patrick.net

First of all, I don't know too much about VUL. I've been reading up on Whole Life policies a bit.

There are a few things you didn't mention here.

You are buying insurance, right? If you actually DIE, especially shortly after you buy the policy, you are going to get a great rate of return for your beneficiaries....which is the main point of life insurance.

Second, most cash value policies let you borrow against the policy while the policy is still growing (at its slow rate).

So suppose the market did crash...your policy didn't lose any value. Let's say its 2009 and the market drops 50%.

You then have all that cash to borrow and put in the market if you like. Could you do that if you had invested in STRIPs? Could you borrow against them? Maybe there is some kind of margin account for that.

I think the key thing to remember here is that Life Insurance is a different asset class; it behaves differently; it serves different goals.

Sometimes people present these choices as all or nothing...why not put part of your money in an insurance policy, and part in the market, and part in bonds?

Life Insurance is more like cash than an investment in my opinion...cash doesn't get a great return but its great to have when the market is down. It creates the opportunity to get great returns.

CT, preach on brother. VULs are almost invariably lousy retirement vehicles, lousy investment vehicles, and many of them work like "pick-a-pay" home loans in a way.

Where the holders don't understand the way the premium works, and can often find themselves underwater early on, especially if the VUL's investment vehicles don't perform well (they don't even have to lose money). The fees creep up on them. M&E's, Premium Expense Fees, Policy Fees, Fees for the subaccounts/tranches, etc. etc.

People can not only find themselves losing money, but in danger of losing their insurance coverage from the VUL.

The surrender charges are insane. You can put thousands in these turds, and in a few months later, you compare it to your other holdings and policies and realize what shit it is, you won't be getting the few thousand you put it back; as it is assigned to surrender charges.

VULs are cash cows for "Financial Advisers", which is why it is often the largest or sole "investment strategy" recommended to dummies who walk in the door.

Unless you are in your 70s with a 25 year old trophy wife and 2 young children, VULs suck. Dying early is the only way that these puppies make sense.

Very few people buy a $1000 piece of electronics or a $15,000 subcompact car without doing some research first. Yet when it comes to financial products, the alleged complexity daunts people and lets them get taken to the cleaners on insurance products...

The title of this post caught my eye because I thought maybe it was going to be an explanation of how VUL actually works.

I can't find much good information out there on the topic; often it is just skimmed over citing its complexity.

From what I understand, these VUL/Universal Life Policies first came into existence in the early 80s, when interest rates were really high, and people were taking money out of there Whole Life policies and reinvesting it in higher yielding securities. The insurance companies needed a product suitable for higher interest rate environments, and that's why VUL/UL came into existence.

But the actual mechanics of VUL/UL escape me. These two products are often lumped together...why? Are they that similar?

rob8024 says

You then have all that cash to borrow and put in the market if you like. Could you do that if you had invested in STRIPs? Could you borrow against them? Maybe there is some kind of margin account for that.

Ummm, a STRIP is a Treasury note, bill, or bond. You could just sell it in a liquid Treasury market. It has a finite value, so presumably you could borrow against it.

You can also buy multiple STRIPs to provide additional liquidity. For example, you could ladder them -- in the example I gave, buy one 5-year STRIP, one 10-year STRIP, one 15-year STRIP, and one 20-year STRIP. Ultimately, it's just a bond in the highly highly liquid Treasury bond market.

rob8024 says

You are buying insurance, right? If you actually DIE, especially shortly after you buy the policy, you are going to get a great rate of return for your beneficiaries….which is the main point of life insurance.

I think you should learn more about VUL and UL. It's more like an investment than like insurance and is marketed like an investment as well as as insurance.

The fees are massive, and you can essentially replicate what they do and get better returns. The only advantage is that the insurance company does this in the aggregate, so they have some cost advantage due to actuarial reasons, but their massive fees and relative illiquidity negate their cost advantage and in many cases the tax advantage.

rob8024 says

But the actual mechanics of VUL/UL escape me. These two products are often lumped together…why? Are they that similar?

It's a bundled Cash Policy ("Universal" Life) and multi-account "Mutual-Fund-ish" ("Sub Accounts") system.

