1. Introduction to Variable Life Insurance (VUL)

Variable Life Insurance, also known as VUL (Variable Universal Life), is a type of life insurance policy that combines the benefits of life insurance with investment opportunities. These policies are particularly popular in the U.S., where they are called Variable Life insurance products, and in Europe, where they are known as Unit-linked or Investment-linked life insurance products. The policyholder's premiums are used to purchase units in one of the company's investment funds, linking the policy's value directly to the performance of these investments.

How Do Variable Life Insurance Policies Work?

Variable Life Insurance operates similarly to mutual funds. Here’s a detailed breakdown of its workings:

1. Premium Allocation: A major portion of the policy premium is used to purchase units in the VUL funds managed by the insurance company. A smaller part of the premiums is allocated for mortality protection under the policy.
2. Investment Returns: The returns on the investments in VUL policies are not guaranteed and are directly linked to the performance of an investment fund managed by the company. The fund's ownership is divided into units, each representing an equal share of the fund's net asset value.
3. Market Fluctuations: The fund invests in assets whose values fluctuate with market prices. As the asset value of the fund rises, the unit price increases, and vice versa. Unlike traditional participating life policies, VUL policies reflect the actual investment performance without a smoothing process, leading to variable results for policyholders.

Differences Between Traditional and Variable Life Insurance Policies

Traditional Participating Life Policies:

• Aim to produce a steady return by smoothing out market fluctuations.
• Premiums are divided into insurance protection, expenses, sales costs, and investment.
• The smoothing process adjusts investment returns to provide a consistent rate of return.

Variable Life Insurance Policies:

• Offer potential for higher returns but come with market volatility and higher risk.
• Provide a wider choice of investment funds (e.g., shares, government bonds, property).
• Investment elements are transparent and invested in a separately identifiable fund.
• Policy charges and investment content are specified in the policy documents.

Policy Charges

Charges in VUL policies are openly stipulated, unlike traditional policies where charges are often not detailed. Here are common charges in VUL policies:

• Policy Fee: Annual fee for managing the fund.
• Bid-offer Spread or Initial Charge: A difference between buying and selling prices.
• Reduction in Allocation of Units: Unallocated premiums.
• Initial Units: Units allocated at the policy's inception.
• Mortality Charges: Costs for providing the death benefit.
• Surrender Charges: Fees for early policy termination.

By understanding these elements, policyholders can better grasp the workings of Variable Life Insurance (VUL) and make more informed decisions about their insurance and investment strategies.

For additional details and key terms related to Variable Universal Life (VUL) Insurance, visit our Essential VUL Insurance Terms and Concepts.

2. Types of Investment Assets

In this section, we will explore the range of investment choices available to individual investors. These investment instruments include:

• Cash and Deposits
• Fixed Income Securities
• Shares
• Common Trust Funds
• Mutual Funds
• Properties

2.1. Cash and Deposits

Cash and deposits refer to all liquid instruments that carry little or no risk of losing the principal amount invested. These represent the highest safety in the investment universe but also provide the lowest returns. Although strictly speaking, cash is not considered an investment as it is used as a means to finance investments rather than generate additional income.

For our purposes, the definition of cash includes short-term debt instruments such as:

1. Treasury Bills (T-Bills) - Short-term government securities (one year or less) issued to borrow money from the public to fund government expenditures. They are considered the safest type of investments as they are generally risk-free and backed by the government.
2. Bank Accounts - These include various types of deposits placed with banks for fixed periods with fixed interest rates. The common types are:
   • Savings Accounts
   • Current Accounts
   • Fixed Deposits
   • Investment Accounts
   • Time Deposits
   • Offshore Accounts

The choice of deposit depends on factors such as the amount of funds available, the investment period, potential need for emergency withdrawals, and prevailing market conditions. The disadvantage of bank deposits is their low yield, which may not keep pace with inflation, and penalties for early withdrawal.

