Variable Life Insurance: Structure and Features

9.2.1 Structure and Features

Variable life insurance is a type of permanent life insurance that offers both a death benefit and a savings component, where the cash value can be invested in a variety of separate accounts, similar to mutual funds. This section will delve into the intricate details of variable life insurance, focusing on its structure, features, and the rights and guarantees offered to policyholders.

Premium Structure

Variable life insurance policies typically have a flexible premium structure, allowing policyholders to adjust their premium payments within certain limits. This flexibility can be advantageous for policyholders who experience fluctuations in their income or financial priorities.

• Fixed vs. Flexible Premiums: While some variable life insurance policies require fixed premium payments, others allow for flexible premiums. Flexible premium policies enable the policyholder to decide how much to pay, within the minimum and maximum limits set by the insurer. This flexibility can help policyholders manage their cash flow and maintain their policy during financial hardships.

• Allocation of Premiums: A portion of the premium goes towards the cost of insurance, while the remainder is invested in the policy’s separate accounts. The policyholder can choose how to allocate the investment portion of the premium among the available separate accounts, which can include stocks, bonds, money market funds, and other investment vehicles.

Investment Options

One of the defining features of variable life insurance is the ability to invest the policy’s cash value in a range of separate accounts. This investment flexibility allows policyholders to potentially increase the cash value of their policy based on the performance of the chosen investments.

• Separate Accounts: Policyholders can choose from various separate accounts that offer different investment strategies and risk levels. These accounts are similar to mutual funds and can include equity funds, bond funds, balanced funds, and money market funds.

• Investment Risk and Returns: The cash value of a variable life insurance policy is subject to market risk, meaning its value can fluctuate based on the performance of the underlying investments. While this presents an opportunity for growth, it also means that the cash value and potentially the death benefit can decrease if the investments perform poorly.

• Policyholder Control: Policyholders have the right to direct their investments and make changes to their portfolio allocations. This control allows them to tailor their investment strategy to align with their financial goals and risk tolerance.

Policyholder Rights and Guarantees

Variable life insurance policies come with specific rights and guarantees designed to protect the policyholder and provide financial security.

• Death Benefit: The primary guarantee of a variable life insurance policy is the death benefit, which is typically a fixed amount that the insurer pays to the beneficiaries upon the policyholder’s death. Some policies offer a minimum guaranteed death benefit, regardless of the investment performance.

• Policyowner’s Rights: Policyholders have the right to adjust their premium payments (within limits), choose and change investment options, and access the policy’s cash value through loans or withdrawals. These rights provide policyholders with a high degree of flexibility and control over their policy.

• Loan and Withdrawal Provisions: Policyholders can borrow against the cash value of their policy or make withdrawals, subject to certain conditions and potential tax implications. Loans must be repaid with interest, and withdrawals can reduce the death benefit.

• Surrender Value: If a policyholder decides to surrender the policy, they are entitled to receive the cash surrender value, which is the cash value minus any surrender charges and outstanding loans.

Policy Illustrations

Policy illustrations are essential tools that help policyholders understand the potential performance of their variable life insurance policy. These illustrations provide projections based on assumed rates of return and can help policyholders make informed decisions about their premium payments and investment choices.

• Understanding Policy Illustrations: A policy illustration shows how the cash value and death benefit of a policy could change over time based on different assumed rates of return. It includes details about premium payments, investment allocations, and potential policy charges.

• Assumptions and Variables: Policy illustrations are based on assumptions about future investment performance, interest rates, and policy charges. It’s important for policyholders to understand that these are projections, not guarantees, and actual results may vary.

• Using Illustrations for Planning: Policyholders can use illustrations to evaluate different scenarios and make adjustments to their premium payments or investment allocations to better align with their financial goals.

Regulatory Considerations

Variable life insurance is subject to regulation by both state insurance departments and federal securities regulators. This dual regulation ensures that policyholders are protected and that insurers provide clear and accurate information about their policies.

• State Insurance Regulation: State insurance departments oversee the insurance aspects of variable life policies, including premium rates, policy forms, and consumer protections.

• Federal Securities Regulation: Because variable life insurance involves investment risk, it is also regulated as a security by the Securities and Exchange Commission (SEC). Insurers must provide a prospectus to policyholders, detailing the investment options and associated risks.

• Compliance and Disclosure: Insurers are required to comply with both state and federal regulations and provide clear disclosures about the policy’s features, risks, and costs. This transparency helps policyholders make informed decisions.

Practical Examples and Scenarios

To better understand the structure and features of variable life insurance, let’s explore a few practical examples and scenarios that illustrate how these policies work in real-world situations.

Example 1: Flexible Premium Payments

John, a 35-year-old professional, purchases a variable life insurance policy with a flexible premium structure. Initially, he pays a higher premium to build up the policy’s cash value quickly. However, when he experiences a temporary reduction in income, he reduces his premium payments to the minimum required amount, allowing him to maintain his policy without financial strain.

Example 2: Investment Choices and Performance

Sarah, a 40-year-old policyholder, allocates her policy’s cash value among several separate accounts, including an equity fund, a bond fund, and a money market fund. Over time, the equity fund performs well, increasing the overall cash value of her policy. However, during a market downturn, the cash value decreases, prompting Sarah to re-evaluate her investment strategy and make adjustments to her portfolio.

Example 3: Policy Loans and Withdrawals

Mike, a 50-year-old policyholder, needs funds for a home renovation project. He decides to take a loan against the cash value of his variable life insurance policy. The loan allows him to access the funds he needs without surrendering the policy, and he plans to repay the loan over time to restore the cash value and maintain the full death benefit.

Best Practices and Common Pitfalls

When considering a variable life insurance policy, it’s important to be aware of best practices and common pitfalls to ensure that the policy aligns with your financial goals and provides the intended benefits.

• Best Practices:

  • Regularly review and adjust your investment allocations to align with your financial goals and risk tolerance.
  • Use policy illustrations to evaluate different scenarios and make informed decisions about premium payments and investment choices.
  • Stay informed about the policy’s features, charges, and potential tax implications.

• Common Pitfalls:

  • Failing to monitor and adjust investment allocations can lead to suboptimal performance and reduced cash value.
  • Not understanding the policy’s charges and fees can result in unexpected costs and reduced returns.
  • Ignoring the impact of loans and withdrawals on the policy’s cash value and death benefit can lead to unintended consequences.

Conclusion

Variable life insurance offers a unique combination of life insurance protection and investment flexibility. Understanding the structure and features of these policies is essential for making informed decisions and maximizing their benefits. By carefully considering the premium structure, investment options, policyholder rights, and regulatory considerations, you can tailor a variable life insurance policy to meet your financial goals and provide long-term security for your beneficiaries.

Series 7 Exam Practice Questions: Structure and Features