Variable Contracts - Variable Life Insurance

The insurance industry came up with a variation on whole life insurance that allows the consumer to assume the performance risk of the cash value supporting the death benefit amount while guaranteeing at least a minimum death benefit. While this form of insurance existed in other countries since the 1950s, it did not arrive in the U.S. until the early 1970s.

Variable life insurance is similar to other types of permanent life insurance, like whole life and universal life. All three offer a build-up of cash value and the opportunity for policy loans. But there are important differences. Whole life offers a fixed premium and a fixed death benefit, while universal life offers both flexible premiums and a flexible death benefit. However, a whole life policy pays a guaranteed (fairly low) rate of return, while universal life policies may adjust the interest rate that is paid on the policy each year. Variable life insurance offers fixed premiums, a flexible death benefit and the ability to earn a variable rate of return.

The difference in these structures can help a potential policyholder to choose the right type of policy. For individuals who are most concerned with guarantees, a traditional whole life policy might be best, since premiums, death benefits and rate of return are all guaranteed. Universal life insurance might appeal most to someone seeking flexibility (but does not want to worry about investment losses). Variable life insurance would be a good match for an individual who is seeking flexible insurance protection and the opportunity for tax-deferred investment growth.

The structure of a variable life insurance policy is similar to the variable annuity contract in several ways:

  • For one, variable life has a separate account into which the contract holder deposits premiums.
  • The separate account also contains sub-accounts in which the insured allocates his or her assets into accounts similar to mutual funds according to his or her investment objectives.
  • Therefore, variable life combines the protection and savings functions of traditional life insurance with the growth potential of mutual fund investments.

Premiums for variable life insurance are fixed, but a part of them is earmarked for the investment portfolio. In this way, the face amount of the policy and the cash value vary with changes in the sub-account values. The death benefit, however, can never be less than the initial face amount. When the portfolio value increases substantially, the policyholder can use the extra cash in the sub-accounts to purchase additional insurance coverage. Policyholders can also borrow against the accumulated cash value or cash in the policy.

When compared to the same amount of insurance coverage, premiums for variable life are higher than an equivalent whole life policy, as the policyholder is paying for all of the extra features of a variable life policy. Because the separate account is essentially a security, however, a prospectus must be used when selling variable life insurance products.

Earnings from a variable life policy are tax-deferred until withdrawn. The earnings are then taxed only to the extent that they exceed the premiums paid into the policy. However, if death benefits are paid out upon the death of the policyholder, the cash value is included in the owner's gross estate and is not taxed as ordinary income. You can review more information on about taxation of variable life insurance in the Taxation Issues section.

Policy Loans
Like most forms of permanent life insurance, variable life insurance offers policy loans on a portion of the cash value buildup in the policy. Depending on the issuer, loans may be made for up to 75-90% of the cash value. At least 75% of the cash value must be made available to policyholders in the form of a loan after three years.   Since the loan reduces the cash value, it also reduces the death benefit. Taking a policy loan is not a taxable event, since it is not considered a withdrawal. Loans may be paid back with interest.

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