2.2. Fixed Income Securities

Fixed income securities offer a fixed periodic return and represent loans made by the investor to the issuer, typically a government or a company. These securities emphasize current income with little opportunity for appreciation in value. Types include:

1. Government Bonds - Financial instruments used by the government to borrow money from the public. They are considered very safe with low yields compared to other fixed income securities.
2. Corporate Bonds - Companies can issue bonds to raise funds, including:
   • Debenture Stocks: Unsecured loans backed only by the company's creditworthiness.
   • Secured Stocks: Loans backed by collateral, offering more security than debentures.
   • Convertible Stocks: Bonds that can be converted into ordinary shares of the company on a fixed date, providing potential for income and capital appreciation.

2.3. Shares

Shares represent ownership in a company, giving shareholders voting rights and a share in the company's profits. Companies can be public or private, with public company shares traded on stock exchanges like the Philippine Stock Exchange (PSE).

1. Ordinary Shares - Holders are part-owners of the company and share in its profits through dividends, which are not guaranteed and depend on the company’s performance.
2. Preferred Shares - Offer fixed dividends and take precedence over ordinary shares in profit distribution, although dividends are only paid if profits are made.

2.4. Common Trust Funds (CTFs)

CTFs pool funds from many investors, managed by a professional fund manager, to provide access to a diversified range of investments. The investments can generate income through dividends, interest, and capital gains. The trust deed outlines the fund manager's powers, fee structure, and other regulatory measures to protect investors.

2.5. Mutual Funds

Similar to CTFs, mutual funds pool contributions from investors, managed by specialized fund managers. Profits from investments increase the fund’s value, benefiting investors. Mutual funds have a higher risk/reward profile than CTFs and are not suitable for very short-term investments.

2.6. Properties

Real estate investments include agricultural, domestic, and commercial/industrial properties. The value of agricultural properties depends on land quality, location, and buildings. Domestic and commercial property values generally depend on location and building type.

3. Key Considerations in Investment

For consumers to make informed investment decisions, it's crucial to understand key concepts and fundamentals. Here are some essential considerations:

• Investment objectives
• Funds available
• Level of risk tolerance
• Investment horizon
• Accessibility of funds
• Taxation treatment
• Performance of the investment
• Diversification

3.1. Investment Objectives

People typically invest their money to achieve various goals:

• Enhance or maintain a comfortable standard of living
• Improve financial situation
• Provide income in retirement
• Fund education and upbringing of children
• Cover necessary costs and taxes upon death

Based on these objectives, investors need to choose between assets that yield regular income or those with better potential for capital gains. Some investments offer regular income without capital gains, while others, like commodities, do not provide regular income but offer potential for capital gains.

3.2. Funds Available

The amount of funds available significantly impacts investment decisions. With limited funds, certain investment types may not be accessible. More funds provide a greater range of investment options.

The source of available funds also matters. If funds come from surplus income, investments like insurance policies and common trust funds (CTFs) may be suitable.

3.3. Level of Risk Tolerance

Different investments come with varying levels of risk. Short-term government securities or bank deposits carry minimal risk, while shares can be highly volatile in the short term. Generally, higher risk requires a higher potential return to attract investors. Risk tolerance is influenced by factors such as age, investment objectives, financial condition, and personality. For instance, a speculative investment may be suitable for a wealthy individual but not for a young couple with children.

3.4. Investment Horizon

Investment horizon refers to the time period an investor plans to hold an investment. It can range from a few days to several years, depending on the investor's objectives, age, and financial condition.

Matching the investment horizon with the maturity of the investment asset is crucial. For example, while keeping money in a top-tier bank is safe, it may not be suitable for a ten-year horizon due to reinvestment risk and inflation eroding the value of the money.

3.5. Accessibility of Funds

Accessibility of funds involves three components:

1. Timeframe: If funds are needed in a short period, they should not be locked in a long-term investment.
2. Cost/Penalty: The cost or penalty of realizing the investment before its maturity if funds are needed urgently.
3. Initial Cost: The cost of setting up or buying into the investment.

3.6. Taxation Treatment

Different investment vehicles have varying tax treatments, affecting both the investment vehicle and the investor's tax liability. It's essential to consider these tax implications. For instance, the value of a variable life insurance policy fluctuates with the value of the units it holds, impacting the policy's underlying value.

