Updated June 2, 2014 5:21 p.m. ET
A lot of Americans buy life insurance and a lot hold stocks. But only a small number own a product combining the two, called variable universal life insurance, or VUL.
It's a product that has long been out of favor with many financial advisers. But these days it's a better choice for some families than other combinations of insurance and savings, says James Hunt, longtime insurance specialist for the Consumer Federation of America.
Variable universal life is a type of permanent insurance—designed to remain in place no matter how long the policyholder lives, unlike term life. Permanent life insurance combines a death benefit with a tax-deferred savings component that becomes tax-free at the death of the holder.
Variable universal life, unlike other permanent life insurance, allows the holder to select from a menu of stock and bond funds.
For years, VUL got a thumbs-down from many financial advisers and insurance specialists, largely because these policies typically come with steep insurance charges and high investment fees. Mr. Hunt has been one of the critics of those high costs.
But there are low-cost options, and today those are a good choice for people who might otherwise buy more-traditional permanent life insurance such as whole life and plain-vanilla universal life, says Mr. Hunt.
That's because the persistence of ultralow interest rates in the U.S. depresses the earnings in the more traditional policies, which don't offer investment options but instead pay interest to holders based on what the insurers earn on their own investments—typically geared toward high-quality bonds.
Mr. Hunt says VUL buyers should stick with insurers TIAA-CREF and Ameritas Life Insurance Corp., because of their overall low costs.
Here are edited excerpts of a recent email conversation.
Good Practice
WSJ: To start with, your position is that most American families should buy low-cost term life insurance. At the same time, you see a role for more-expensive permanent or "cash value" insurance, with its tax-deferred build up of investment income, for some affluent customers. Right?
MR. HUNT: Term life insurance—highly competitive, meaning it can be shopped for by price, and far more understandable—should be everyone's default choice. Good practice is to consider cash-value policies only after having maximized contributions to tax-favored retirement accounts and considered long-term disability-income coverage, especially if none is available at work.
WSJ: Why were you so down on variable universal life previously?
MR. HUNT: Although I have been critical of VULs, it is not due to the concept. At least for younger buyers, returns [from] equities should significantly exceed returns [from the] corporate bonds and mortgages that whole-life and universal-life insurers invest in. VULs, while possibly more administratively expensive, should outperform over the long periods that a cash-value policy must be held—usuall y to death for tax reasons.
Instead, [my objection has been to] the high fees…that apply to most VUL investment accounts, and the tendency of buyers to buy when markets are high and drop the policies in bad markets.
WSJ: What role do low interest rates play?
MR. HUNT: Nonvariable universal-life insurers typically guarantee just 3% on new policies. Most are paying the minimum rate of 4% on existing policies.
Worry about deflation is heard frequently these days, implying low interest rates, and it may not be alarmist to recall the "Japan scenario"—two decades of interest rates so low that several life insurers failed. A VUL does not expose a life insurer to significant asset risk.
Riding It Out
WSJ: What do you advise about investing within a VUL?
MR. HUNT: Younger buyers, at least, should choose a high percentage, even 100%, in stock accounts; internatio nal exposure may be prudent.
It's best to avoid the high-cost managed accounts that all VULs offer; look for available indexed accounts. TIAA, for example, offers its own low-cost investment accounts, including a stock index account at an annual asset charge of 0.10%. Ameritas Direct offers very-low-cost Vanguard accounts.
VULs for those of retirement age may not be appropriate because equities can take a long time to recover from bad markets.
WSJ: Any other advice for buyers?
MR. HUNT: A VUL buyer must be prepared to ride out bad markets. Do not even think about market-timing shifts of investment-account allocations…. Use the time-honored dollar-cost-averaging approach advocated for decades for mutual funds. If paying a typical level premium, more shares of your investment accounts will be bought when the market is down, and vice versa.
A fast-rising alternative to a VUL…is indexed universal life that of fers stock-market-linked cash values with a minimum interest rate of, say, 1% if the market goes down and a cap, say, of 12% if it soars.
These vehicles have a marvelous "have your cake and eat it too" sales pitch. Not so great is that the index excludes corporate dividends (a fact obscured in the complicated sales illustrations).… Better to stick with a VUL.
Ms. Scism is a news editor for The Wall Street Journal in New York. She can be reached at leslie.scism@wsj.com.
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