As we’ve noted, variable universal life is complex: think of these policies as hybrid products that incorporate aspects of other types of life insurance and financial services products. One way to understand what VUL is – and better appreciate what it can do – is by reviewing the features of other types of policies and compare their relative merits:
Term life insurance
A term life insurance policy is exactly what the name implies: Coverage for a specific term or length of time, typically between 10 and 30 years. These policies are sometimes called pure life insurance products because unlike with a permanent life insurance policy, there’s no cash value component – term life is designed solely to give your beneficiaries a payout (called a death benefit) if you die during the term.
You’ve probably heard the phrase “affordable term life insurance rates.” That’s because one of the biggest advantages of term life insurance is the fact that it’s typically affordable (at least for younger buyers): you can generally get a larger death benefit for a relatively smaller monthly premium. It’s also simpler to understand and buy these insurance products.
Term coverage is temporary – once the term expires, your beneficiaries are no longer entitled to a death benefit – so you have to consider applying for new coverage at a typically higher cost or go without life insurance protection. Also, there’s no cash value component, so many people never see a payout despite years of paying premiums.
Whole life insurance
A whole life insurance policy provides permanent coverage that lasts your entire life as long as premiums are paid3. Like other permanent life coverage, it includes a cash value component: A portion of your premium dollars can grow over time on a tax-deferred basis4. In addition, whole life coverage has three defining characteristics:
- The premium remains the same for life
- The death benefit is guaranteed
- The cash value grows at a guaranteed rate
Cash value can provide a number of important benefits you can use while you’re still alive. It takes a few years to grow into a useful amount, but once that happens, you can borrow money against it, use it to help pay your premiums, or even use it for cash to supplement income in retirement5.
Whole life insurance is the simplest type of permanent coverage, and it provides the most guarantees. As long as premiums are paid, the policy can never be canceled. The cash value is insulated from market risk – it is always guaranteed to grow. Cash value is also a life-long asset that can be accessed to help meet financial goals up to and after retirement. In addition, when you get whole life insurance from a mutual company, such as Guardian, your policy can also earn annual dividends6. Since mutual companies are owned by their policyholders, you can receive a portion of the insurer’s profits, which can be used to increase the value of your policy and provide other benefits. While not guaranteed, most established mutual companies pay dividends consistently. Guardian has paid dividends every year since 1868.
For a given death benefit – e.g., $100,000 – premiums will be higher than term due, in part, to the added cash value component, along with the certainty of an eventual payout. Also, while the cash value grows at a guaranteed rate, other forms of permanent life insurance offer the potential for greater growth (along with greater downside risk).
Universal life insurance
A universal life policy is another form of permanent insurance that offers the tax-advantaged cash value and lifetime coverage benefits of whole life7. Similarly, cash value is guaranteed to grow at a specified minimum interest rate, and while these insurance policies don’t earn dividends, cash value can grow faster than the guaranteed rate depending on the insurance company’s investing experience performance. But there’s a key difference compared to whole life: the premiums are flexible. This gives added flexibility to people with variable incomes.8
With universal life insurance, you have the flexibility to raise or lower your premium payments as you see fit, within the limits of the policy. This makes the benefits of a permanent life insurance policy accessible to more people, especially those with variable incomes.
There’s a downside to flexibility – paying the minimum could result in the need to pay higher premiums in later years to keep your coverage. These policies are also more complex than a whole life policy and need to be managed or reviewed periodically to ensure that values are at a sufficient level to keep the policy in force. Finally, cash value has limited growth potential.
Indexed universal life
In an indexed policy, your cash value is tied to the performance of an index, such as the S&P 500 Index, with caps for minimum and maximum rates of return9,10. So for example, in a year where the index is up 20%, you may only see a 10%-12% gain. Conversely, if your chosen index is negative for the year, your cash value may stay the same.(depending on the specific terms of the indexed policy). Each insurance company has its own selection of indices available, and you may be able to choose more than one. You may also be able to allocate a portion of your funds in a fixed-rate interest account.
These policies offer the advantages of flexible premium universal life insurance along with the potential for more upside and market-driven cash value growth. At the same time, since your money isn’t directly invested in outside securities, downside risk can be minimized.