In the Universal part:

* The cash benefit is generally not limited to age (or to ages where next to nobody lives, like 100 or 120). This is important only if you intend to live past 80-100 years old and still need to support dependent minor children. That's one "advantage". This is because you've contributed so much by then, that you are practically self-insured at that point (ie the insurance company doesn't need to pony up much or anything at all).

* The second advantage is favorable tax treatment on the investment side, because of some loophole in tax law regarding certain forms of insurance contracts. But, you need to be careful, because you can actually 'overpay' into a VUL, and disqualify yourself for those tax benefits. I suppose to prevent abuse of VULs as a tax dodge.

* Taking cash from VULs in many circumstances results in it being taxed as earned income, in other words, your tax bracket rate (not long term cap gains rate). That blows big chunks, and I doubt many insurance reps spend a long time on that key point. Again, this is probably to prevent tax dodging and to underscore the 'insurance' aspect of a VUL by FedGov. In contrast, you can borrow easily from a 401k.

In the Sub-Account (Investment) side:

* The fees involved are outrageous, easily comparable to the highest-load mutual funds, and usually performing even worse if possible.

* "How" the sub-accounts are run, and what they actually invest in versus what they SAY they invest in, is even more opaque than mutual funds.

* Many of the VULs are set up so you put in an initial amount, and if the investments perform, you may not need to add sizable amounts on a regular basis. However, if the investments don't perform, you need to pony up extra cash to keep the VUL viable. Sometimes even just to keep the policy funded.

What often happens is, people don't understand they have to contribute extra to keep the plan in effect when the investment tranche(s) take a nose-dive. Or, they can't afford the big cash infusion needed to stabilize the plan, or they get P.O'd about the whole thing. They can't get out of it because the surrender charges are too high. So they just let the puppy unwind itself to nothing, but they are out thousands, maybe tens of thousands - and have no life insurance, either. And sometimes, they simply don't read the statement.

* Another major big problem is that the cash value on death isn't generally a guaranteed, set amount, but variable as to the value of the investments, how long you have contributed, etc. etc. etc. Naturally you can buy riders that define a minimum benefit, but of course you are going to pay dearly for them. With term, if you have a 20-year $500k policy, you have a $500k policy for 20 years, period.

VULs are very difficult to understand, extremely difficult to navigate properly, and companies are constantly changing the fine print, which is absolutely mind-blowing on these products for their small font and multitude of pages.

All these factors make VULs useful for people with very high incomes and a great deal of sophistication or old men who are the fathers of toddlers at the age of 90.

isnt there a loophole in VUL that gains are tax free? I don't know much about it or own it, but I've met a broker who was trying to sell me this stuff.

ChrisLA says

isnt there a loophole in VUL that gains are tax free? I don’t know much about it or own it, but I’ve met a broker who was trying to sell me this stuff.

Chris, yes. But VULs are tricky in that in certain conditions it can lose tax free status, especially if you contribute too much.

I forget exactly what the term is, it was quite a while ago that I sold insurance...

thunderlips11 says

VULs are very difficult to understand, extremely difficult to navigate properly, and companies are constantly changing the fine print, which is absolutely mind-blowing on these products for their small font and multitude of pages.

All these factors make VULs useful for people with very high incomes and a great deal of sophistication or old men who are the fathers of toddlers at the age of 90.

This where most blogs seem to end the discussion on VUL...that its just too complex, financially, dangerous, etc.

Term is probably the easiest insurance to understand. Whole Life, is a step beyond this on the understanding curve; I'm surprised how many people misunderstand how it works and the benefits, based on comments on blogs.

A really good resource for understanding the nitty gritty of how Whole Life works, technically is this site:

http://r0k.us/insurance/vp/

I haven't found this kind of resource for VUL. It looks to me like VUL just places the investment risk on the owner, rather than the insurance company handling it. Because of this you can get a higher return, but you could also lose everything you put in.

I'm willing to buy that VUL is really and investment choice geared for people earning over $175k per year. You really need to be earning that much in order to max out Solo 401k, HSA, IRAs, etc.