3.7. Performance of the Investment

Investment performance depends on various factors, including:

• Economic conditions
• Competence of the management team
• Cost structure of the invested company
• Historical performance and life cycle of the investment

3.8. Diversification

Diversification involves spreading investments across different asset classes and market environments to reduce risk without sacrificing returns. This strategy, used by professional fund managers, is effective in minimizing risk. Investors should aim to diversify their portfolio by investing in a range of vehicles like stocks, bonds, and money market instruments. Diversification can also be achieved by investing in different countries and types of shares.

The adage "never put all your eggs in one basket" is particularly relevant to investing. Diversification can significantly reduce risk with only a small reduction in potential returns.

4. How Variable Life Insurance Products Work

Variable Life Insurance (VLI) products allow policyholders to invest their premiums in various funds, offering a flexible and potentially high-return investment option. Here's an in-depth look at how these products work.

The Workings of Variable Life Insurance

Example Fund Dynamics: Imagine a fund invested solely in stocks and shares (an equity fund) with a total value of PHP 1 million. This value represents the aggregate of all investments in the fund.

Instead of dealing with the entire fund value, the fund is divided into units, similar to shares in a company. If the fund has 100,000 units, each unit would be worth PHP 10 (PHP 1 million ÷ 100,000 units).

Unlike traditional life insurance, which guarantees a minimum value and adds cash dividends to the guaranteed cash values, a Variable Life Insurance policy's value fluctuates with the value of its underlying units. If unit values decrease, so does the policy's value.

Premium Allocation: Premiums paid under a VLI policy are used to purchase units in the fund. For example, with a premium of PHP 200 and a unit price of PHP 2, the policyholder would receive 100 units (PHP 200 ÷ PHP 2). The policy's value depends on the number of units accumulated and their current value.

Top-Ups

Policyholders can add additional premiums, known as top-ups, to their policies at any time, subject to a minimum amount. These top-ups purchase more units of the variable life fund. The steps involved are:

1. Top-Up Payment: An additional single premium is paid.
2. Purchase of Units: The premium (after deducting top-up charges) buys additional units at the offer price.
3. Units Accumulation: The newly purchased units are added to the existing units in the policyholder's account.

Top-ups can be partial withdrawals (selling some units) or full withdrawals (selling all units), which may impact the policy's value and benefits.

Single Premium Policies: Methods of Calculating Benefits

Single Pricing Method: The single premium is used to buy units at a single quoted price, regardless of buying or selling. Charges, like initial and mortality charges, are deducted either before or after the premium is converted into units.

Dual Pricing Method

Dual Pricing Method: In this method, units are bought at the offer price and sold at the bid price, with the bid price being lower than the offer price. The difference, or bid-offer spread, impacts the calculation of units and charges.

Death Benefit

Types of Death Benefits:

1. Unit Value Plus Sum Insured: Pays both the value of units and the sum insured upon death.
2. Higher of Unit Value or Sum Insured: Pays the higher amount between the sum insured and the unit value.

Regular Premium Policies

Key Points:

• Flexible Payments: Policyholders can vary premium amounts, make top-ups, or take premium holidays.
• Surrender Options: Policyholders can surrender all or part of their units.
• Sum Insured Adjustments: The sum insured can be increased or decreased, affecting mortality charges and cash values.

Regular premium policies provide flexibility but require ongoing management and adjustment to optimize benefits and coverage.

5. Benefits and Risks of Investing in Variable Funds

Variable life funds offer access to a diversified portfolio of investments, including a range of equity stocks and fixed income securities. This diversification reduces risk compared to investing in a single asset or a less diversified portfolio. For an individual investor, creating such a diversified portfolio independently can be challenging, especially with a small amount of capital.

Variable life products feature straightforward designs with distinct sections for investment (unit-driven) and insurance protection (charge-based). This structure allows policyholders to:

• Choose the amount of death benefit or premium.
• Take premium holidays.
• Add extra contributions (top-ups).
• Make withdrawals.
• Switch investments between funds.

The funds are managed by professional fund managers who leverage their investment expertise to pursue high returns over the long term, aligning with the investment objectives. This professional management is valuable since most policyholders do not possess extensive financial market knowledge.

Policyholders gain access to well-diversified funds managed by experienced investment managers with proven track records. This access is beneficial for individuals who prefer not to manage investments directly.

Day-to-day investment administration can be complex. Variable life insurance simplifies this by providing regular unit statements and unit prices through major newspapers, allowing policyholders to track their investments without needing to manage them actively.

