By Bill Boersma
Is Variable Life Insurance More Expensive? Maybe, maybe not. It depends. How’s that? But seriously, folks, I hear this all the time. What I don’t understand is why people think this in the face of evidence that it’s not true.
Let’s be objective about this. Variable life comes in two basic flavors: variable whole life (VL) and the much more prevalent variable universal life (VUL). There is also private placement life insurance (PPLI) that I will label a version of VUL and not discuss here. Other types of insurance include traditional whole life (not just any cash value insurance being generically referred to as whole life) and a bunch of iterations. Besides the variable version of universal life, there’s traditional, current assumption universal life (CAUL), guaranteed universal life (GUL), and indexed universal life (IUL). Again, there can be many iterations and sub-categories of all of these.
So, what’s what when it comes to life insurance expenses? How are the respective policies built? What are the assumptions that have been plugged in? At what time horizon? At what funding level? Why do all of these variables matter?
There are also various ways to define what expenses are. Do we look at gross policy expenses? The IRR of one transaction against another? The spread between the gross crediting rate and the net return on the deal? We can look to different tests, but we can’t pick and choose to benefit our own horse. If a financial advisor told you his product was less expensive because it had a 50 basis point charge rather than the 75 basis point charge of the competitor, but the 50 basis point charge was on a 3% return, and the 75 basis point charge was on a 7% return, are they being fair?
I could take the same product from the same insurance company on the same person and build it very differently. $10 million of death benefit could have a $50,000 annual premium or a $250,000 annual premium. Clearly, these are not the same, but how? It might seem like a silly question, but which one costs more? Are we focusing on cash flow or internal expenses?
Let’s use a 45-year-old healthy male as our guinea pig today. I can find a $10 million GUL policy with an annual premium to guarantee for life of $75,000. I can also build a $10 million VUL policy that accepts $235,000 annually. The first one results in a $10 million death benefit, and the latter results in a $82 million projected death benefit at life expectancy, assuming a 7% market return assumption.
Over 50 years, the first has total cumulative expenses of $22,602,000, and the second has total expenses of $7,490,000. Not only is the gross expense of the variable policy less, but the cost per dollar is dramatically lower. The higher premium contract is much less costly, regardless of how you slice it. You think 7% is too aggressive an assumption? At 5% the projected cumulative expense is $4,766,000, which is lower than assuming 7% because the death benefit doesn’t grow as much, reducing the mortality charges. On the other hand, a guaranteed variable UL, with a guaranteed $10 million death benefit and a projected death benefit much higher at life expectancy, has a 50-year gross expense of $3,273,000. What would you say the less or more expensive one is?
Those were two different kinds of policies. What if it was the same kind of policy? Two $10 million CAUL products have a $68,062 and a $62,337 annual premium that is different based on one single variable regarding future cash value. The expenses over 50 years are $9,574,000 and $15,486,000, respectively- a 61.7% increase. The lower premium design targets a lower cash value at age 100 than the higher premium design and the lower cash value results in greater mortality expenses. They are theoretically both going to pay a $10 million death benefit, but the policy with the higher premium has significantly lower costs over a 50-year life expectancy and can much better handle unexpected market conditions that could threaten the viability of the lower funded product.
Is a $68,000 premium or a $62,000 premium more expensive? Is $9.5 million in lifetime policy charges or $15.5 million in lifetime policy charges more costly? How can anyone say how “expensive” a traditional universal life policy is when the exact same policy has significantly different expenses? You can’t.
At least with universal life policies I can click a box in the illustration system to include the policy expense page, which shows the various expenses and crediting on an annual basis every year. Whole life doesn’t allow this. It’s a black box product that you can’t see in to. If that’s the case, how can someone say VUL is more expensive than whole life? They can’t, so I’d appreciate it if anyone saying this would kindly shut up. Stick to what you know about.
What I can do is go to the software and run it as 100% base whole life and also run it with a 50% term blend. For one option, the first has an annual premium of $193,750 and a projected death benefit at age 95 of $31,339,000. The latter had a premium of $101,608 with a projected death benefit of $12,512,000. In the first, it’s an IRR of 4.06%, and in the second, it’s 3.10%. That leads me to believe the lower premium blended product is more expensive, at least per dollar of insurance.
If I put the same $193,750 premium in a $10 million GVUL, at a projected market return the same as the current whole life dividend crediting rate of 6.1%, the death benefit projects to be $41,831,000 at age 95. That’s a 33% increase in death benefit over the whole life product at the same point, assuming the same initial death benefit and same premium and same crediting rate. Hmmmm…. Is one riskier than the other? They both have a base $10 million guaranteed death benefit with projected death benefit increases based on policy expenses and various performance aspects of the financial markets. Whole life is historically thought to be more conservative, but think about this. Would you more trust a 6.1% crediting rate for a product invested in the general account of an insurance company that is primarily in investment grade bonds or a 6.1% long term return in the stock market?
If the S&P 500 did the same over the next 50 years as it did over the past 50 years, the projected death benefit of the guaranteed variable UL policy is roughly $200 million! Well, geez… that might be a way to consider approaching this. And that’s going with the higher expense policy with guarantees. If I chose the non-guaranteed variable UL and built it efficiently, the projected death benefit would be meaningfully higher.
I’m not saying this is what will happen, but I am trying to put policy expenses into context between different types of life insurance policies. You can’t escape the fact that VUL, guaranteed or not, isn’t an expensive product.
Using IRR metrics leads me to believe that GUL expenses fall right between the expenses of the two whole life policies, and all of them are considerably more expensive than the variable life policy.
I tried to make the economics of a variable life policy as bad as possible. What it took was to go with one with a lifetime premium and death benefit guarantee that had such a poor long-term market return (unprecedented in the history of the market) that the death benefit never increased. This still had an expense lower than some other types of policies.
What I believe many are referring to when they say variable life insurance is expensive may be the sub-account expenses in the securities-based variable life products. Rather than go into the general account of the insurance company, premiums and cash value goes into sub-accounts chosen by the policy owner. This is the same as selecting sub-accounts in a 401(k) plan. Any given variable policy will have dozens to scores of sub-account options. Some are very low cost, and the expenses for more specific investment approaches are higher, as with anything in the financial markets. Many sub-accounts have exceedingly low charges, including S&P 500 accounts with charges as low as ten basis points. If someone chooses to use a different sub-account with meaningfully higher expenses, it’s because they’re specifically trying to accomplish something, and this doesn’t have anything to do with the life insurance policy expense; it’s the investment expense. And it’s not like a whole life company doesn’t incur expenses managing its own investments. Of course they do! They just don’t tell you what it is.
Ultimately, variable life has policy expenses lower than most other types of life insurance, and much lower when appropriately built. This is definitive. If anyone tells you otherwise, ask them to show you the numbers. They won’t be able to.
The examples given are hypothetical and are for illustrative purposes only. Actual results may vary from those illustrated.
Securities offered through Valmark Securities, Inc. Member FINRA, SIPC. Investment Advisory Services offered through Valmark Advisers, Inc. a SEC Registered Investment Advisor. OC Consulting Group and its affiliates are separate entities from Valmark Securities, Inc. and Valmark Advisers, Inc.
Guarantees are based on the claims-paying ability of the issuing company. Indices are unmanaged and do not incur fees. One cannot directly invest in an index.
