Variable & Variable Universal Life Insurance  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 Chapter 18 Tools & Techniques of Life Insurance Planning

Variable & Variable Universal Life Insurance  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 Chapter 18 Tools & Techniques of Life Insurance Planning

Variable & Variable Universal Life Insurance  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 Chapter 18 Tools & Techniques of Life Insurance Planning

Variable & Variable Universal Life Insurance  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) Chapter 18 Tools & Techniques of Life Insurance Planning

Variable & Variable Universal Life Insurance  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 Chapter 18 Tools & Techniques of Life Insurance Planning

Variable & Variable Universal Life Insurance  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 Chapter 18 Tools & Techniques of Life Insurance Planning

Variable & Variable Universal Life Insurance  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 Chapter 18 Tools & Techniques of Life Insurance Planning

Variable & Variable Universal Life Insurance  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 Chapter 18 Tools & Techniques of Life Insurance Planning

Variable & Variable Universal Life Insurance  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 Chapter 18 Tools & Techniques of Life Insurance Planning

Variable & Variable Universal Life Insurance  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 Chapter 18 Tools & Techniques of Life Insurance Planning

Variable & Variable Universal Life Insurance  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 Chapter 18 Tools & Techniques of Life Insurance Planning

Variable & Variable Universal Life Insurance  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 Chapter 18 Tools & Techniques of Life Insurance Planning

Variable & Variable Universal Life Insurance  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 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 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 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% 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 Variable & Variable Universal Life Insurance Chapter 18 Tools & Techniques of Life Insurance Planning