The cash and maturity values of a variable life insurance policy are tied to the value of the underlying units, which fluctuate with market performance. Although the sum insured is guaranteed, the value of the units is not. During volatile market conditions, the value of the policy can experience significant fluctuations. Equity funds, while offering the potential for higher returns, also come with greater risk. Therefore, these policies are more suitable for investors who can handle short-term volatility in exchange for potential long-term gains.

Various charges associated with variable life insurance, such as administration fees, insurance charges, and fund management fees, are typically not guaranteed. These charges are subject to periodic review and can be adjusted by the insurance company with prior written notice (e.g., three months).

Types of Variable Life Insurance Policies

The Single Premium Variable Whole Life Plan involves a one-time premium payment that is used to purchase units in a variable or unitized fund. This plan is straightforward, with a single premium contributing to both the investment and insurance components of the policy.

Key Features:

• Insurance Coverage: Typically provides a death benefit of around 125% of the single premium paid, with a minimum guaranteed amount.
• Investment Focus: Primarily designed for long-term savings and investment, offering only nominal life protection.
• Charges: Administration and insurance costs are covered by policy fees, administrative charges, and mortality charges. Investment management fees typically range from 0.5% to 2% per annum.
• Flexibility: Allows for top-ups or additional premium injections and offers the option to withdraw part or all of the allocated units, providing easy access to funds.

The Regular Premium Variable Whole Life Insurance Plan shares similarities with the single premium variant but involves paying premiums at regular intervals—monthly, quarterly, semi-annually, or annually.

Key Features:

• Premium Payments: Regular contributions purchase units in a variable fund, aligning with the policyholder’s payment schedule.
• Dual Purpose: Combines investment with life protection, with a strong emphasis on providing life cover.
• Flexibility: Premium holidays or top-ups are generally allowed, and partial or full withdrawals can be made after a certain period of premium payments.

The Variable Individual Pension Plan focuses on retirement savings by allocating a significant portion of premiums to investments. Upon retirement, the accumulated fund can be used to purchase a traditional annuity or a variable annuity.

Key Features:

• Investment Focus: High allocation to investment with the aim of growing the fund for retirement.
• Life Cover: Typically does not include life insurance coverage except for a return of investment funds upon death. Separate term insurance can be purchased for additional coverage.
• Recent Developments: Newer versions include life insurance coverage funded through investment cancellations or options to convert funds into traditional participating life insurance policies.

Variable Permanent Health Insurance is designed to offer health coverage with cash value accumulation, distinguishing it from traditional health insurance products that do not build cash value.

Key Features:

• Coverage: Includes health coverage such as disability income and provides cash value.
• Market Success: This type of product has gained popularity, particularly in the UK, for its competitive pricing and cash value benefits. It’s becoming increasingly available in markets like the USA.

The Variable Crisis Cover Insurance provides financial support in the event of critical illnesses, such as heart attack, stroke, or end-stage renal failure. One notable product, Living Assurance by Abbey Life, advances the full sum insured upon diagnosis of these conditions.

Key Features:

• Coverage: Offers a lump sum payment upon diagnosis of specified critical illnesses.
• Regular Reviews: The risk cost is reviewed regularly, with improvements in product benefits or premiums passed on to policyholders if claims or investments perform better than expected.

Some variable life insurance policies allow for loans and withdrawals, providing flexibility in accessing funds. However, the availability and terms of these features can be affected by the performance of the underlying investments.

Key Features:

• Loans: Policy loans are available but may be limited to a percentage of the withdrawal value due to potential declines in the portfolio’s value.
• Withdrawals: Partial or full withdrawals are possible, with amounts met by cashing sufficient units at the bid price.

Variable life insurance is gaining traction due to its clarity, transparency, and flexibility. Understanding the terms and charges associated with these policies is essential for effective management:

• Policy Fee: Covers administrative expenses of setting up the policy, typically uniform across policies.
• Annual Fund Management Fee: Deducted annually to cover investment management charges, ranging from 0.5% to 2% of the fund.
• Bid and Offer Price: The bid price is lower than the offer price and is used for withdrawals or policy surrenders. The bid-offer spread represents the initial cost to the policyholder, typically between 5% and 6%.
• Mortality Charge: Covers the cost of life insurance and can be recurrent, funded by the cancellation of units.
• Full Withdrawal Charge: Deducted from the value of units upon full withdrawal, covering initial expenses.

