Question

Who bears the investment risk in variable life and universal variable life policies? How does this differ from investment risks borne by the buyer of a universal life policy?

Answer 1

Below is a brief description of the variable life, universal variable life, and the universal life policies, which will help to know how the risks of the investments differ for each of them.

Universal Life Insurance

Universal life insurance is a kind of permanent life insurance (an umbrella term for insurance policies that do not expire). Apart from lower premiums, it also provides for investment savings that may be similar to the term life insurance policies. However, unlike term life insurance, universal life insurance may accumulate cash value. When compared to the whole life insurance policies, the universal life insurance policy will provide more flexibility and allow the policyholders to adjust their premiums and consequently the death benefits as well. Policyholders can pay more than the lowest premium amount and cash value is generated that also accumulates interest.
However, due to the flexible premiums, there is a risk that a policyholder may be required to pay a premium amount that is greater than what was planned initially for maintaining the policy. It occurs when the expected interest rates decrease than what was originally assumed (at the time the policy was purchased). Therefore, because the economic and market factors can affect the interest rates, some of the risks are assumed by the policyholders and the universal life policy proves to be riskier when compared to the whole life insurance policies or the term life insurance policies. Some of the risks are transferred to the policyholder as well for the universal life insurance policies.

Variable Life Insurance Policy

A portion of the premium is allocated to the investment fund of the insurance company that can generate tax-free profits for the policyholders, in a variable Life insurance policy. The death benefits and the cash value may fluctuate for the performance of the investments in mutual funds, stocks, and bonds (among other investment instruments). The variable life insurance policy is the riskiest of all as the death benefits and cash value fluctuates following the way the investment performs. When the stock market performs well, the cash value and the death benefits increase, and vice versa. However, there may still be a guaranteed death benefit in a variable life insurance policy, due to which the benefit does not fall below a given amount. Therefore, the insurance policyholder carries the risks of the investments to a great extent. Policyholders can choose where their investments would go in the investment portfolio, but the choice-making capability also increases the risk even further (as in the case of more aggressive investments).

Variable Universal Life Insurance

Variable universal life insurance is a policy that may carry certain characteristics of variable life insurance as well as universal life insurance. This life insurance is a type of permanent life insurance policy that builds up for cash value. The money is invested in many different and separate accounts, just like mutual funds. The investment subaccounts are exposed to the fluctuations of the market. Therefore the investments can result in substantial losses or can make substantial gains and returns. A variable universal life insurance policy offers greater returns when compared to a universal life insurance policy as there are more flexibility and growth options and potentials available. The policy differs from the traditional universal life insurance policy in that it has a separate sub-account, which invests a piece of the cash in the market.

Some of the risks of the investment risks also transferred to the policyholder, who, however, does not get a right to make choices regarding the investments. The investments may be managed by a dedicated fund manager. The policy buyer agrees that negative returns may also occur when the markets are not suitable. When the returns gained from the market (through the stock and bond investments) are negative, there may be a negative cash value to the policy as well. When that occurs, the insurance policyholder may be required to invest even greater premium payment amount so that cash value is rebuilt. However, when the markets are on a rise or perform well, the risk reduces as the net insurance amount is tied to the risks.