Leimberg: Bill Boersma: Is Variable Life Insurance More Expensive

“Is variable life expensive? It depends. People regularly say this in a categorical brush off of securities-based life insurance. It’s not clear why people think so in the face of evidence it’s not true. Let’s approach this objectively. Variable life comes in two basic flavors: variable whole life (VL) and the much more prevalent variable universal life (VUL). There’s also private placement life insurance (PPLI); a version of VUL, but not the focus of today’s discussion. Within VUL, there are guaranteed VUL (GVUL) and non-guaranteed options. Other types of insurance include non-variable whole life and universal life. Besides the variable version of universal life, there’s traditional, non-guaranteed universal life (UL), guaranteed universal life (GUL), and indexed universal life (IUL), and iterations of each.

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? Over 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 return on 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.”

In his commentary, Bill Boersma explains why variable life insurance should not be broadly characterized as “more expensive,” since actual costs vary based on policy structure, funding strategy, and long-term assumptions.

Bill Boersma is a CLU, AEP and LIC and the founder and owner of OC Consulting Group. More information can be found at www.OC-LIC.com, www.BillBoersmaOnLifeInsurance.info or email at bill@oc-lic.com or call at 616-456-1000. Bill has spent his entire career specializing in life insurance. He predominantly works with wealthy business owners and professionals regarding insurance for estate planning, business succession and charitable strategies. Bill is generally introduced by estate planning and business attorneys, CPAs, trust officers, family offices, non- profit leaders and various financial planning professionals.^[i]

Here is his commentary:

COMMENT:

Is variable life expensive? It depends. People regularly say this in a categorical brush off of securities-based life insurance. It’s not clear why people think so in the face of evidence it’s not true. 

Let’s approach this objectively. Variable life comes in two basic flavors: variable whole life (VL) and the much more prevalent variable universal life (VUL). There’s also private placement life insurance (PPLI); a version of VUL, but not the focus of today’s discussion. Within VUL, there are guaranteed VUL (GVUL) and non-guaranteed options. Other types of insurance include non-variable whole life and universal life. Besides the variable version of universal life, there’s traditional, non-guaranteed universal life (UL), guaranteed universal life (GUL), and indexed universal life (IUL), and iterations of each.

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? Over 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 return on 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. 

Many Design Options

The same product from the same insurance company on the same person can be built very differently with a huge variation in policy expenses. Let’s use a 45-year-old healthy male as our subject today. I can find a $10 million GUL policy with an annual premium of $70,000 to guarantee the death benefit for life. I can also build a $10 million VUL policy that accepts over $600,000 annually. The first one results in a $10 million death benefit and the latter projects to grow to hundreds of millions of death benefit, even at a historically modest return. 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? Raw internal expenses or as a percentage of death benefit?

Policy Expenses

What about those expenses? In one product, $70,000 annually into a $10 million level death benefit VUL shows cumulative policy expenses at age 100 of $14 million. Add just $2,000 to the annual premium of the very same policy and the cumulative policy expenses get cut to $7.3 million. Taking the same premium and putting it into the same product with an initial death benefit of $2 million, it projects to grow to $20-30 million or more in death benefit at the same return and results in a cumulative expense of only $1.2 million. If I started with $10 million death benefit and jammed in $374,000 of annual premium, the death benefit projects to grow to $100-$200 million with $5.4 million in policy expenses.

The takeaway? There’s clearly no answer to what a variable life policy, or any policy, “costs.” Remember, this is the exact product on the same person and $10 million of death benefit could have $14 million in expenses and $200 million of death benefit could have a third of that. It doesn’t seem like anyone could make a categorical statement about how expensive the policy is. Anything can be shown to deliver a particular message. I could build one product to reflect much higher expenses and then turn around and show exactly the opposite… and the policy owner would never know why.

Is the $70,000 premium policy less expensive than the $72,000 premium policy when they both project $10 million in death benefit? If the “more expensive” $72,000 policy results in a reduction of millions of dollars of internal policy expenses, does that make it less expensive?