While there’s no actual market risk to your cash value account (i.e., it can’t lose value due to poor market performance), you can have 0% returns; this could cause cash value to decline due to policy and administrative costs. Also, because there is an upside cap, you may not realize the full gains of the reference index in a high-performing year.
Variable universal life
This brings us to the subject of this article: variable universal life insurance, which offers permanent life insurance coverage and flexible premiums along with greater potential for cash value gains – and greater market risk than the other types of policies previously discussed. Instead of tying cash value growth to an index, VUL gives you investment options called “subaccounts” that are very similar to mutual funds. Each subaccount investment options is offered by a prospectus, which contains important information such as investment objectives and performance history, and you will need to choose how much of your cash value to invest in each subaccount. There are also management fees and other expenses, which typically range11.
The advantages and disadvantages revolve entirely around risk and reward: reward (i.e., upside growth) in a VUL policy is not limited by caps –but there is no floor to downside risk associated with the investment options you select either. If you choose to invest in stock-based investment option in a very good year for the stock market, the value of your subaccounts (and cash value) can rise substantially. In a bad year, they can and will decrease substantially if the funds you select perform poorly.
“Variable life insurance” is not the same as “variable universal life insurance,” although it’s easy to confuse the two. Both kinds of policies are “variable” because investments are not guaranteed – cash values in both types of policies can and will dories and fall based on the market performance of the investment options selected by the policy owner. The main difference has to do with premium flexibility:
- A variable life insurance policy does not offer premium flexibility
- A variable universal policy lets you raise and lower premiums within a certain range
The death benefit in both types of variable policies can also fluctuate depending on the performance of the underlying investment selections and the amount of money in the cash account. However, the two policies provide different death benefit options:
- A variable life policy typically offers a guaranteed death benefit rider that states the payout will not drop below a certain level even if the underlying investments perform poorly. However, this will typically cause premium payments to increase.
- A variable universal life policy lets policyholders increase or decrease the death benefit independent of how the cash value account is doing, as long as they are willing to adjust premium payments accordingly. An increase will typically require a medical exam or evidence of good health; a decrease may incur certain charges. Also, the death benefit can be fixed (i.e., set at the original or amended face amount) or variable (i.e., equal to the face amount plus any cash value at the time of the policyholder’s death).
This type of life insurance policy can be a powerful tool for creating and protecting family wealth, but it is an inherently complex financial product that isn't for everyone. However, it could be an option for you. Ask yourself:
- Do you want greater cash value growth potential – along with a higher level of risk?
- Are you comfortable choosing and allocating investments?
- Do you want (or need) premium flexibility?
- Are you willing to commit to an annual (or more frequent) policy review in order to manage your investment subaccounts and premium payments?
- Are you willing to invest the time to evaluate policy options and customize a strategy to your needs?
If you answered yes to most or all of the above questions, then VUL insurance could be an option for you. However, you really can’t know for sure until you take the time to understand the specific provisions and investment options available to you. Review various “What if” scenarios with your financial professional to understand, for example, what happens to the death benefit if your investments don’t perform well. All of this means you should talk things over with an experienced professional who understands VUL and will take the time to learn about your specific situation and goals. How do you find such a professional? Ask a friend or colleague for a recommendation. Or, we can put you in touch with a Guardian representative who will provide you with a quote.
Is variable universal life insurance an option I should consider?
Compared to other types of permanent life insurance, a VUL policy offers more potential for cash value growth because it has an investment aspect. However, like other securities, the investment portion of the policy is not guaranteed, so cash value can and will decrease if the underlying investments perform poorly.
What is the difference between variable life insurance and variable universal life insurance?
Both types of policies let you invest cash value in market securities to take advantage of potential market gains (and are also subject to potential market losses), but the primary difference has to do with premium flexibility. A variable universal policy lets you raise and lower payments within a certain range – like other universal life policies. In a variable life insurance policy, premiums are fixed (like a whole life policy).
How does variable universal life insurance work?
A variable universal life policy provides permanent life insurance protection with a cash value component. Premiums are flexible and can be raised or lowered within certain limits. You also have investment options: market-based securities that can go up or down in value. For this reason, cash value growth is not guaranteed.