VUL charges explained: premium charge, policy fee, administration fee, cost of insurance, surrender charge and asset-level fees

Definition: two layers of cost

A variable universal life (VUL) policy has two layers of cost. The policy layer is what the insurer charges for issuing and running the contract and for the death benefit: a premium charge, a policy fee, an administration fee, the cost of insurance (COI), and surrender or withdrawal charges. The asset layer is what it costs to hold and manage the investments: custody, management and dealing costs agreed with the custodian bank and the manager. The policy layer is described in the Product Summary and policy contract; the asset layer is described in separate agreements and does not appear in the insurer's schedule.

MoneySense's list of ILP fees covers the same ground for retail policies: insurance coverage charges that rise with age, fund management fees, policy or administration charges, surrender charges, a premium allocation rate, the bid-offer spread and fund switching charges. LIA's consumer guide adds that there are usually significant charges in the early policy years. Names and bases differ between products, so the table below describes the categories most often seen in high-net-worth VUL documentation and not any one product.

Policy-level charges in practice

Three features of the policy layer deserve attention. First, the premium charge and policy fee are concentrated in the early years, which is why the account value after the first premium can be below the premium, and why a cash illustration at year one looks very different from one at year ten. Second, the administration fee is tied to the account value, so a larger or growing account pays more in absolute terms. Third, MoneySense states that fees and charges may not be guaranteed and are subject to change, so the right to change charges, and the notice owed to the policyholder, is a clause to find in the contract and not to assume.

A hypothetical, rounded example shows the premium effect. If a policyholder paid a premium of US$3,000,000 and the premium charge were 2%, US$60,000 would be deducted, leaving an opening account value of US$2,940,000 before any other charge. The rate is a placeholder for arithmetic and not a quotation; the Product Summary and the policy contract give the actual figure.

Cost of insurance and the net amount at risk

COI pays for the death benefit. It is calculated on the net amount at risk (NAR), the part of the death benefit that exceeds the account value. Where the death benefit is the higher of a sum assured and the account value, a large account reduces the NAR and can reduce COI to nil; where the account falls, the NAR rises and COI rises with it. COI rates also rise with the life assured's age, and the figures depend on factors such as coverage amount, age, sex and smoking status (MoneySense). COI is usually funded by selling assets, so it is one reason the account holds a cash buffer.

The table uses hypothetical figures only, for an illustrative sum assured of US$5,000,000 and an illustrative annual COI rate on the NAR.

With an administration fee of 0.25% of the account value (hypothetical), the first row would add US$8,000 a year (0.25% of US$3,200,000). Both amounts leave the account, and in the second row a market fall raises the COI at the moment the account is smaller. Designs with a small fixed amount above the account value, often sold without medical underwriting, charge COI on that small amount, so COI is low but protection above the account value is thin. Check which formula your policy uses.

Surrender charges and early exit

A surrender charge is deducted if the policy is surrendered, in whole or in part, during the early years. It is typically expressed as a percentage of the initial premium, is highest in year one, falls year by year and ends on a date set in the contract. A hypothetical schedule would be 6%, 5%, 4%, 3%, 2%, 1% and then nil from year seven. On a premium of US$3,000,000, a surrender in year two under that schedule would cost US$150,000 (5%), before the effect of the market, other charges and any tax. LIA states plainly that ILPs typically do not provide guaranteed cash values or benefits and that a policyholder can lose the entire investment value.

The surrender value that matters is the figure after all deductions, and the schedule says nothing about market value: a surrender at a loss and a surrender charge compound.

Asset-level fees outside the policy

Custody fees, management fees and dealing costs are agreed between the policyholder and the custodian and manager, and are charged under those agreements. They can be deducted from the account by the insurer on instruction, but they are not insurer charges and may not appear in the policy schedule. Ask for each in writing, including any minimum fee, performance fee, transfer-in or transfer-out cost and the bid-offer spread on dealing. In a retail ILP, MoneySense notes that the bid-offer spread is usually around 5%; in an open-architecture arrangement, the spread is the dealing cost the custodian or counterparty applies and should be priced on its own terms.

Asset-level fees reduce the return before it reaches the account, so an illustration that shows only the insurer's charges understates the total drag; ask whether it includes them and, if not, add them yourself. Frequent trading raises dealing costs, so the mandate should state how turnover and dealing costs are monitored and reported.

Can charges change, and what if the account cannot pay them

MAS Notice 318 sets market conduct standards for direct life insurers as product providers, covering matters such as disclosure, the sales process, replacement of life policies and loans and advances. The level of each charge, the insurer's right to change it and the notice it must give are matters for the policy contract, so read that clause before relying on any illustration.

When the account cannot cover charges, MoneySense states that the policyholder must either pay a top-up premium or reduce cover. LIA's policy-illustration guidance notes that policy value could drop to zero, in which case the policy is terminated. Most contracts also define a minimum account value and a grace period to restore it. See guarantees and risks.

A contract may allow the insurer to change non-guaranteed charges on notice, may cap some of them and may leave others open, so ask which charges are stated as maximums, which are described only as current, and how a revision is notified. A charge that can rise is a risk that sits alongside the market risk already carried by the account.

How to compare charges between quotations

1. Ask for the COI schedule by age across the full range of the life assured's age, not just the first ten years.
2. Ask for a year-by-year projection at 0% (the LIA column where an LIA-format illustration is issued, or the insurer's own projection where none is) and compare it with the upper rate; the 0% column shows what the structure costs when the assets earn nothing, and the gap shows how much of the illustrated outcome rests on market assumptions.
3. Ask for the surrender schedule in table form and the year it ends.
4. Ask whether any charge is guaranteed and for the notice period if the insurer changes one.
5. Add the asset layer: custody, management and dealing costs from the custodian and manager.
6. Compare all-in cost as a percentage of the account value over the same horizon.

A comparison is only fair when the sum assured, the life assured's age and risk class, the policy currency and the horizon are the same; the comparison page sets VUL beside other products on cost structure.

To compare two quotations on the basis set out here, register an enquiry through the contact details on this site.