As I began to brainstorm for this article, something I am always honored to be asked to write, I came across a blog from a well-known financial guru on variable life insurance (VUL). The piece was mostly dedicated to tearing apart any kind of permanent insurance product and insisting that the only life insurance worth buying is term insurance. It’s actually pretty impressive how strongly the mantra of “buy term and invest the difference” is ingrained in our collective psyche. While term obviously has an important place, I think most Broker World readers would agree with me that it is far from the only valuable option.
The bulk of the article was around the principle that cost is the most important concern when it comes to purchasing life insurance. If you are looking for term insurance and a specific death benefit, spreadsheeting a bunch of carriers and choosing the lowest price option is a well proven strategy, but is cost really all that matters? Do people make a point to always buy the cheapest house, cheapest car, cheapest phone, etc? Does everyone only eat at McDonald’s and shop only at Walmart? While some people certainly do, by and large, most people simply don’t. People are more complicated than that. As with any important decision, there are a multitude of potential factors that go into the decision-making process.
One common myth, especially as it applies to variable life, is that insurance products are not designed to build wealth and, as a result, are more costly and complicated than other tools making them not worth the investment. I’ll admit, parts of this statement are true. There is an additional cost for participating in a VUL policy that is greater than what you pay for some other investment options. Truthfully, you may even make a higher return in another investment as opposed to the limited menu of subaccount options in a VUL policy. 3 One key component is missing in this argument though: The power of tax deferred growth.
Any financial professional worth their compensation will be familiar with the value of minimizing taxation. Getting 20 percent in capital gains taxes taken out of your account when you sell a position will always be less preferred than not taking the 20 percent hit. I’m not going to break down the math, my colleague Charles Arnold has written several great articles for this publication doing just that, but it’s not hard to see where continued taxation can have a significant drag on the overall performance of a client’s portfolio. What about 401(k)s? These are powerful tools built on the same concept but with the catch that there are annual contribution limits. Once a client maxes out their 401(k), what next? There’s only so much money that a client can put into a ROTH IRA, and many people don’t even qualify. I’d argue most people that max out their 401(k) probably don’t. Once both of these are exhausted, financial professionals can utilize concepts like tax-loss harvesting, but in many cases this only helps so much. While there are other differences between all these products and investment strategies, variable life does benefit from tax-free growth and will allow the client to put more money into the product than many other tools.
From an estate planning standpoint VUL (as with all life insurance products) has a tax-free death benefit, unlike many other planning tools. It’s obviously a bit morbid to talk about death benefits and what your heirs/spouse/charity/etc. could receive, but if you are reading this article, you probably are already having these types of discussions. In the “buy term and invest the difference” mindset, all you need is term to take advantage of this benefit. This is technically correct. If all the client wants is a guaranteed death benefit to pay to the beneficiary of their choice, and they have a low risk tolerance, term might be all they need. But here again, I’d like to bring up that cost (one of the biggest benefits of term) is not the only thing that matters. If a client is presented with the option to give $500k to their beneficiary when they die or the option to potentially give more, with a risk that they could get less, the client may be comfortable with the risk. If you add in the possibility that they could get more than the $500k without much downside risk (IUL or protection focused VUL), more clients may be interested.
This brings us to another talking point I hear a lot: That permanent life products, and especially IUL and VUL, are too expensive. You have policy fees and expenses, transaction fees, manager fees, and potentially other costs that absolutely mean that permanent insurance products are more expensive than term products and many other investment vehicles. So what? You also are getting something different in the form of guarantees and preferred tax treatment and, as we all know, nothing is free. In some situations this is a very clear factor to determine that these types of products may not be a fit for a specific client. No tool or technique can (or should) be classified as one-size-fits-all.
An additional common complaint brought is that permanent insurance contracts are exactly what the name hints at, permanent, and therefore hard to get out of. The unnamed financial guru I mentioned earlier pointed to the concept of free-look periods but gave policy lapse as one of the only other options if someone wants to get out of an insurance contract. First, I would like to point to the different benefits in a life insurance contract vs some other financial instruments. If your client likes these benefits, lack of liquidity is a real concern but may be something they are comfortable with. Second, I can name nearly a dozen different life settlement brokers that our reps have worked with over the years to help a client out of a policy that they no longer want or need. There are obviously certain criteria that the settlement firm uses to determine their offer price (or lack thereof), but I would argue it is against a financial professional’s duty of care to not at least explore this commonly overlooked option.
A last point of note is a lesser advertised benefit of many permanent insurance products, the concept of a policy loan. Again, permanent products are designed to be permanent, the government and insurance companies don’t want you to take the money out. There is a loophole here. While taking the cash out of a policy is not allowed, many cash value policies will allow the client to take a loan out of the policy. This could provide additional financing options for a client looking to put a down payment on a house or send a kid to college. It could even help a small business owner make payroll. At the end of the day it is still a loan, and it needs to be paid back with interest, but who is the client paying that interest to? Themselves. Obviously, the funds cannot grow in the policy while a loan is outstanding and any balance left when the policyholder dies will be taken out of the death benefit, but this does give them an interesting financial tool that they may not otherwise have access to.
There are some clear truths to the “buy term and invest the difference” mindset; there’s a reason we all know it. Permanent products, especially VUL and IUL, are usually more expensive than term. Paying the least amount for something is important to some clients, regardless of other potential benefits. Permanent life insurance products are permanent and more difficult to get out of than simply selling some shares. On the flip side, there is a reason we have more than just McDonald’s and Walmart everywhere. Price is absolutely a factor in any financial decision, but the price for just death benefit and investing in a taxable account is not necessarily going to be cheaper than investing in a permanent product. If you have the possibility to pass on more money to your beneficiaries than the original death benefit you signed up for, your assets can grow tax free, and you have access to a line of credit, the all-in price may not actually be that different. There are plenty of insurance salespeople that are much smarter than me that could point out other benefits I’m not covering here. For some clients, “buy term and invest the difference” is absolutely going to be the right strategy, but if it is the only thing you recommend to every single client you are not only setting yourself up for a visit from a regulator (depending on how you are licensed) but you are missing out on a whole realm of possibilities for your clients. I remember back in the ancient days of the 1990s getting some t-shirts that were labeled one-size-fits-all and, much like those shirts that never fit right, no single investment product or strategy is the right fit for every situation.
