Investor Bulletin: Variable Life Insurance

The SEC’s Office of Investor Education and Advocacy is issuing this Investor Bulletin to educate investors about variable life insurance and how it works. This bulletin provides a general description of variable life insurance. The features of each policy may vary by product and by state.

What Is Variable Life Insurance?

A variable life insurance policy is a contract between you and an insurance company. It is intended to meet certain insurance needs, investment goals, and tax planning objectives. It is a policy that pays a specified amount to your family or others (your beneficiaries) upon your death. It also has a cash value that varies according to the amount of premiums you pay, the policy’s fees and expenses, and the performance of a menu of investment options—typically mutual funds—offered under the policy.

What Should I Do Before I Invest In A Variable Life Insurance Policy?       

• Know how it works. Look up key terms you might not be familiar with. Be prepared to ask your financial professional questions about whether the policy is right for you.
• Figure out how much it costs.  Ask what the fees and expenses are.

• Get the details. Different policies have different features. Ask your financial professional for the policy prospectus, which will describe the policy you’re considering in detail. Read the prospectus carefully and ask questions about what you don’t understand.

  The prospectus is available free of charge. It contains important information about the variable life insurance policy, including fees and expenses, investment options, death benefits, and other features.

Remember: Variable life insurance is only appropriate for individuals with specific life insurance protection needs. Substantial fees, expenses, and tax implications generally make variable life insurance unsuitable as a short-term savings vehicle. You will be required to pay a certain amount of premiums or maintain sufficient cash value to cover your policy’s fees and expenses. Loans or poor investment performance may also lower your cash value. Failure to maintain sufficient cash value may cause your policy to lapse and terminate. Variable life insurance involves investment risks, just like mutual funds do. If the investment options you selected for your policy perform poorly, you could lose money, including your initial investment. The prospectus does not describe the amount of insurance you purchased and the amount of fees you will pay. Therefore, you should also review any additional materials provided to you when you purchase your policy. Policy fees may go towards your financial professional’s compensation. That means they may receive higher compensation for selling some policies or investment products than for others.

Things to consider:

• You should consider your insurance needs, investment goals, and your tax situation.
  • Learn what kinds of insurance policies or other investment products can meet your needs.
  • Consider whether you can afford the policy. The fees and expenses associated with the insurance policy may be significant. If you cannot pay those fees and expenses, your policy may terminate.
  • Consider how the policy fits within your overall financial scenario.

• If you determine that variable life insurance is the best option for you, consider:
  • The amount of insurance you need and how long you need the insurance.
  • The value of your investment and any returns will depend, in part, on the performance of the investment options you choose.  It is possible you can lose money.
  • Fees and expenses vary based on your personal characteristics (such as age, gender, health, and family history). Make sure you consider the total actual costs for your specific policy. In addition, the fees associated with certain policies may increase over time.
  • Other special features offered under the policies may fit your needs, and those features may be purchased more cheaply separately.
  • The financial strength of the insurance company is important.
  • Insurance companies or your financial professional may make personalized illustrations available for certain policy features. It may be prudent to request and review these illustrations. They can help you understand how your policy will operate under your circumstances.

What If I Change My Mind?

You may cancel your policy within a short period (usually lasting at least 10 days) of receiving it without charge. Upon cancellation, you will typically receive a refund of your premiums. The refund may be adjusted up or down to reflect the performance of your investment options. The length of the free look period may vary depending on the state where you signed your application.

Tax Rules The federal tax rules that apply to variable life insurance can be complicated. In addition, there may be state tax implications. Before investing, you may want to consult a tax adviser about the tax consequences of investing in variable life insurance.  Your cash value may accumulate on a tax-deferred basis. This means you will only be subject to federal income tax when you withdraw money from your policy. The policy’s gains will be subject to ordinary federal income tax rates rather than lower capital gains rates. You may take loans from your policy without paying federal income taxes. However, if your policy terminates with a loan outstanding, you may owe federal income taxes on the loan. The death benefit paid to your beneficiaries is not subject to federal income tax. Under certain circumstances, the death benefit may not be subject to federal estate tax.

How Variable Life Insurance Works

Variable life insurance is a form of life insurance. Like other life insurance, it provides a death benefit that may be significantly larger than the amount of premiums you pay.

With a variable life insurance policy, you will be required to pay premiums into an account. The amount of the premium payments that go into the account may be less than you paid because fees were taken out of the premium payments. The money in the account gets invested in a menu of investment options—typically mutual funds— that you can select.

In addition, you may be able to allocate part of your premiums to a fixed account. A fixed account, unlike a mutual fund, pays a fixed rate of interest. The insurance company may reset this interest rate periodically, but it will usually provide a guaranteed minimum (e.g., 3% per year).

The money in your account will vary according to the amount of premiums you pay, the amount of policy fees and expenses, and the performance of the investment options you choose.

