What Is a Mirror Fund?

An insurance provider will create a mirror fund to replicate the performance of a high-quality mutual fund. These mirror funds come as the investment options for a variable life insurance policy. The method allows policyholders to invest in mutual funds without the requirement of investing directly in the market. Also, the policyholder may avoid the minimum acceptable investment by accessing the fund through the insurance company's mirror fund.

Understanding Mirror Fund

A mirror fund most often will accompany variable universal life insurance (VUL) products. Variable life insurance is a permanent life policy that has a separate investment account. The investment account may include a menu of various investment instruments, such as stocks, bonds, equity funds, and money market funds. The tax-deferred performance from the investment account will add or deduct from the death benefit. Premiums paid will cover administrative fees and the management of the investment account. Policyholders must undergo a full medical underwriting.

Frequently, the funds available for the investment portion of this type of life insurance will be mirror funds. The insurance company will create an in-house fund that attempts to mirror or replicate the investments and returns of the underlying mutual fund, such as Vanguard, J.P. Morgan, BlackRock, and others. 

While all mutual funds will have fees and expenses, which will reduce the overall annual returns, the fees of the mirror funds will exceed those of the underlying fund. Also, these policies will have a limited number of funds available for the investment portion of the policy, usually three to five.

The Darkside of a Mirror Fund's Cost

A typical mutual fund charges 1.5% to 2% in managing fees. An investor who purchases a mirror fund will usually pay double those fees, so between 3% and 4-percent. In some cases, an investor who buys a mirror fund through an insurance company is likely to have to pay a broker or independent financial advisor on top of the management fees. This added cost means that the investor’s return on the mirror fund is significantly lower. 

Also, a mirror fund tends to lag behind the performance of the underlying funds. Since these are replications of the underlying fund, the provider must move into and out of holdings at a later date than the mutual fund. Also, the difference in returns between the directly holding the underlying fund and the mirror fund becomes more significant the longer the policyholder holds the investment.

Policies with mirror funds advertise as giving the policyholder access to high-quality, third-party funds. However, the policyholder is usually able to invest in the same high-quality mutual fund themselves directly. The only limitation the policyholder may have is in the minimum investment requirement of the high-quality mutual fund. Also, for direct investment, the policyholder will need an account with a broker such as Schwab or Ameritrade.

Not all insurance providers will use mirror funds. Those who do not use mirrors will offer a selection of between 50 and 100 approved investment vehicles. Since providers allow the investment in non-mirror funds, they will limit where the policyholder may invest the dollars to only the most secure funds. Also, consumers should be aware that some policies may place a limit or cap on the annual gains, which may add to the death benefit. 

Equity Indexed Policies are Another Choice

Equity-indexed universal life insurance is also a type of permanent life insurance policy which has the opportunity to place the policy's cash value in an equity index account. The separate account pays interest according to a market index without actually investing the money in the market. Some insurance providers may also offer mirror funds that replicate the index. As with the copycats of mutual funds, these index mirrors will charge additional fees.