Other Types of Insurance

How does VUL stack up against GUL, UL, GVUL and IUL? Running the projections similarly results in expenses in the same ballpark for each. I’m not sure that should be a surprise. Each of the products has a different objective or crediting methodology, but there’s a lot of horse trading. For example, one has guarantees but gives up cash value. The premiums are all similar with some having more upside potential with fewer guarantees. There’s no reason the expenses should be substantively different.

At least with universal life policies I can click a box in the illustration system to include the policy expense page, that shows the various expenses and crediting on an annual basis. Whole life doesn’t allow this. It’s a black box product that you can’t see into. If that’s the case, how can someone say VUL is more expensive than whole life?

What About Whole Life? 

Regarding whole life, I can go to the software and run it as 100% base whole life or run it with a 50% term blend. The premiums, death benefits and rates of return are going to be different. The lower premium version also has a lower rate of return on premium to death benefit. Does that mean it’s more or less expensive? There are various dividend options that result in different returns on premium to death benefit, though that’s not necessarily tied to basic policy expense and mortality charges. Does a lower return on a particular set-up make it more expensive if the basic policy expenses are the same?

Looking to one of the major mutual carriers, $10 million of whole life has a premium two to three times that of VUL, even GVUL for the same death benefit. It projects to grow significantly over the insured’s life, but so does VUL funded the same. In fact, only a 5% assumed return in the VUL results in a projected death benefit to equal the whole life projected death benefit. At 7% the VUL is running circles around it. At 10%, admittedly aggressive but what it would have averaged over the past 50 years, the death benefit projects multiple times that of the whole life.

How can VUL be considered not only expensive, but more expensive than fixed insurance?

Guarantees

What about guarantees? Products with guarantees generally cost more than products without guarantees. An F250 is more expensive than a minivan, but if I need to haul a 14,000-pound dump trailer that’s kind of irrelevant, isn’t it? The point is, what am I trying to accomplish? If the S&P 500 grows moving forward like it has historically, the projected death benefit of a VUL policy would grow like a bad weed. If it costs more for that opportunity (it doesn’t) would it be worth it?

If the same whole life premium goes into a GVUL policy and realizes even a modest equities-type return, it may end up with a much higher death benefit, and it’ll end up with a lower death benefit if it performs at guarantees and the whole life doesn’t. However, it only takes 6% for the GVUL and whole life projections to equal each other. Which one do I base my expense calculations off? Is one riskier than the other? They both have a $10 million death benefit guarantee. If I run both products at their respective guarantees and focus on death benefit, the VUL will have a much lower premium to guarantee the $10 million than the whole life policy. Does that mean it’s cheaper? Is it fair to compare them this way?

Whole life is historically thought to be more conservative but think about this; are you more likely to trust a 6% crediting rate for a product invested in the general account of an insurance company that is primarily in investment grade bonds, or a 6% long-term return in the equities stock market? Also, if an insurance carrier goes bust, as has happened recently, whole life, UL, GUL and IUL policy cash value is lost, but with a VUL policy the separate account cash value is safe from creditors. Should that be loaded into the overall risk calculation?

It’s evident there are numerous ways to slice and dice and analyze this. Anything can be made to look more or less expensive, but you can’t escape the fact that VUL, guaranteed or not, isn’t an expensive product.

Policy Expenses vs Investment Expenses

What 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, VUL premiums and cash value go into sub-accounts chosen by the policy owner. This is similar to selecting funds in a 401(k) plan. Any given variable policy will likely have scores of sub-account options. Some are very low cost, such as index funds with charges as low as ten basis points. If someone chooses to use a different sub-account with higher expenses, it’s because they’re trying to accomplish something specific. I’m not sure that should be considered a categorical expense of VUL policies. And it’s not like a life insurance company doesn’t incur expenses managing its own general account investments. Of course they do. They just don’t always tell you what it is. Additionally, if the VUL policy is being used for accumulation, those assets elsewhere aren’t being managed for free.

All the numbers related include the investment expenses, so it’s evident it doesn’t change the math. Ultimately, variable life can be structured to have policy expenses as low as or lower than most other types of life insurance. When someone says that variable life is expensive, it’s generally because they don’t understand it or don’t have the licensing to sell it.

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