There may be no greater controversy than the idea of selling Variable Universal Life (VUL) policies as investments. Many buyers of VUL policies signed the contract based on a real, or perceived, need for additional life insurance. For these people the suitability of these sales varies widely based on the cost and actual need for insurance.
The real question of the suitability of VUL policies centers on those sales based on the idea that they are good investments. I suspect these sales can be identified as unsuitable transactions and here are a few reasons to support that opinion:
The investment component of Variable Universal Life is in separate accounts, essentially mutual funds. These separate accounts may be invested in any one or several of a number of investments from: bonds to stocks, low quality to high quality, low risk to aggressive. The reality is that these investments are the same as inside of a VUL as they are when purchased outside of a VUL. The investment results do not vary because of VUL structure.
The second component of a Variable Universal Life policy is the administrative cost associated with creating, selling and maintain a VUL. Actual costs are often disclosed to the owners as varying from 1% to 3% and may not include all of the actual cost associated with a VUL. This expense can be the deal killer when a large back-end surrender charge is attached. That large expense is related to the cost the insurance company pays in sales commissions to the selling broker/agent of the VUL policy it can be as high as 6-10%. That cost is paid by the insurance company, but they recoup it from the policy holder in the form of higher administrative cost over the first few years of the policy and the surrender charge if the policy holder decides to exit before they have recouped their cost.
The third component of a Variable Universal Life policy is the mortality charge, the cost of the insurance that makes a VUL a life insurance product. This cost will vary from company to company and often depends on the age and life expectancy of the insured. This is the cost and associated benefit that may determine that a VUL is a suitable insurance vehicle and an unsuitable investment.
The last component quoted by those who sell Variable Universal Life policies is taxes. Life insurance has always displayed some unique tax benefits. But there are special policy taxes attached to these products. There is the other risk that at some time in the future the folks who write tax policy may decide to change some of these special tax policies. There is no doubt the insurance lobby is actively protecting the interest of insurance companies as there is no doubt those who write the tax laws are always looking for additional sources of revenue.
The primary tax advantage is the ability to make money inside of a VUL and borrow it out without paying taxes. That concept has two challenges attached to it. The first is making money inside the VUL and the second is paying the insurance company interest on the money you are borrowing; essentially paying interest to borrow your own money. Paying a capital gains tax is a relatively low amount and a one-time event. Though paying interest is relatively low amount, but it is a recurring annual expense.
This is my opinion and it is supported by a NASD (now FINRA) memo to members issued over a decade ago that warned those members to be aware of the unsuitability of VUL policies sold as investments.