At that point, a person might still be looking for somewhere they can put money that it will grow tax free. Or they need to protect their assets from litigation because of their career; say they are a doctor and they could get sued and lose their personal assets. Life Insurance would protect against that IIRC.

I guess the 90 year old gazillionaire with a toddler would be another situation; they would want to pass a lot of money on to your heirs without it being taxed.

rob8024 says

I’m willing to buy that VUL is really and investment choice geared for people earning over $175k per year. You really need to be earning that much in order to max out Solo 401k, HSA, IRAs, etc.

At that point, a person might still be looking for somewhere they can put money that it will grow tax free. Or they need to protect their assets from litigation because of their career; say they are a doctor and they could get sued and lose their personal assets. Life Insurance would protect against that IIRC.

I guess the 90 year old gazillionaire with a toddler would be another situation; they would want to pass a lot of money on to your heirs without it being taxed.

A good wills and trusts lawyer + learning the basics of investment would be far better than using one of these high fee, no control, poor return, low liquidity insurance products. Also, if you have enough money, a financial adviser that's paid a flat fee might be helpful.

You can protect personal assets through a combination of insurance, and if you have enough money, trusts and other asset protection methods a good lawyer could advise. The 90 year old could easily get a good trusts lawyer.

Someone making $175K/year shouldn't want to pay that much in fees and should instead learn the basics of investment, but some of them are lazy and buy these stupid products because they get suckered by the triangle diagram the salesman draws to explain VUL.

Most VUL products are for stupid relatively well-off, but not rich, people who don't want to learn about investment. If you have real money, you should be savvy enough to get real advice instead of listening to a salesman. They will talk to you about capital preservation and other stuff, and you will typically buy Munis to save on taxes too.

rob8024 says

I haven’t found this kind of resource for VUL. It looks to me like VUL just places the investment risk on the owner, rather than the insurance company handling it. Because of this you can get a higher return, but you could also lose everything you put in.

It depends on the exact plan, as thunderlips said, because you have to read the fine print. The specific VUL plan I mentioned is a typical one that says you can't lose principal ever, but your return is capped, so you lose out big in boom years.

thunderlips11 says

Chris, yes. But VULs are tricky in that in certain conditions it can lose tax free status, especially if you contribute too much.

Also, the fees might be so high, and the investment methods so crappy, that you might be better of in a taxable account anyway. I have seen 401(k) plans where you'd be better off investing in a taxable account because all of the choices had fees of 1.5-2% or more or comparable to high-load mutual funds. I'm assuming the employer or the HR person was getting a massive kickback for fleecing the employees in this manner. If someone was smart, they'd sue the employer for breach of fiduciary duty under ERISA.

People poop themselves in joy when they hear the words "tax benefits", but they often don't realize what the tax benefits actually are and don't realize that the stated tax benefits might not compensate for the extra expense required to obtain those tax benefits.

Very interesting thread, thanks for posting.

Damn.

My Central Valley brother in law, a middle aged career shelf stocker at a big box discounter, laughed and made fun of me to make an example of me at an extended family event, when I suggested he'd be better off with a 20-year term policy than that stupid friggin VUL "product" someone in his social circle "helped him" to obtain. Did my job as an inlaw to look like an idiot, humor all the relateds.

The sad part is, for him at least, he is probably right. Because he doesn't have the discipline or vision to invest conservatively on his own.

Would it be fair to say that the only reason VUL exists as a "financial product" is because the insurance industry managed to get special tax treatment for it?

justme says

Would it be fair to say that the only reason VUL exists as a “financial product” is because the insurance industry managed to get special tax treatment for it?

I don't think so. People still like the marketing speak about how you typically don't lose principal, but you can still gain a percentage of the market increase. The tax treatment does help quite a bit, however, because people always poop themselves to get tax benefits even though they don't understand the tax benefits and how they might cost more than replicating something without tax benefits.

Sybrib says

The sad part is, for him at least, he is probably right. Because he doesn’t have the discipline or vision to invest conservatively on his own.

Yeah, the problem with people who don't take the time to understand insurance/finance products and then buy them without understanding them is that they often aren't very good at investing or even having the discipline to save. For anyone who puts a modicum of effort into either, most VULs probably don't fit their profile very well -- the massive fees alone.