Choosing permanent life insurance is a very interesting option. It will give you long-term peace of mind and guarantees that, when you die, your loved ones will receive a payout that helps them carry on in your absence. Some permanent insurance policies, such as whole life insurance, are relatively rigid products that do not always adapt well to your needs. If you need more flexible policies that can better adapt to your situation, you should consider purchasing variable life insurance. Variable permanent life insurance invests the cash value in a variety of separate accounts so you can obtain a bigger profit. In addition, when compared with less flexible products, this insurance leave many decisions in your hands, especially those related to investments. At the same time, this also means higher risks for you.
In this article, we will explain what variable life insurance is, how it works, and how it can benefit you.
Table of Contents
What is Variable Life Insurance?
Permanent life insurance is a stable product created for long-term performance. In contrast to term life insurance, which has a fixed period and then expires, permanent life insurance stays in effect for as long as the insured pays his or her policies. The objective is a payout or death benefit that will be collected by the beneficiaries designated by the insured after his or her death.
There are several types of permanent life insurance. The most traditional is whole life insurance (also known as traditional or ordinary life). This is the simplest form: level premiums are paid throughout the term of the insurance, and when the insured dies, the stipulated payout is made. This insurance has a savings component that accumulates and is paid to the insured in the form of cash value.
Other options are more flexible. For example, some allow you to modify premium amounts, increasing or decreasing them relative to your needs. Or they may offer more sophisticated and complex savings tools, so understanding the investment aspect is key in grasping determining factor in understanding how they function. These insurance types are variable, universal, and universal-variable, which is a combination of the other two.
In this article, we will try to explain in detail the workings of the first of these more adjustable products: variable life insurance. This is an option that is frequently used by people who are looking for more versatile insurance that provides greater returns on their money.
In the case of variable permanent insurance, the main difference from the other insurance types is in the associated savings mechanisms. One part of the money you contribute through your premiums is invested by the insurer in stock market products, which may be bonds, shares, or holdings in investment funds, that is, the equity market, which is where this insurance concept comes from.
These markets are volatile by nature, so possible returns are subject to fluctuate unpredictably. Profitability may be high or low, or there could be no profit at all.
The money generated by these investment instruments can also affect the death benefit paid out by the policy upon the death of the insured. This means that the payout will vary relative to the result of the investments made by the insurance company.
How Variable Life Insurance Works
The way variable-type permanent life insurance functions is simple, though it requires you to understand a few important concepts. How these concepts behave will affect the evolution of your insurance.
As with any life insurance, there are some fundamental elements: the insured, premiums, beneficiaries, payouts, investment instruments, and cash value. In contrast to whole life insurance, where these elements hardly change and stay stable and level for the entire duration of the insurance, variable insurance does experience changes to some of these elements.
- Qualification. As with any life insurance, the qualification or underwriting process determines whether you have a right to the policy or not. Remember that the biggest mistakes when buying insurance happen at this stage, generally because the insurance applicants lie about matters related to their health or lifestyle habits. In the process, the insurer will want to know your health status, and so will require extensive medical exams. The insurer will also want to know if you lead a healthy lifestyle and if you engage in risky activities, smoke, or have a dangerous job. Be candid and honest, because if you hide something and the insurance company finds out, they could cancel your insurance.
- Premiums. Premiums are monthly fees that you must pay in exchange for maintaining permanent life insurance. Under any and all circumstances, premium payments must be up-to-date in order for the payout to be made when the insured dies.
- Beneficiaries. Beneficiaries are people or institutions designated by the insured to collect the death benefit (payout) once the insured dies. The insured can modify the beneficiaries as many times as he or she wants, and can also decide how much money will correspond to each after their death. Keep in mind how important it is to choose your life insurance beneficiaries carefully, since for many, this choice ends up being problematic. And once you have chosen, notify them of the existence of the life insurance and let them know that they have been designated to collect it.
- Death benefit. Also called a payout, this is the quantity that belongs to the beneficiaries, the amount of money paid out by the insurance once the insured dies. As is the case with the majority of life insurance, this money is tax-free for whoever receives it. In the case of variable life insurance, this final quantity may or may not be level. This means that it can be a fixed quantity taken out when the policy was underwritten, or it can depend upon the investments made by the insurer in the equity market via savings instruments using the insured's money. Generally, there will be a minimum amount that will not decrease, even when the investments associated with the insurance perform poorly. However, this amount may peak if the investment performs favorably.
- Investment instrument. When purchasing variable life insurance, the insured is not just purchasing a death benefit. He or she also purchases one (or various) investment accounts that will be associated with the insurance. A part of the premium money is allocated for this investment, which is placed in one or several accounts that invest in equity products, such as shared, bonds, or holdings in investment, bond, money market, or mutual funds, or in other financial solutions. The final payout will fluctuate relative to the return from these investment accounts. Since they are subject to the equity market, these investments are not guaranteed, so they may or may not produce the profitability expected.
In contrast to other insurance types where the insured does not know how the savings is generated, transparency is the status quo for variable life insurance. As such, you decide which accounts and assets you invest in, so you should pay constant attention to the evolution of these investments. In addition, you can change them as many times as you want. Therefore, if you are leaning toward one of these variable insurance types, it is recommended for you to have financial knowledge: investment is not always easy and requires thorough knowledge of market risks. Generally, insurers have investment managers and advisers to help you with these transactions. If you are not totally sure about what you should do, turn to them, because the insurance company is not responsible for losses caused by poor management.
