5.1 Variable Life and Variable Universal Life (Securities Regulation)

Variable life products move the investment risk from the insurer to the policy owner. Because the cash value is invested in separate account subaccounts that behave like mutual funds, these contracts are regulated as securities as well as insurance.

Two Variable Permanent Products

Variable Life Insurance (VL) is a permanent policy with a fixed, level premium but a death benefit and cash value that rise and fall with subaccount performance. It guarantees a minimum death benefit floor; the cash value has no floor and can fall to zero.

Variable Universal Life (VUL) combines variable subaccounts with universal life's flexible premiums and adjustable death benefit. It offers the most policy-owner control and the most risk.

General Account vs. Separate Account

The distinction drives the regulation. Fixed products credit a guaranteed rate from the insurer's general account; variable products invest in the separate account, which is not part of the insurer's general assets.

Because the separate account is invested at the owner's direction with no guarantee, the contract is treated as an investment and triggers federal securities oversight.

Dual Regulation: Insurance + Securities

A producer who sells variable products needs two licenses:

• A state life insurance license (the insurance side), and
• A FINRA (Financial Industry Regulatory Authority) registered representative registration, earned by passing the Series 6 or Series 7 exam plus the SIE (Securities Industry Essentials) exam.

The separate account must be registered with the SEC (Securities and Exchange Commission), and the prospectus rules of the Securities Act of 1933 and Investment Company Act of 1940 apply.

Exam trap: Selling a variable contract without securities registration is a serious violation even if the producer holds a valid life license. Both credentials are required.

The Prospectus Requirement

Before or at the time of solicitation, the prospect must receive a prospectus — the SEC-mandated disclosure describing the subaccounts, fees, and risks. Unlike fixed-policy sales literature, the prospectus cannot be replaced by a producer's verbal summary.

Key conduct rules:

• The producer may not guarantee or imply guaranteed returns on subaccounts.
• Past performance illustrations must carry the required disclaimers.
• Suitability must be documented — variable products are unsuitable for owners who cannot tolerate loss of principal.

Subaccount Mechanics

The owner allocates cash value among subaccounts (equity, bond, money market). Most contracts allow a limited number of free transfers/reallocations per year. Charges typically include a mortality and expense (M&E) risk charge, fund management fees, and administrative loads — these reduce net return.

VL vs. VUL Side by Side

Worked scenario: A VL policy has a $250,000 minimum guaranteed death benefit. After strong markets the variable portion adds $40,000, so the death benefit is $290,000. After a market crash the variable portion drops to $0, so the death benefit returns to $250,000 — but never below the floor. The cash value, by contrast, could fall to nearly zero.

Free-Look and Exchange Rights

Variable contracts carry an enhanced free-look period. During this window the owner may return the policy, and because of market risk the refund is generally the greater of premiums paid or current account value — protecting the buyer from early market loss. Standard fixed policies refund premiums only.

Section 1035 Exchanges

An owner can move from one variable (or fixed) cash-value contract to another via a Section 1035 exchange — a tax-free swap of like-kind contracts (life-to-life, life-to-annuity). Gains are not recognized at the exchange. A 1035 exchange does not reset suitability obligations; the producer must still document that the new variable product fits the client's risk tolerance and time horizon.

Why Variable Products Suit Long Horizons

Because subaccount values can drop sharply, variable life is generally appropriate only for owners with a long time horizon and the ability to ride out volatility. Charges layer on top of investment risk:

• Mortality and expense (M&E) risk charge — compensates the insurer for guaranteeing the death-benefit floor.
• Cost of insurance (COI) — the pure protection charge, rising with attained age.
• Fund and administrative fees — reduce net subaccount return.

Trap: If poor performance plus rising COI drains a VUL's cash value, the owner must pay more premium or the policy lapses — even though premiums were 'flexible.' Flexibility is not a guarantee that the policy stays in force.