Example:  You purchase a variable life insurance policy with an initial premium payment of $100,000. You allocate 50% of that payment ($50,000) to a bond fund, and 50% ($50,000) to a stock fund. Over the following year, the stock fund has a 10% return, and the bond fund has a 5% return. At the end of the year, your account has a value of $107,500 ($55,000 in the stock fund and $52,500 in the bond fund), minus fees and expenses (discussed below).

Your policy may require you to pay a specified amount of premium payments or provide you the flexibility to pay varying premiums as long as you contribute enough to pay your policy fees and expenses. 

Some policies may also provide protection from lapse (that is, not having sufficient policy value to pay your policy fees and expenses) if you pay in a certain level of premiums. A policy may lapse if there is not enough cash value (either as a result of policy fees and expenses or poor investment performance or loans) to pay the current policy fees and expenses.

The more money you pay in premiums, the lower some of your policy’s fees and expenses may be. This is because your net amount of risk determines some policy fees and expenses. Your net amount of risk is the difference between your policy’s face amount and your policy’s cash value, so it goes down if there is more money in your account.

Key Risks of Your Variable Life Insurance Policy

• Not a short-term savings vehicle. A variable life insurance policy is designed to provide a death benefit or to help meet other long-term financial objectives.
• Policy lapse. If you do not maintain sufficient cash value to pay your policy fees and expenses, your policy may lapse. That means it will terminate without value and your beneficiary will not receive any death benefit. A significant number of life insurance policies lapse.

Example: If your policy has a current value of $40,000 and fees and expenses that are $10,000 per year (based on a death benefit of $300,000), your policy may lapse within four years. This could occur sooner due to poor investment performance or if you make a withdrawal or take a policy loan. Positive investment performance and paying additional premiums can reduce the risk of lapse.

• Policy fees and expenses. Policy fees and expenses may be significant. These may include deductions from premium payments, surrender charges, and significant ongoing fees and expenses associated with owning a policy.
• Risk of loss. You can lose money in a variable life insurance policy, including potential loss of your initial investment.
• Risks associated with investment options:
  • The value of your investment and any returns will depend on the performance of the investment options you choose.
  • Each underlying fund may have its own unique risks. You should review the investment option’s prospectus before making an investment decision. You should consider a variety of factors with respect to each fund option, including the fund’s investment objectives and policies, management fees and other expenses that the fund charges, the risks and volatility of the fund, and whether the fund contributes to the diversification of your overall investment portfolio.
• Insurance company risk. The financial strength of the insurance company that issues the policy backs all guarantees, including the death benefit. If the insurance company experiences financial distress, it may not be able to meet its obligations to you.

The Death Benefit, Policy Loans, and Other Optional Insurance Features

The death benefit is the amount of money your beneficiaries get when you die. When you purchase a policy, you select a “face amount.” This is the amount your death benefit is based on. For instance, a death benefit could be equal to:

• the face amount;
• the face amount plus the cash value of your account; or

• the face amount plus the amount of premium payments you contributed to your policy.

  Example:  You paid $100,000 in premiums for a variable life policy and, due to positive market performance, it is now worth $150,000. If the face amount of the policy is $1,000,000, your death benefit would be the following, depending on which option you selected:

  • If based on your face amount: $1,000,000.
  • If based on your face amount plus the cash value of your account: $1,150,000 ($1,000,000 + $150,000)
  • If based on your face amount plus your premium payments: $1,100,000 ($1,000,000 + $100,000)

You may also be able to purchase additional insurance features that may increase the value of your death benefit. In addition, you may be able to increase your face amount at a later date. Such changes might require another medical examination or other evaluation by the insurance company.

Policy Loans. Variable life insurance policies typically permit you to take loans on a portion of the policy’s cash value without incurring surrender charges or paying federal taxes. Policy loans typically have the following effects on your policy:

• They reduce your policy’s cash value.
• They may reduce your death benefit.
• By reducing your policy’s cash value, they increase the likelihood your policy will lapse.
• Policy loans (unlike withdrawals) are not generally considered taxable events. However, if your policy lapses with a loan outstanding, that loan may be considered a withdrawal for federal tax purposes.
• They are typically not subject to surrender charges.
• You will typically owe interest on the amount borrowed.
• They may be repaid without the deduction of a sales fee.

Other Optional Insurance Features. There are fees and expenses associated with each of these optional features.

• No lapse features—keeps your policy in effect if you do not have sufficient account value to pay your policy’s charges. These features may only be available in certain years, or if a certain level of premiums are paid. When elected, a no-lapse feature may significantly reduce your death benefit.
• Disability rider—keeps your policy in force if you become disabled and cannot pay your policy charges.
• Accelerated death benefit—pays a portion of your death benefit while you are still alive if you are chronically or terminally ill.
• Long-term care insurance—provides coverage for the cost of long-term care.
• Income benefit —provides a minimum level of monthly income to you or your beneficiaries for a specified period.
• Additional term insurance—provides the opportunity to purchase additional term life insurance for you or your family as part of your variable life insurance policy. Term life insurance is a fixed amount of life insurance for a specified period.
• Accidental death benefit—provides an additional death benefit if you should die because of an accident.