- Cash value. As with other types of life insurance, variable life insurance accumulates cash value that may be paid to the insured. This money comes from excess premium payments that occur during the first years of the insurance period, when the risk assumed by the company was lower and, as such, the premiums were higher than they needed to be. In the case of variable insurance, the cash value is also linked to the returns on investments in financial markets. If these investments are not profitable, the cash value may fall.
In this case, cash value becomes very important: since it is accumulating thanks to financial investments, it determines the amount of money that will ultimately go to the beneficiaries.
As with other types of insurance, cash value can be partially or fully withdrawn by the insured starting at a certain amount, although variable policies end up being less flexible on this point than whole life, for example.
In addition, cash value may also be used to obtain a loan. But if the insured dies without repaying it, the total will be deducted from the potential death benefit.
And finally, similarly to what occurs with other types of insurance, this cash value can be used to pay future premiums, thus mitigating the final stage of insurance, which would correspond to the insured in his or her twilight years.
In addition to these basic elements, you should also know some of the specifics of variable life insurance. For example, you should know that, given that you control a good part of what will happen with your investment, these policies can be more expensive than other types of insurance. In addition, the price may change as you age, which is why it is very important for you to know how the premiums you pay will evolve over the life cycle of the insurance.
Also, do not forget that this type of insurance relies on investment, which always carries certain risks. The federal laws of the United States consider these policies to be investment products, which means they are governed by the securities laws that regulate contracts and investment products, so insurance professionals should offer you a pamphlet that clearly explains investment potential to buyers. This pamphlet should contain clear information on investment objectives, additional fees, possible expenses, and risks you assume with the policy.
Finally, and also due to the investment component, variable insurance has its own fiscal benefits, such as accumulated earnings that are tax-deferrable.
Why You Might be Interested in Variable Life Insurance
Now that you know how variable life insurance functions, you should contemplate whether it is the type of product you need.
This insurance was designed for people who are willing to risk a little more of their money when looking for life-long insurance. It was also designed for anyone who wants to have a more active role in managing the investments associated with their life insurance.
If you want a little more profitability out of your money, even by accepting a higher risk, this might be your type of insurance.
There are the most significant advantages of taking out variable life insurance:
- Level premiums. You will not have to worry about unexpected changes to monthly premiums: they will be level throughout the life cycle of the insurance.
- Minimum guaranteed payout. Even if insurance investment accounts take a hit, there is always a guaranteed minimum that will go to your beneficiaries. This means that you can take risks in the equity market with the certainty that there will be a payout no matter what.
- Tax-deferrable. A big advantage of this insurance is that the taxes generated by the investment are deferrable, so capital accumulates more quickly, which in turn may increase investment.
- Loans. Many variable life insurance policies allow you to take loans out of the money allocated for investment at a very low or no interest rate. In addition, these loans are fiscally friendly and even tax-free, which promotes savings.
- Greater earnings (not guaranteed). As you might expect, risks also sometimes imply large benefits. If your stock market transactions have perform as expected, the profits you obtain may be very high and your insurance could accumulate a lot of money. However, never forget that no one guarantees these earnings and they are subject to notable risks and the ebb and flow of the financial market.
- Guards against inflation. With a variable life insurance, you have an opportunity to better manage issues caused by inflation. With one of these policies, you can react to a change in inflation without losing money. Since you are able to choose between different types of investments, you can insert money over different periods of time to greatly reduce the inflationary effects that would make your money worth less after 20 or 30 years.
However, this variable insurance also presents some disadvantages that you should be familiar with:
- Cash value not guaranteed. In contrast to the death benefit, which has a guaranteed minimum, cash value does not. This means that if the equity investments perform poorly, the cash value could even disappear. As a result, as the insured, you assume the full risk of a poor investment.
- Higher cost. These policies tend to be more expensive than normal, given that payments, or fees, must be added to the premium prices for things like investment portfolio management, withdrawal of cash against added value, and other administrative fees. Additional expenses will also be charged if the policy is canceled and the added value is surrendered.
- No loss protection. If the investment performs poorly, you will have no protection. Losses affect your cash value directly. Some insurance holders, as a means of protection, assume higher premiums in order to better ensure future cash value.
- A complex product. As you have seen, this insurance requires certain knowledge on your part. Therefore, it is harder to understand and manage than other insurance policies. It also requires levelheadedness to confront difficult market situations and consistency in order to keep investments under control and determine their direction.
Somewhere in between these pros and cons lay the clauses in life insurance policies. In general, insurance has clauses that modify the way it functions. They tend to give the insured advantages, but they also make the policy more expensive, which is a disadvantage.
In the case of variable life insurance, the most common clauses are those that allow you to buy an additional death benefit in exchange for an extra amount of money in the premiums. Another is the so-called acceleration clause, which allows you to receive a part of the payout in advance if necessary in order to pay for medical care or similar expenses. Accidental death clauses are also common, paying an extra benefit if the insured dies in an accident. There are also some that protect against disability. If the insured suffers from a problem that makes him or her unable to work and so can no longer generate income, this clause releases this person from premium payment.
In any case, you should know that clauses always make insurance more expensive and can reduce your benefits, so if you are looking to maximize your benefits, you should waive most clauses.
In conclusion, if you are looking for insurance that is flexible, capable of leaving your loved ones a significant benefit after you have passed on, and allows you to make your money as profitable as possible, you should consider taking out variable-type permanent life insurance. But always remember that this is a risky option and is only recommended for people who know the investment field well, are capable of assuming the corresponding risks, and are willing to assume the extra costs from this type of policy.
This article was updated on Wednesday, July 25, 2018.