What Is Variable Life Insurance, and How Does It Work?

Variable life insurance is a type of permanent coverage that allocates cash value to investment subaccounts. It’s designed for people who:

• Plan to pay active attention to their life insurance.

• Can fund a policy heavily in its early years.

• Are willing to add stock market risk to their life insurance.

But in recent years, variable life insurance has become increasingly hard to find. A similar but more flexible policy called variable universal life insurance (VUL) is now the product of choice for many people seeking life insurance with an investment component.

Variable life insurance is a permanent policy with fixed premiums and a minimum guaranteed death benefit — the amount of money paid out to your beneficiaries when you die. The policy has a cash value component, which you can invest in mutual fund-like subaccounts of your choosing. If your investments do well, your death benefit could potentially pay out more than the minimum.

Having your cash value invested in stocks and other securities means more risk and more potential for growth compared with other permanent life insurance options. Variable life insurance appeals to investors who have a high risk tolerance and want to get more out of their life insurance than just a death benefit, but who like the regularity of premium payments offered in whole life insurance policies.

» MORE: Permanent life insurance: Definition, types and cost

When you pay your premiums, a portion goes toward the cost of insurance and other fees to keep your policy active. The rest of the money is added to your cash value.

With any “variable” policy, you can decide how your cash value is allocated, with some limitations. Your insurance company will let you know your options, and then you can choose based on your investment strategy.

Your cash value will go up when your subaccounts do well and decrease when they perform poorly. If the cash value exceeds a certain amount, the life insurance death benefit will increase. But if the cash value reaches zero, your policy may lapse — which is why this kind of coverage requires a more hands-on approach.

If you’re thinking about buying variable life insurance, make sure you understand the risks and policy structures before making a purchase. When you’re in the market for any permanent life insurance policy, it’s helpful to consult a fee-only life insurance consultant who can help you understand all the financial implications of a policy.

» MORE: Is whole life a good investment?

Variable life insurance and VUL both have cash values that vary with the performance of an underlying portfolio of investments. They also share some other features, such as:

• Control over what your cash value is invested in.

• Return rates without caps.

• Increased reliance on your investing experience.

• The chance your investment subaccounts could drop in value.

While there is some overlap, variable life and VUL are different products. Variable life is more like whole life insurance, with its fixed premium payments, while variable universal life has the flexibility of universal life insurance.

VUL is best suited for investors who are comfortable with risk. If you make poor choices, you can easily end up with higher premiums than you’d planned or lose coverage entirely. Most buyers will be better off — and may sleep more soundly — with a term life insurance policy or a whole or universal life option.