Q: As the financial markets have declined over the last two years, has my VUL insurance policy become a ticking time bomb ready to implode?
The Problem - Avoiding a Variable Universal Life Insurance Implosion
Like most people, you purchased life insurance to protect your family when you passed away. Unlike term, universal or whole life insurance, where there is no financial market risk component, Variable Universal Life insurance (VULI) is subject to financial market risk. Combining something that is intended to be your safest financial instrument (life insurance) with risky investments (stocks and bonds) can be a recipe for disaster.
Over the course of the last decade, insurance agents marketed and sold VULI policies with projections of 8%-12% returns on your investments inside the policy. Many agents did not stress the inherent risks of these types of policies - including the risk of the policy becoming worthless during and even after difficult financial market returns.
The Solution - Defuse the Implosion
Just a quick background on VULI and how it works. VULI is designed to provide a life insurance benefit for your entire life, like whole life insurance. Unlike whole life insurance, where cash values are invested at a fixed rate, VULI cash values are subject to financial market risk. If the values decline, as they have over the last two years, there may not be enough cash value to offset the annual life insurance premiums. This would require you to pay additional premiums or watch the policy implode (translation: the insurance company cancels the policy).
The Nuts and Bolts of a VULI Policy
Although often marketed as a retirement plan, VULI is simply stated...permanent life insurance. You can invest the cash value inside of the policy into one or more sub-accounts. Similar to mutual funds, sub-accounts invest in stocks, bonds and other risky investments. Although any gains and interest inside the policy are tax free, there are some important concerning aspects of these policies.
These include a host of fees:
1) premium expense charges,
2) policy fees,
3) mortality and expense (M&E) charges,
4) surrender charges,
5) increasing life insurance costs, and
6) additional rider fees.
Defusing the Implosion
The first step in defusing the implosion is obtaining a current prospectus that provides an overview of the policy. Next, obtain an in force illustration of the VULI policy, ideally every two to three years. It is at this is the time when the insurance agent's marketing pitch is reconciled with reality. Based on the conservative assumption you can gleam key data about the sickness or health of the policy. You may soon realize you have a time bomb ready to implode.
After careful review, determine:
1) which sub-account changes should or should not be made,
2) what additional contributions may be required,
3) if you want the policy to implode,
4) if the policy should be exchanged to another insurance carrier or another type of policy.
Making an Exchange
Fortunately, section 1035 of the Internal Revenue Code permits you to make a tax free exchange of a VULI policy to another insurance contract that is considered a "like kind exchange". There are a number of ways you can trip this up, so work closely with each carrier throughout this process.
Action Steps
Find out if your VULI policy is a ticking time bomb. Analyze all the data of your policy to determine if it is the best solution for your goals. Unless you are extremely comfortable reviewing an extensive set of tables provided with your in force illustration, work with a licensed insurance agent that has in depth analytical skills - ideally a CFA.
As the Financial Markets Have Declined Has My VUL Insurance Policy Become a Ticking Time Bomb?