Using Variable Universal Life In A Tactical Asset Allocation Strategy

Different markets demand different products. In todays environment, when the subject of variable universal life insurance is discussed, many clients ask whether the cash value of their VUL may be managed to grow even if the market continues to fluctuate up and down and, ultimately, remain flat over a period of years.

In markets that consistently fluctuate and remain flat, strategic asset allocation strategies and, consequently, strategic asset allocation products may not be managed effectively to achieve cash accumulation. In such cases, financial advisors may consider incorporating a more tactical approach to asset allocation and products that accommodate tactical asset allocation strategies.

Strategic Asset Allocation

Strategic asset allocation is familiar and most VUL products are designed to accommodate it. The basis of strategic asset allocation is Modern Portfolio Theory, the 2 key elements of which are the establishment of the clients time horizon and risk profile.

Risk profile is separated into 2 components. The first component is risk tolerance, which is generally defined as an investors financial ability to absorb risk. Risk tolerance is an objective measurement and involves the determination of how much money the client will need in order to meet his or her objective. The second component of risk profile is risk aversion, the investors subjective thoughts and feelings about risk.

After the clients time horizon and risk tolerance have been established, strategic asset allocation involves establishing an initial mix of investments. Strategic asset allocation also contemplates periodic rebalancing back to the original investment mix. In many cases, such rebalancing is conducted at some calendar event, such as the end of a year or end of a quarter.

When a client does not re-allocate back to the initial investment mix, the strategy evolves into a buy-and-hold approach, which is what we often saw happen in 1997, 1998 and 1999. A buy-and-hold approach may result in difficulties as many clients experienced in 2000, 2001 and 2002. This methodology may not be a very effective risk management strategy.

Tactical Asset Allocation

The majority of equity-based products and services available today accommodate strategic asset allocation strategies. Perhaps that is why tactical asset allocation may be misunderstood.

Tactical asset allocation strategies also establish an initial investment mix, which may or may not be diversified among different investment types. The initial investment mix is generally more short term in nature than under a strategic asset allocation strategy.

Typically, under tactical asset allocation, the investment mix is restructured more frequently than a strategic asset allocation model. Additionally, with tactical asset allocation strategies, the restructuring of the investment mix is typically dictated by prevailing market conditions, rather than a calendar date.

Insurance carriers have developed both variable annuity and variable universal life insurance products specifically designed to accommodate tactical asset allocation strategies. Target clients for these products include:

Insureds aged 45 to 55 with a need for life insurance;

Affluent, high-net-worth clients with a significant asset base;

Aggressive clients who willingly take on risk, are willing to risk losing principal for potentially higher returns and are willing to pay fees for this opportunity;

Clients seeking tax-deferred build-up of cash values combined with the ability to trade among subaccounts without realizing taxable gains;

Sophisticated investors who understand sophisticated investment techniques; and

Clients who trust their investment advisors to manage their subaccounts actively like a brokerage account.

Its important to note that it may not be a choice between strategic and tactical asset allocation. Rather, the 2 may complement each other. Diversification of asset allocation models is an important consideration in financial and insurance planning and risk management, in general.

Managing Assets in Trust

In estate planning today, many trust clients seek creative ways in which to achieve estate tax benefits while providing some access to cash values during lifetime. A VUL policy is often used when cash accumulation is an important objective in the trust planning completed by a qualified estate-planning attorney.

For example, one popular trust planning technique, which uses a VUL policy, is the spousal access irrevocable life insurance trust. In this planning technique, the insured spouse establishes and is the sole grantor of an irrevocable life insurance trust (ILIT). The insured spouse makes gifts of separate property to the ILIT, which uses such gifts to pay premiums on a single life policy on the insured spouse.

As owner of the insurance contract, the trustee may take loans and withdrawals from the policy. Assuming the policy is not an MEC and does not lapse, the trust receives the loans and withdrawals income tax-free. Under the typical terms of a spousal access ILIT, the trustee is permitted to make discretionary distributions to the non-insured non-grantor spouse. If ILIT is properly drafted and properly funded with the insured spouses separate property, the spousal access ILIT may provide 2 key benefits: (1) estate tax-free proceeds when the insured spouse dies, and (2) access to cash surrender values for discretionary distribution to the non-insured spouse.

The point is that trusts and trustees may depend on the cash accumulation aspects of a VUL policy as much as individual clients. As a result, trustees need to consider strategic asset allocation and tactical asset allocation products as potential funding vehicles. Of course, trustees must remember and financial advisors must counsel that no investment strategy, asset management strategy or asset allocation strategy ever assures a profit or guarantees against a loss. Strategies that may offer potentially higher rates of return also may involve a higher degree of risk to the principal. Nevertheless, trust planning strategies using a VUL policy demand consideration of the alternatives.

Implementing the Strategy

The tactical asset allocation variable products manufactured today, along with the strategic asset allocation products, package world-class money management and disciplined investment strategies for the financial advisors and their clients. Many insurance professionals using the tactical asset allocation strategies and products point out that they partner with independent investment advisors, specializing in these strategies.

These insurance professionals identify 2 main benefits of partnering with these specialists.

First, the independent investment advisors help implement, monitor and manage the strategies and products for the clients.

Second, the independent investment advisors often have other high-net-worth clients or trust clients who may need and/or want the tactical asset allocation insurance products offered by the insurance professionals.

In summary, tactical asset allocation products can provide value in many ways in the high-net-worth estate and financial planning markets.

Brett W. Berg, JD, LLM, CLU, ChFC, is field director of advanced sales for Nationwide Financial. He can be reached at bergb@nationwide.com.


Reproduced from National Underwriter Edition, August 19, 2004. Copyright 2004 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.