3.2 Variable and Variable Universal Life

Variable life and variable universal life (VUL) shift investment risk from the insurer to the policyowner. Instead of crediting a declared interest rate, the insurer places cash value in separate-account subaccounts — essentially mutual-fund-like portfolios of stocks, bonds, and money-market instruments that the policyowner selects. Cash value and (in many designs) the death benefit rise or fall with the performance of those subaccounts.

Securities Regulation — Dual Licensing

Because the policyowner bears market risk, variable products are classified as securities as well as insurance. This produces the single most-tested fact in the chapter: to sell variable life or VUL, a producer must hold both a state life insurance license and a securities registration (FINRA Series 6 or 7, plus a state securities license), and the insurer must be SEC-registered. A prospect must receive a prospectus before or at the time of solicitation — not after the sale.

Separate Account vs. General Account

Variable Life vs. Variable Universal Life

Variable life (VL) has a fixed scheduled premium like whole life but a variable cash value and death benefit. It guarantees a minimum death benefit (the original face amount) that cannot drop below the floor even if subaccounts lose value — although strong performance can push the death benefit above the guarantee.

Variable universal life (VUL) combines the flexible premium of universal life with the subaccount investing of variable life. VUL generally has no guaranteed minimum death benefit and no guaranteed cash value unless a separate rider is purchased — a key distinction tested heavily.

Worked Cash-Value Example

A VUL has $30,000 in subaccounts. During the year the chosen equity subaccount returns +10% while a $250 fund management charge and $600 of cost-of-insurance/expense are deducted.

• Investment gain = $30,000 × 10% = $3,000
• After fund charge = $3,000 − $250 = $2,750 net investment
• New cash value ≈ $30,000 + $2,750 − $600 = $32,150

If the subaccount instead lost 10%, cash value would fall by roughly $3,000 plus charges — the policyowner absorbs that loss directly. There is no guaranteed floor on VUL cash value.

Common Traps

• A producer selling variable products needs both insurance and securities licenses — a life-only license is never sufficient.
• The prospectus must be delivered at or before solicitation.
• Subaccount transfers are generally free of current income tax because they occur inside the policy, but FINRA suitability and the NAIC Best Interest standard still apply.
• Variable products carry mortality and expense (M&E) charges plus fund-level fees that fixed UL does not.

Suitability, Disclosure, and Sales Practice

Because variable products are securities, the sales process carries duties beyond ordinary insurance. The producer must have a reasonable basis to believe the recommendation is suitable given the client's risk tolerance, time horizon, liquidity needs, and investment objectives, and FINRA rules plus the NAIC Best Interest standard both apply. Sales literature must be filed and may not project specific future investment returns; only hypothetical or historical illustrations clearly labeled as such are permitted.

The prospectus, which discloses subaccount objectives, fees, and risks, must reach the prospect at or before solicitation, never after the application.

The regulatory split is itself a tested point. The insurance side of a variable contract, such as the mortality charges and the policy form, is regulated by the state insurance department, while the investment side, including the separate account and the prospectus, falls under the SEC and FINRA. A producer therefore answers to two regulators and can lose either the insurance license or the securities registration for misconduct.

Worked Death-Benefit Floor Example

The variable-life guarantee is best seen in numbers. A variable life policy issued with a $100,000 face amount guarantees the death benefit never falls below that floor regardless of subaccount losses. If strong markets push the calculated benefit to $130,000, the beneficiary receives $130,000; if a market crash would mathematically drop it to $85,000, the beneficiary still receives the guaranteed $100,000. VUL, by contrast, typically offers no such floor unless a rider is added, so the same crash could reduce both the cash value and the death benefit, and a severely underfunded VUL can lapse like any universal life.

Exam items exploit this by pairing a guaranteed-floor answer with a no-floor answer and asking which product fits a client who wants market upside but cannot tolerate a death benefit below the original face.

Fee Layers and Tax Treatment

Variable products carry more cost layers than fixed UL, and the exam tests their effect on net return. Beyond the mortality and expense charge, the owner pays subaccount management fees, administrative fees, and any rider charges, all of which reduce the gross investment return before cash value is credited. Because these charges continue regardless of market performance, a flat or down market can erode cash value even with no investment loss, mirroring the lapse risk of any universal life.

Despite the charges, the inside buildup grows tax-deferred, subaccount transfers inside the policy are not currently taxable, and a properly funded contract still pays an income-tax-free death benefit, so the tax advantages partly offset the higher expense load. The producer must disclose the fees and confirm the client can tolerate both market risk and the cost drag, which is exactly the suitability judgment the securities and best-interest standards demand.