What is Variable Universal Life Insurance (VUL)?

Variable universal life insurance is a type of life insurance policy that allows the account holder to invest a portion of the premium dollars.

It is not the same as a variable life insurance policy (though it is similar).

How Does Variable Universal Life Insurance (VUL) Work?

Variable universal life insurance is a combination of variable life insurance and universal life insurance. Most notably, a variable universal life insurance policy allows you to change your premiums and death benefits (though this will change the coverage amount, of course). Buyers can also make one lump sum payment for their insurance.

A portion of the premium is invested in various instruments -- bonds, mutual funds, etc. The value of those instruments changes daily (hence the name 'variable universal life insurance policy'). If the value of these securities rises, insureds can sometimes apply those paper profits toward their premiums (which saves them money). Of course, if the investments don't do well, the premium is still due. If there is enough cash value in the policy to cover the costs of the policy, the policy will stay in force (though some have a required premium for a set number of years to keep the policy in force).

There are two kinds of death benefits in variable universal life policies:fixed death benefits and variable death benefits. The fixed benefit does not increase over time, and cash value builds up against the value of the death benefit, which means the cost of the insurance could decrease over time if the value of the investments are growing. The variable death benefit is equal to the cash value at the time of John's death plus the base death benefit value.

Buyers can increase their death benefits, though they'll likely have to prove that they're in good health. Buyers can also decrease their death benefits, though they may have to pay a surrender charge to do so.

The investments in a variable universal life insurance policy grow tax-deferred, which means that your returns compound at a higher rate than if you had to pay taxes on the gains every year. This can significantly boost the amount that accumulates in the investment accounts.

Why Does Variable Universal Life Insurance (VUL) Matter?

Variable universal life insurance policies are regulated as securities, which means your advisor or insurance agent should give you a prospectus that describes the policy in detail, as well as all the investment options. The important thing about this instrument is that the death benefits and value of the investments can fluctuate with the market and with the insured's wishes. In some cases, the policyholder can borrow against the value of the investments in the account. It is important that investors consider the financial stability of the insurer with which they do business; ratings services such as Standard & Poor's and AM Best help.