• Bid Price: Offer Price × (1 - Spread %)
• Offer Price: Bid Price / (1 - Spread %)
• Yield: (Full Withdrawal Value / Single Premium)^(1/n) - 1
• Accumulation of Funds: X × (1 + i)^n

7. Types of Variable Funds

Understanding the types of variable funds available is crucial for making informed investment decisions within variable life insurance policies. These funds are categorized based on their investment focus and risk-return profiles, providing policyholders with various options to match their financial goals and risk tolerance.

Variable life insurance policies invest premiums in different types of variable life funds based on the policyholder's instructions. The value of these policies fluctuates according to the performance of these financial instruments, meaning that policyholders assume both the risks and benefits associated with their investments.

Variable life funds are generally structured into two main categories:

• Accumulated Units
• Distribution Units

These funds may include various financial instruments, such as:

• Cash Funds
• Equity Funds
• Bond Funds
• Property Funds
• Specialized Funds
• Managed Funds
• Balanced Funds

Cash Funds invest primarily in cash and bank deposits. They are considered low-risk and provide relatively stable returns.

• Risk: Low risk due to the stable nature of cash deposits.
• Return: Generally lower compared to other fund types.

Equity Funds focus on investing in stocks and shares. They are known for their potential for high returns but come with high risk due to the volatility of stock prices.

• Risk: High risk as stock prices can be volatile and susceptible to market fluctuations.
• Return: Potential for high capital appreciation, though returns can vary significantly.

Bond Funds invest in government and corporate bonds, emphasizing fixed income instruments. These funds are also referred to as "income" or "fixed income" funds.

• Risk: Moderate risk; generally lower than equity funds but subject to interest rate changes and credit risk.
• Return: Steady income through interest payments, with typically lower volatility compared to equities.

Property Funds invest in real estate and properties. While generally considered safer than equity funds, they have lower liquidity due to the nature of real estate.

• Risk: Lower risk compared to equities but can be less liquid. Redemption might be deferred, especially during market downturns.
• Return: Potential for stable returns through rental income and property appreciation.

Specialized Funds are segmented based on geographical regions or specific industries.

• Geographical Funds: Examples include the ASEAN Fund, Emerging Markets Fund, and the US Fund.
• Industry Funds: Focus on sectors such as commodities, mining, or utilities.
• Risk: Varies based on the region or industry, including currency risk for international investments.
• Return: Can offer high returns based on specific market or sector performance.

Managed Funds invest in a diversified mix of assets, including equities, bonds, properties, and cash. The allocation is determined by the fund manager's market outlook.

• Risk: Varies depending on the fund manager’s strategy and asset allocation.
• Return: Aims to balance risk and return by adjusting asset allocation based on market conditions.

Balanced Funds maintain a fixed allocation between different asset types, such as 70% equities and 30% bonds.

• Risk: Moderate, as the fund aims to balance the higher risk of equities with the stability of bonds.
• Return: Provides a blend of growth potential and income, suitable for moderate risk tolerance.

The risk-return profile of various variable life funds illustrates the trade-off between potential returns and associated risks. The following is a general comparison:

• Equity Funds: High return potential with high risk.
• Balanced Funds: Moderate return with moderate risk.
• Managed Funds: Varies depending on asset allocation and management strategy.
• Bond Funds: Lower return with moderate risk.
• Cash Funds: Lowest risk with lowest return.

The risk-return graph visually represents that higher returns are typically associated with higher risk, while lower-risk investments like cash funds offer lower returns.

Most life insurance companies offering variable life policies provide a switching facility, allowing policyholders to transfer investments between funds. Switching options may include:

• Free Switching: Some companies offer unlimited free switches.
• Limited Free Switching: A certain number of free switches within a year, with charges applied for additional switches.
• Charged Switching: A specific fee for each switch.

Switching is valuable for adapting investments to changing financial goals and market conditions. For instance, a policyholder may choose to switch from equity funds to cash funds during market volatility or adjust asset allocation as they approach retirement.