Life Insurance
Now that you understand how the "who bears the investment risk?" test works for annuities, the same logic applies to life insurance. Most life insurance policies are purely insurance products. Only those with subaccounts (where the policyholder directs investments) cross into securities territory.
Term Life Insurance
- Pure death benefit protection for a specified period (10, 20, or 30 years)
- No cash value or investment component
- Least expensive type of life insurance because you're paying only for the death benefit
- If the policyholder outlives the term, coverage ends and there is no payout
- Not a security
Whole Life Insurance (Ordinary Life)
- Permanent coverage with level premiums for the policyholder's entire life
- Builds cash value on a guaranteed, tax-deferred basis
- Cash value grows at a fixed rate set by the insurer
- Policyholder can borrow against the cash value
- Premiums are fixed and guaranteed never to increase
- More expensive than term life because part of each premium funds the cash value
- Not a security because the insurer guarantees the cash value growth rate
Universal Life Insurance
- Permanent coverage with flexible premiums and adjustable death benefits
- Cash value earns interest at a rate set by the insurer (with a guaranteed minimum)
- More flexibility than whole life:
- Can increase or decrease premium payments
- Can adjust the death benefit amount
- Can skip payments if enough cash value has accumulated
- Not a security because the insurer sets the interest rate, not the policyholder
Whole Life vs. Universal Life
| Feature | Whole Life | Universal Life |
|---|---|---|
| Premiums | Fixed, level for life | Flexible, adjustable |
| Death benefit | Fixed | Adjustable |
| Cash value growth | Guaranteed fixed rate | Interest rate set by insurer (with minimum) |
| Flexibility | Low; rigid structure | High; can modify premiums and death benefit |
| Security status | Not a security | Not a security |
Variable Life Insurance
This is where the securities line gets crossed.
- Permanent coverage with cash value invested in subaccounts (similar to mutual funds)
- Is a security: Must be sold with a prospectus; requires both securities and insurance licenses
- Death benefit has a guaranteed minimum but can increase based on investment performance
- Cash value fluctuates with subaccount performance; no guaranteed cash value
- The policyholder bears the investment risk on the cash value
- Premiums are fixed (like whole life), but the cash value and potential death benefit above the minimum are variable
Exam Tip: Gotchas
- Variable life has a guaranteed minimum death benefit but no guaranteed cash value. The death benefit can increase if investments perform well, but it never drops below the guaranteed minimum. The cash value, however, can decline to zero.
Variable Universal Life Insurance (VUL)
Variable Universal Life (VUL) combines the features of variable life and universal life. It is the most flexible and most complex insurance product.
- Flexible premiums (from universal life) + subaccount investment options (from variable life)
- Adjustable death benefit
- Is a security: Prospectus required; requires securities and insurance licenses
- Greatest flexibility but also greatest complexity and risk
- Cash value depends on subaccount performance; no guarantee
- Policyholder bears the investment risk
Variable Life vs. Variable Universal Life
| Feature | Variable Life | Variable Universal Life (VUL) |
|---|---|---|
| Premiums | Fixed | Flexible |
| Death benefit | Guaranteed minimum; can increase | Adjustable; can increase or decrease |
| Cash value | Invested in subaccounts; no guarantee | Invested in subaccounts; no guarantee |
| Flexibility | Moderate | Highest |
| Security status | Yes; prospectus required | Yes; prospectus required |
Exam Tip: Gotchas
- Variable universal life (VUL) is the most flexible insurance product. It combines flexible premiums (from universal life) with subaccount investing (from variable life).
- Sellers of variable products need both a securities license and an insurance license.
The Securities Test: Complete Comparison
Think of it this way: The word "variable" is the trigger. If the product name contains "variable," the policyholder is choosing investments through subaccounts. That shifts the investment risk to the owner, which makes it a security.
If you can recall which products are securities and why, you will answer most exam questions on this topic correctly.
| Product | Security? | Who Bears Investment Risk? | Prospectus Required? | Regulator |
|---|---|---|---|---|
| Fixed annuity | No | Insurance company | No | State insurance dept. |
| Equity-indexed annuity | No | Insurance company (floor protects owner) | No | State insurance dept. |
| Variable annuity | Yes | Contract owner (subaccounts) | Yes | SEC + FINRA + State |
| Term life | No | N/A (no cash value) | No | State insurance dept. |
| Whole life | No | Insurance company | No | State insurance dept. |
| Universal life | No | Insurance company | No | State insurance dept. |
| Variable life | Yes | Policyholder (subaccounts) | Yes | SEC + FINRA + State |
| Variable universal life | Yes | Policyholder (subaccounts) | Yes | SEC + FINRA + State |
The pattern: If the word "variable" is in the name, it is a security. Variable means subaccounts. Subaccounts mean the owner bears the investment risk. Investment risk to the owner means it must be registered with the SEC and sold with a prospectus.
Exam Tip: Gotchas
- Only variable annuities and variable life insurance are securities. Fixed annuities, equity-indexed annuities, term life, whole life, and universal life are NOT.
- Equity-indexed annuities are NOT securities despite being linked to a market index. The floor (guaranteed minimum) means the insurer bears the downside risk.