Decisions, Decisions. Choosing Between SPVLs Or SPVAs
Toward the mid- to late-1980s, one of the hottest life insurance products was single premium whole life insurance. SPWL, as it was called, was widely sold not only by traditional life insurance agents, but by banks and stockbrokers as well.
Thats all changed, and now the industry has single premium variable life coming to the fore.
This article explores this product evolution, and also addresses the advantages of SPVL over another single premium productthe single premium variable annuity. Well also touch on how variable life stacks up against variable annuities.
The examination should help producers understand the products merits, and assess which ones might be most suited to various needs.
First, some history. As you may recall, when SPWLs were the rage, they provided an easy method for wealth transfer, afforded life insurance protection, and were easily understood by unsophisticated purchasers and sales persons.
Then, in 1988, Congress changed the tax law applicable to the product. For the first time, loans and other distributions–other than on the death of the insured–were subject to federal (and in most cases, state) income taxes. Moreover, on distributions prior to age 59 (other than for death, disability, or annuitization for life expectancy), a 10% tax penalty was imposed.
Almost immediately, word spread throughout the SPWL market that the product had lost its favorable tax status. Sales people switched to selling annuities instead of SPWL.
To the trained eye, this sudden shift was hard to understand. All the tax law change did was make distributions from SPWL taxable in the same manner as for annuities. Therefore, switching from selling SPWL to selling annuities seemed unfathomable, considering that taxes on pre-death distributions are identical in both products.
At the time, SPVL insurance products were just beginning to come to market. The timing was such that the product, in effect, died on the vine–before the industry even had a chance to see how effective it could be as a wealth transfer mechanism.
Today, however, SPVL sales are beginning to pick up–probably in recognition of the products unique value in the financial planning process.
One of the main advantages of any life policy, variable or fixed, is that death proceeds transferred to the beneficiary free from income taxes on any amounts in excess of the owners basis in the policy. This advantage is not available for an annuity.
Without effective estate planning, both products may be includable in the gross estates of the owner on death. However, the addition of an income tax on the increase in basis of an annuity makes it compare unfavorably with VL–particularly when considering that the vast majority of life policyowners will not be subject to estate taxes on death and that probably all annuities will be subject to income tax on the contract owners death.
Some designers prefer to build VAs to use with sophisticated investment strategies for high net-worth investors. Why a VA instead of a VL for this sophisticated market? The VL is “too complicated and too expensive,” we have been told, while the VA is “simpler and cheaper.”
Lets explore these two points. True, many VLs are more complicated to design, administer, underwrite, and sell. It is also true that the cost for the insurance element must be deducted from policy cash values.
Yet, today many new, simplified VLs have come to market, on both a single premium and periodic premium basis. These products are easier to understand and have no or very little underwriting. We have seen some VLs that can be issued in as little as 15 minutes from receipt of the application and the rest of the medical information.
The cost for a VL is somewhat more difficult to compare with a VA.
Granted, many VLs and VAs have a similar “mortality and expense risk charge.” (Note: The M&E terminology is no longer as universally used as it once was; some insurers now call the non-insurance charge an “asset charge,” or an “administrative charge,” or some other term). However, some VLs have a smaller asset charge than is usually imposed on VAs.
The major additional cost for VLs (whether single or periodic premium products) is the cost for the insurance factor in the product. This COI, as it is called, will, of course, depend on the age, sex and health status of the insured. However, for the average policyowner, this cost is usually less than 1% to 2% of the cash value annually.
When considered with the fact that the COI not only provides for insurance coverage at very favorable rates, but also affords the ability to have accumulated investment income pass free from taxes, the cost is quite modest.
The variable product industry has come under some criticism lately (unjustified, we believe). Here is a key complaint: Though many VA owners did enjoy spectacular increases in contract values throughout the 1990s, now, as these owners begin to die, the VA beneficiaries are becoming upset at the combination of income taxes and estate taxes that highly appreciated VAs can engender.
With 20/20 hindsight, these beneficiaries are claiming that the VA owners should have been sold VL insurance, rather than a VA!
Although we do not have much sympathy with this revisionist position, we do think that it affords some guidance for current and future sales of variable products.
VA sales people should always consider whether a VL policy might be more appropriate to the customers need–particularly in view of the new simplified products that are now available.
Norse N. Blazzard, JD, CLU, and Judith A. Hasenauer, JD, CLU, are principals in the Westport, Conn. and Ft. Lauderdale, Fla. law firm of Blazzard, Grodd & Hasenauer, P.C. E-mail them at Norse.Blazzard@BGHPC.com.
Reproduced from National Underwriter Life & Health/Financial Services Edition, April 8, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.