Remember: You will pay extra for optional insurance features such as long-term care insurance or accidental death benefit. Be sure you understand the fees. Carefully consider whether you need the feature. If you do, consider whether you can buy the benefit more cheaply separately (e.g., through a long-term care insurance policy). In addition, these optional features are complex and may carry certain risks and limitations.

Variable Life Insurance Fees and Expenses

You will pay several fees and expenses when you invest in a variable life insurance policy. Be sure you understand all the fees and expenses before you invest. These fees and expenses will reduce the value of your account and may require you to contribute additional premiums to your policy to prevent the policy from terminating. Often, they will include the following:

• Sales fees imposed on premiums. Sales fees are a percentage of the amount paid. They reduce the amount of your premium payment applied to the policy. They typically compensate the insurance company for sales expenses.   
• Surrender charge. This fee applies if you surrender the policy or make a withdrawal in the early years of the contract. It compensates the insurance company for sales expenses that it would otherwise not recover in the event of early surrender. Be sure to check the length of your surrender charge period when evaluating a policy.
• Mortality and expense (M&E) risk fees. These ongoing fees are equal to a certain percentage of your account value. They help cover the risks the insurance company assumes with respect to the policy. Risks might include that the policy owner may die sooner than expected, that administrative and sales costs are higher than expected, and that policy owner behavior does not match the insurance company’s expectations.
• Cost of insurance. This ongoing fee varies for each insured based on factors including the insured person’s age, gender, health, and death benefit amount. It compensates the insurance company for providing the death benefit.   
• Administration fees. These ongoing fees help cover the insurance company’s costs of issuing and administering the policy, and activities such as processing claims, maintaining records and communicating with you. They may be charged as a flat account maintenance fee or as a percentage of your account value.
• Loan interest. If a policy permits you to take loans, you will be charged interest on any loan amount outstanding.
• Underlying Fund Expenses. You will also indirectly pay the ongoing fees and expenses for the mutual funds that are the underlying investment options for your variable life insurance. These fees are in addition to the fees charged by the insurance company and are reflected in the performance of the investment options.
• Fees and Expenses for Optional Features. Policies may offer a number of additional features for an additional fee, as described further in this bulletin. The fees and expenses may vary significantly based on the type of features offered and/or on the basis of the individual insured.
• Transaction fees. These fees cover services you request. Some policies assess fees for transactions like transferring money among investment options, partial withdrawals, increasing or decreasing the face amount, or providing additional reports (such as policy illustrations).

Other fees and expenses may also apply. You should ask your financial professional to explain to you all charges that may apply. You can also find a description of the fees and expenses in the prospectus for any variable life insurance policy that you are considering.

Remember: If you do not maintain sufficient cash value (either as a result of policy fees and expenses or poor investment performance or loans) to pay your current policy fees and expenses, your policy may lapse (that is, terminate). Certain charges are based on your personal characteristics. These charges may be more significant if you present a greater risk to the insurance company (that is, if you are more likely to die sooner). The policy may quote fees and expenses on a monthly or yearly basis. Be sure you understand the amount of fees and expenses you are paying. Policy fees may go towards your financial professional’s compensation. That means they may receive higher compensation for selling some policies than for others.

Exchanging One Variable Life Insurance Policy For Another

If you are considering replacing one life insurance policy for another, here are some things to consider:

• As you age, the cost to insure you is likely to increase, so a new policy may be more expensive. Be sure to compare the costs associated with an existing policy to any new policy.
• Surrender charges are typically higher in the early years you own a policy. If you exchange a policy, you may be subject to a surrender charge on your existing policy and a new surrender charge period on the new policy.
• Be sure to compare the old and new policy features to determine which policy better suits your needs.
• Consider the tax consequences associated with any policy exchange.
• Do not cancel your existing policy until your new policy is in effect to ensure that there is no gap in your insurance coverage.
• Request a policy illustration from your financial professional comparing your old and new policy.
• Consider the financial motivation your financial professional may have to recommend that you exchange one policy for another.

Additional Information

Mutual Funds and ETFs – A Guide for Investors

Investor Bulletin:  Performance Claims

Updated Investor Bulletin:  How Fees and Expenses Affect Your Investment Portfolio

Investor Bulletin:  How to Check Out Your Financial Professional

How To Contact the SEC With Questions or Complaints:

Office of Investor Education and Advocacy
U.S. Securities and Exchange Commission
Email: [email protected]
Telephone: (800) 732-0300
Submit Questions and Complaints

The Office of Investor Education and Advocacy has provided this information as a service to investors. It is neither a legal interpretation nor a statement of SEC policy. If you have questions concerning the meaning or application of a particular law or rule, please consult with an attorney who specializes in securities or tax law.