the premiums are fixed for the life of the policy. The insurance company invests the premiums in its general account, which means the policyholder does not bear investment risk but also does not participate in market gains. Whole life is NOT a security.

Universal Life Insurance

Universal life insurance is a flexible permanent life insurance product that allows the policyholder to adjust premiums and death benefits within certain limits. Like whole life, the cash value earns a guaranteed minimum interest rate set by the insurance company, and the funds are held in the general account. Universal life is NOT a security (unless it is a variable universal life policy).

Variable Life Insurance (VLI) Features

Variable Life Insurance (VLI), also called Scheduled Premium Variable Life, is a permanent life insurance policy where the cash value is invested in subaccounts chosen by the policyholder, similar to a variable annuity. The investment performance of these subaccounts directly affects the cash value and may affect the death benefit. Because the policyholder bears the investment risk, VLI is classified as a security and must be sold with a prospectus.

Key Features of Variable Life Insurance

• Fixed, scheduled premiums: Unlike variable universal life, VLI has fixed premiums that must be paid on schedule. If premiums are not paid, the policy may lapse.
• Guaranteed minimum death benefit: Regardless of how poorly the subaccounts perform, the death benefit will never fall below a guaranteed minimum (typically the face amount of the policy). This guarantee distinguishes VLI from some other variable products.
• Variable cash value: The cash value fluctuates based on the performance of the selected subaccounts. There is no guaranteed minimum cash value. The cash value can decline to zero if the subaccounts perform very poorly, though the death benefit guarantee still applies.
• Variable death benefit: While there is a guaranteed minimum, the death benefit can increase above the guaranteed amount if the subaccounts perform well. The death benefit reflects the guaranteed minimum plus any excess cash value generated by strong investment performance.
• Separate account: The cash value portion is held in the insurance company's separate account, protected from the insurer's creditors.
• Subaccount selection: The policyholder can choose from various subaccounts (equity, bond, money market, etc.) and can typically transfer between subaccounts without tax consequences.

Variable Universal Life (VUL) Insurance

Variable Universal Life (VUL) combines the investment flexibility of variable life with the premium flexibility of universal life. It is the most flexible type of variable insurance product and is also the most complex.

Key Differences from Standard Variable Life

• Flexible premiums: Unlike standard VLI with fixed premiums, VUL allows the policyholder to vary the amount and frequency of premium payments within certain limits. The policyholder can pay more in good years and less in lean years, as long as the cash value is sufficient to cover the cost of insurance.
• Adjustable death benefit: The policyholder can increase or decrease the death benefit (subject to insurability requirements for increases).
• No guaranteed minimum death benefit: This is a critical distinction from standard VLI. Because VUL premiums are flexible, the insurance company cannot guarantee a minimum death benefit in the same way. If premiums are insufficient and the cash value is depleted, the policy can lapse.
• Same subaccount structure: Like VLI, the cash value is invested in subaccounts within the separate account.

Cash Value and Policy Loans

The cash value of a variable life insurance policy represents the investment value accumulated within the policy's separate account. It serves multiple purposes: it can be borrowed against through policy loans, it can be surrendered for its cash surrender value, and it contributes to the overall death benefit.

How Cash Value Builds

When a policyholder pays premiums on a variable life policy, the insurance company deducts the cost of insurance (mortality charges), administrative expenses, and any other fees. The remaining amount is invested in the selected subaccounts within the separate account. Over time, if the investments perform well, the cash value grows. If they perform poorly, the cash value can decline. Unlike whole life insurance, there is no guaranteed rate of return on the cash value in a variable life policy.

Policy Loans

One of the valuable features of permanent life insurance (including variable life) is the ability to borrow against the cash value through policy loans. Key points about policy loans include:

• Loan availability: The policyholder can typically borrow up to a percentage (often 75-90%) of the cash value at any time without qualification or credit checks.
• Interest charged: The insurance company charges interest on the loan, typically at a competitive rate. If interest is not paid, it is added to the loan balance.
• No required repayment: Policy loans do not have a mandatory repayment schedule. The policyholder can repay at any time or not at all. However, outstanding loans reduce the death benefit and cash surrender value.
• Tax treatment: Policy loans are NOT considered taxable income because they are a loan, not a withdrawal. However, if the policy lapses or is surrendered with an outstanding loan balance, the loan amount may become taxable.
• Impact on death benefit: Any outstanding loan balance (principal plus accrued interest) is deducted from the death benefit paid to the beneficiary.

Cash Surrender Value

The cash surrender value is the amount the policyholder receives if they cancel (surrender) the policy. It equals the cash value minus any surrender charges and outstanding policy loans. During the early years of a policy, surrender charges may significantly reduce the amount received. Variable life policies, like variable annuities, often have declining surrender charge schedules.

Separate Account vs. General Account

Understanding which insurance products use the separate account versus the general account is a fundamental Series 6 concept that applies to both variable life insurance and variable annuities.

The General Account

The insurance company's general account holds the assets that back the company's fixed, guaranteed obligations. Products funded through the general account include:

• Term life insurance
• Whole life insurance
• Fixed annuities
• Fixed universal life insurance
• The guaranteed minimum death benefit portion of variable life

Assets in the general account are subject to the claims of the insurance company's creditors. The insurance company assumes the investment risk and guarantees the returns or benefits. General account products are NOT securities.

The Separate Account

The separate account holds assets that are segregated from the general account. Products funded through the separate account include:

• Variable annuities (cash value portion)
• Variable life insurance (cash value portion)
• Variable universal life insurance (cash value portion)

Assets in the separate account are NOT subject to the claims of the insurance company's creditors. The policyholder or contract owner assumes the investment risk. The separate account is registered as an investment company with the SEC, and the products are securities requiring a prospectus.

Suitability Considerations for Variable Life

Variable life insurance is a complex product that is not suitable for all clients. Series 6 representatives must carefully evaluate whether the product is appropriate based on the client's needs, goals, and financial situation.

When Variable Life May Be Suitable

• The client needs permanent life insurance protection (not just temporary coverage)
• The client has a long time horizon and can tolerate investment risk
• The client wants the potential for higher cash value growth than whole life offers
• The client is in a high tax bracket and benefits from tax-deferred growth
• The client understands the risks and has been fully informed through the prospectus
• The client has already maximized contributions to other tax-advantaged accounts (401(k), IRA)

When Variable Life May NOT Be Suitable

• The client only needs temporary death benefit protection (term life would be more appropriate and less expensive)
• The client is risk-averse and uncomfortable with fluctuating cash values
• The client cannot commit to paying the scheduled fixed premiums
• The client is primarily seeking an investment vehicle (a mutual fund or variable annuity might be more appropriate)
• The client is elderly and the cost of insurance would consume most of the premiums