Variable & Variable Universal Life Insurance

1. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Variable Life • Combined traditional whole life insurance with mutual fund type of investments • Similar to traditional insurance • Guaranteed minimum face amount • Level premium • Differs from traditional insurance • Policyowner's fund placed in separate accounts • Separate accounts are distinct and separate from the companies general investment fund

2. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Variable Life (cont'd) • Differs from traditional insurance (cont'd) • Policyowner's fund placed in separate accounts (cont'd) • Premiums less sales loads placed in separate accounts • Policyowner chooses to invest premium among account alternatives • Stock funds • Bond funds • Money market funds • Real estate funds • Market index funds • Small cap stock funds • No guaranteed minimum cash values • The death benefit is variable

3. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Variable Life (cont'd) • Policy features (Similar to traditional insurance) • Guaranteed maximum mortality charges • Nonforfeiture values • policy loan provisions • reinstatement provisions • settlement options • Participating and nonparticipating policies • Dividends derived only from mortality and expense savings • No element of excess investment earnings • Single premium, limited pay and lifetime pay policies

4. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Variable Universal Life • Combination of Universal Life and Variable Life • VUL Policy owners can • Determine timing and amount of premium payments • Skip a premium payment • If cash values are sufficient to cover mortality and expense charges • Adjust the death benefit (within limits) • Increases are subject to evidence of insurability • Withdraw money without creating a policy loan • Choose between multiple death benefit options • Option A (or 1) – Level • Option B (or 2) – Increasing (level plus account value) • Option C (or 3) – Increasing (Level plus cumulative premiums paid)

5. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Variable Universal Life • Policyowner's receive periodic reports • Mortality and expense charges • Changes in the investment value of their accounts • Considered securities • Policyowner receives a prospectus • When is the use of this tool indicated • Policyowner's • Want control over their cash values • Have an understanding of investments • Willing to bear the entire risk of their investments

6. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Variable Universal Life (cont'd) • When is the use of this tool indicated (cont'd) • Business insurance needs • Flexibility and growth of cash values and death benefits desired • Funding nonqualified deferred compensation plans • Potentially higher growth of cash values than traditional insurance • Advantages • Policyowner control over how premiums are invested • Transfers between fund permitted multiple tome per year with little or no charges • Transfers between funds are income tax free • Cash values more secure in the event of insolvency of the insurance company because they are held in separate accounts

7. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Variable Universal Life (cont'd) • Advantages (cont'd) • Earnings on assets underlying the cash values grow income tax deferred • If policy is properly structured • Death benefits are paid income tax free • If policy is properly structured • Death benefit provides some measure of inflation protection • Because they are tied to the underlying assets • Policyowner has wide discretion of flexibility in the timing and amount of premium payments • Policyowner can change the level of death benefits (within limits) • Increases may be subject to evidence of insurability • Policies are transparent • Annual report breaks out policy elements separately

8. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Variable Universal Life (cont'd) • Advantages (cont'd) • Multiple death benefit options • Option A (or 1), Option B (or 2) and Option C (or 3) • Back end loads • Cash value can grow more quickly than traditional whole life policies • Policy loans can be borrowed at a low net cost • Cash value can be withdrawn without surrendering the entire policy • Life insurance proceeds not part of the probate estate

9. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Variable Universal Life (cont'd) • Disadvantages • Policyowner bears all the investment risk • Death benefits depend on the investment performance of the policy • If investment performance is poor, the policyowner may have to pay additional premiums • Policyowner bears all the responsibility for premium payments • Policy could lapse without proper attention • Gains in the policy realized upon surrender are taxed at ordinary income rates as opposed to capital gains rates

10. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Variable Universal Life (cont'd) • Disadvantages (cont'd) • Surrender of policy within first 5 to 10 years may result in considerable loss • Policy expenses greater in the early years than later years • Premium and death benefit flexibility may cause policyowner to inadvertently create a modified endowment policy • Adverse tax consequences • Expense loadings typically higher than those with other types of policies

11. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Tax implications • General tax rules • VUL (Non-Mac's) are taxed in the same manner as other types of life insurance policies • Cash values grow income tax deferred • Death benefits income tax free • Cost recovery rule (FIFO) • Only after policyowner’s investment on the contract is fully recovered are additional amounts treated taxable gain in the policy • Policyowner can withdraw up to their basis in the policy, then take policy loans on an income tax deferred basis

12. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Tax implications (cont'd) • Exceptions to the cost recovery rule • Withdrawals coupled with reductions in death benefits • Years 1-5 • Any withdrawal may be taxable if there is a gain in the policy • Years 6-15 • Taxation of withdrawal based on mathematical test • Cash value corridor test • Potential taxation under the MEC rules • Distribution under the contract • Taxed under interest first rule • Distributions prior to age 59 1/2 subject to 10% penalty tax • Distributions include withdrawals and loans

13. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Tax implications (cont'd) • Modified Endowment Contract (MEC) Rules (cont'd) • Ways to run afoul of the MEC rules • Increase in premium payments during the first 7 contract years may push cumulative premiums above the amount permitted under the “seven Pay Test” • A reduction in death benefit during the first seven contract years triggers a re-computation of the seven pay test • A material change in the death benefit at any time triggers a new seven pay test which is applied prospectively • VUL illustrations will indicate the maximum amount (the seven pay premium) that may be paid over the first seven years, without classifying the policy as a MEC • If the policyowner inadvertently violates the test, they have 60 days (typically) to reverse the transaction that created the MEC

14. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Tax Implications (cont'd) • Taxation of capital gains on the underlying assets • Capital appreciation on the underlying assets lose their character as capital gain • Taxation of transfers between investment funds • Transfers or switches between one fund and another are tax free • Alternatives • Adjustable Life (AL) • Combines elements of fixed premium ordinary life and the ability to alter, within limits to alter the policy plan, premium payments and face amounts • Universal Life (UL) • Same premium and death benefit flexibility as VUL • Also provides minimum cash value guarantees

15. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Fees and acquisition costs • Charges to VUL policies • Sales loads • Initial - 0% to 30% of first year premium • Renewal – less than 10% • Policy fees • Typically $3 to $10 per $1,000 of guaranteed face amount • Administrative charges • Typically $5 per month • Premium tax • 2% to 2 1/2 % of premiums paid

16. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Fees and acquisition costs • Charges to VUL cash value accounts • Cost of insurance(mortality charges) • Applied to the “net amount at risk” • Difference between the death benefit and cash surrender value • Mortality & expense risk(M&E) • Additional charge to cover risk of adverse mortality experience • Management fees • Similar to those fees for mutual funds • Varies by sub-account ranging from.25% to 2%

17. Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning • Selecting the best VUL policy • Policy loading and expenses • Suitability and variety of investment options • Relative performance of the sub accounts • Review the prospectus • Total returns • Expense ratios • Turnover rates • Compare similar sub-account funds between companies