By Jack Korte
For most investors, the goals of their investments change with time. As investors age they often seek to secure their financial future for retirement, while also providing and protecting an inheritance for their loved ones. As such, traditional, equity based investing often becomes less appealing. As a result, investors tend to look to more complex and structured investment vehicles to safely accomplish their various investment goals. However, hidden behind the structure and complexity of these investments can lie details, fees, and risks that go unforeseen by even experienced investors. A relatively new example of such an investment is Variable Life Insurance.
Variable Life Insurance (“VLI”) policies are appealing to investors for a variety of reasons. At their most basic level, they offer investors the traditional benefits of a life insurance policy (a death benefit with the option for additional features). Additionally, the policies provide the opportunity for capital growth and also provide a preferable tax status. These are the facets of the investment that brokers and insurance salesman are sure to share with potential clients. However, it is the more nuanced aspects of the policy that should be reviewed thoroughly.
For the right investor and under the right circumstances, a VLI policy can be both an appropriate and a successful investment. Unfortunately, too often the policy is purchased without appropriate review. The first trap that investors fail to notice is the most apparent; fees and commissions. VLI plans can carry some of the highest fees and commission rates in the insurance industry. While the promised return might seem appealing, it is essential to properly balance the return with the actual cost of investment. Premiums for such policies may appear either lower or higher than they actually are. In some cases, an investor may falsely perceive that all the money they are paying as premiums each month is increasing the value of their investment. In reality, a sizable portion of that premium may be consumed by fees, meaning it will never be returned to the investor. Additionally, a premium may appear lower than it actually is in cases where an investor mistakes the amount needed to fund their accounts as the total amount needed to subsidize the account. Either way, when unclear, these miscalculations can lead to serious problems with properly funding the investment and/or ensuring the investment’s profitability.
The second major issue with VLI policies is the autonomy over an investment that insurance companies retain for the majority of the policy. While insurance salesmen and brokers may tout an investor’s ability to withdraw money without tax penalties, they may fail to address the fees that their own company will charge if you try to touch your money too early. Most VLI policies stipulate that an investor cannot remove any of their investment for a certain period of time (usually 10 years) without suffering a substantial surrender fee. What further complicates this feature is what can happen to an investment while it’s locked up. For many policies, the insurer has the ability to collect premium payments not only from the investor but also from the investment. Meaning, if an individual misses a monthly payment of $8,000, the policy will automatically deduct the $8,000 from the investor’s funding of the policy. This process creates a dangerous paradox. The people who need to access the money in their policy the most (those who are short on cash) are also those who are most likely to not be able to make their monthly payments. If this cycle goes unchecked, an investor may be forced to watch as the insurance company writes monthly or yearly checks to itself as their principal investment decays to nothing.
Although VLI policies are classified as securities, they very much fall in a grey area both in administrative oversight and enforcement. They can be very complex investment vehicles with equally complex prospectuses and statements. As such, potential investors should be cautious with the product and discuss it thoroughly with their broker, insurance salesmen, or financial advisor before purchasing.