Doing financial planning for clients generally includes making recommendations on life insurance of some kind. The particular type of policy depends, of course, on the client and the portfolio–and the need. Choices range from term to whole life to variable universal life and a host of other products, each with its own special niche of usefulness. Choices are many, and advisors must be savvy to select the best fit for their clients’ situations–particularly now, when the value of clients’ portfolios is down. Some advisors are recommending that clients replace that lost value with additional policies of various types to beef up protection for families and other potential heirs.

Enthusiasts will tell you that variable universal life can offer the the best of both worlds: the premiums that policyholders pay are invested in mutual funds offering potentially higher returns (higher than standard whole life insurance), but with a guaranteed death benefit. So you get the insurance, but can also see your money grow much faster than with a standard whole-life policy.

VUL also can be a bad choice, however, depending on the client’s risk tolerance (if an investment can go up, it can also go down, so there’s a greater risk of losing money) and on the performance of the markets in general (what goes up can come down for everybody). In the case of protecting a market-reduced portfolio through additional insurance, it would seem not to be the optimum choice.

There are other factors to consider, as well, when contemplating whether to add a VUL policy to your client’s portfolio. Particularly in the wake of the events of September 11, you must take into account a number of factors that perhaps had not been of prime importance before. You should also reexamine some areas where attention to detail could make the difference between a sound decision and a waste of time and money, or worse, a possible case for bringing into play your own unique brand of insurance–E&O.

VUL is appropriate and particularly useful in a limited range of circumstances, but that range may be narrowing due to the ferocious bear market of the past 18 months that has been exacerbated by the September 11 terrorist attacks. The main uncertainty is whether the stock market returns will be sufficient to pay current expenses of the policies and the future needs of the policyholders. And then there’s the question of whether the policy will cover your client in the event of terrorist attacks or war.

Appropriate in This Market?

John Henry McDonald, a planner in Austin, Texas, who happens to be working on getting a CLU, argues that VUL is a product to avoid, particularly in this market. Variable universal life insurance is sold through illustrations, he reminds us, and illustrations tend to assume particularly optimistic returns on policy investments. They also fail to cite returns after expenses, which McDonald says can be pretty hefty.

Those expenses include charges such as sales load (which can range from 4% to 7% of the premium per year for the first seven years); state premium tax (2% in Texas); Federal deferred acquisition charge (1%); mortality and expense charges (90 basis points); and fees for management or administration of separate accounts (75 bps). Totaling the expenses could yield close to 8%. Then remember that the investment on which the policy is based has to return not only that 8%, McDonald notes, but also the additional 12% many illustrations quote as the assumed return. In that instance, the VUL policy must post returns of 20% per year to achieve its goals. Not bloody likely, in this market.

Add to that the complications of losses in a down market, which have to be made up in a subsequent year or years to achieve the assumed “average” returns. Then recall that if the policy does not return enough to cover expenses, investments within the policy must be sold, even if the market is down. All of the above can add up to a negative number–not a good thing when what you’re trying to do is protect the value of a portfolio.

Then there’s the question of the rates themselves. McDonald does not think that rates will go up on VUL policies. Indeed, he says, they should go down, based on new actuarial tables that came out in 2000. Says McDonald, “Life expectancies are going into the hundreds now. What are the VUL companies going to use for the underlying cost of insurance? Costs stay pretty much where they are right now, without reflecting new life expectancy tables. For a 24-year-old female in good health, it’s a negative number.”

Another thing he points out is that for existing VUL contracts, “a majority endow at age 100. So if you live to be 100 and a day, you will receive a taxable event. You will receive all your money. [Clients will say,] ‘What happened to the death benefit that I want to pass to my heirs tax-free?’”

And then there’s the matter of act-of-war and act-of-terrorism exclusion clauses. All the insurance companies and industry spokesmen we were able to reach said that they would not invoke any such clauses for the September 11 event, and that they had no plans to add such clauses to future policies. From a purely practical standpoint it makes sense, however, to consider that at some point life insurers may feel compelled to add or invoke such clauses, since some property and casualty reinsurers in Europe were discussing the feasibility of invoking such clauses in the wake of September 11. Even though those particular European companies no doubt would find it hard to do business in the United States if they followed through on their discussions, it is only logical to assume that in the future, if conditions warrant (further acts of terrorism, growing loss of life in a prolonged military action), life insurance companies may do the same.

McDonald says that if you want to be sure that the policy you buy is free of those clauses, you should ask for a specimen policy. Otherwise, he says, you may not know of their existence within the policy, since they’re not cited in the illustrations used to sell policies. “That’s what you have to ask for, a copy of the documentation that represents the policy that you’re about to buy,” he cautions. “Every policy has one.”

On the One Hand, Responsive. On the Other . . .

We found it interesting that although John Hancock and Lincoln National Life Insurance took the time to respond to our questions about how the VUL industry would be affected by the tragedy and the market turmoil in its wake, a number of other companies chose not to comment, citing the issue as “too sensitive,” or simply did not respond to queries by deadline after we sent off our questions. The companies did tell us that they were safe and secure and policyholders would have no problem with VUL claims. Both companies said that if act-of-war or act-of-terrorism clauses were included in any of their policies (and this might be the case, said Lincoln in particular, due to policy acquisitions from other underwriters), those clauses would not be invoked. And the insurance industry as a whole has been very responsive and helpful to victims of the terrorist attacks by, among other things, setting up mobile claims centers to ease the process for traumatized families and forming a joint call center and Web site where victims’ families can go to determine whether family members even had insurance–and if so, how much, and with whom.

Herb Perone of the American Council of Life Insurers has a valid point in saying that it is too soon to know how the insurance industry will be affected long term by the terror attacks and the President’s promised war on terrorism. David Wood of the Life and Health Insurance Foundation for Education (LIFE) points out that we’re in uncharted territory in the wake of the attacks. Still, it would be nice if the VUL insurers were more forthright about what, if any, steps they are taking in their efforts to navigate the current turbulence.