Younger Buyers and VUL: A Retirement Planning Duo
By Cary Lakenbach
The debate that President Bush has generated by proposing significant changes in the structure of Social Security should force Americans to think very carefully about retirement needs and consequently to prepare more proactively for retirement.
Great opportunities exist here for insurance companies, reps and agents, and clients. Clients of all demographic segments in the working population should examine their retirement needs.
Interestingly enough, particular advantages exist for insurers and producers specializing in younger age demographic segments. Younger individuals should expect to fund a greater percentage of their retirement on their own as opposed to relying Social Security or corporate retirement plans. That will impose a greater planning and funding burden on these workers, but the earlier they start such a program, the better served they will bebecause the compounding effect of investment gains is likely to be materially greater than if starting later.
Variable universal life insurance is an ideal product to explore for this purpose. Its fit is especially compelling. The remainder of this article explores the design and positioning of such contracts insofar as appeal to younger buyers is concerned.
A basic question to ask is: why life insurance? The answer is inherent in the product itself. Using life insurance as an accumulation and distribution vehicle certainly offers valuable design efficiencies (such as deferral of income recognition). Further, this insurance provides self-completing and guaranteed death benefit protection.
To a very significant degree, a sale to younger individuals can begin by estimating desired income amounts beginning at retirement. The assumption will need to include desired years of payout (as discussed later). The desired income amounts can be expressed as a percentage of the anticipated Social Security payout, which could be small or large, depending on market.
Young people increasingly want to save for retirement. Therefore, at the younger ages, lower premiums should be allowed.
Ordinarily, translating a desired retirement benefit to the required death benefit protection is based upon paying the highest level premium possible while still maintaining the favorable distribution treatment of non-MEC (modified endowment contract) life insurance.
One option to accommodate the needs of younger individuals is to pay a lower than maximum level of premium initially, allowing the premium to ramp up as the clients disposable income increases. (Rarely, if ever, should working people pay extra premium to build value within the insurance policy before they have made the maximum possible contribution to a 401(k).)
The impact of the savings component will be greatest at the highest possible premium level but would still be considerable at the initial lower premium levels. The key is that the potential for future long-term investment growth is greater the longer the funds are deployed.
Young people typically are willing to take somewhat more risk. However, many are, and should be, concerned about investing all in equities. Most VUL policies respond to that by providing all sorts of fund choices that reflect various risk and reward parameters.
For the VUL to provide the self-completing benefit upon death, it must be in force, of course. To this end, several new contracts today offer a so-called hybrid design, which guarantees the death benefit coverage as long as premiums paid are at the required level or higher. Some contracts require that this premium be deposited in a fixed account, whereas others impose few or no investment restrictions.
When the goal is long-term investment performance (in addition to insurance protection), contracts of the latter type are preferred. That is because all the funds are invested in vehicles that, on the basis of past performance, are likely to generate more favorable investment returns.
So far, the design aspects discussed here have addressed the VULs ability to stay in force and how it will be funded. This enables accumulation to occur.
Compared to annuities and mutual funds, which have either no death benefit or a modest one, a VUL policy contains a significant death benefit. Such benefit costs money. That means the accumulated policy values will likely be less than that of an annuity having funds invested in similar investment vehicles. (That may or may not be true compared to a mutual fund, because when funds are moved from one fund to another in a nonqualified plan, there may be tax consequences, thus drawing down the amount of fund assets under investment.)
The key to the success of the VUL offer lies in the ability to distribute funds without tax consequences according to current tax law. This is accomplished by a judicious use of withdrawal and loan provisions.
Whether the buyer is younger or older, advisors selling these products must provide sound investment guidance during the distribution phase. For assistance, they can use the growing number of sophisticated tools that exist for policy management.
Policies whose funds are distributed using loans run the risk of having the remaining unborrowed amounts shrink in value and, if the fall is egregious, lapsing. Tax consequences would occur if there are no unborrowed values to pay for the tax. As a result, an increasing number of insurers are developing “overloan” provisions, which guarantee policy continuation regardless of the size of the unborrowed cash amount. This gives buyers considerable protection.
Annuity sellers have prospered over the past few years by offering attractive living benefit guarantees. They provide downside protection in case investment performance doesnt materialize to the extent hoped for. Life insurers will very shortly be adding such features to their VUL contracts. These benefits can be paid out for fixed durations or, in fact, for lifetimes, and very importantly, would not modify the life insurance character of the contract.
In the VUL contract, then, the industry offers a structure that is valuable for younger people as well as others. The most valuable elements are shown in the accompanying box. These features together warrant a serious look by younger buyers interested in insurance protection and supplemental retirement income.
Cary Lakenbach, FSA, MAAA, CLU, is president of Actuarial Strategies Inc., Bloomfield, Conn. He can be reached via e-mail at [email protected]
Reproduced from National Underwriter Edition, April 1, 2005. Copyright 2005 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.