Filed Under:Life Insurance, Life Products

Looking to Expand Your Portfolio? Consider Indexed Universal Life

Image: digitalart / FreeDigitalPhotos.net

Image: digitalart / FreeDigitalPhotos.net

Indexed Universal Life (IUL) is the fastest growing individual life product. [1]   This popularity is largely attributed to the perceived potential for growth because unlike a traditional UL, where interest is credited based on a declared rate determined by the insurance company, IUL interest is credited based on the underlying performance of an index or indexes and unlike variable universal Life, there is some protection to the cash value as the assets have protection from market losses.

This article discusses some of the basics insurance professionals need to be aware of when selecting an IUL product for their clients.

Indexed Universal Life policies are not stock market investments and do not directly participate in any stock or equity investments.  Past index performance of an index is no indication of future crediting rates because your clients are buying an indexed universal life insurance  policy does not involve actually purchasing or owning securities or stock, so it’s not the same as investing directly in the stock market and therefore does not receive dividend or capital gains participation.

When discussing IUL there are many levers that can be used by the insurance company to determine the ultimate crediting rate to the cash account.  Caps and floors and participation rates play a major part as well as the underlying index they are linked to. These features are prevalent in IUL because the issuing company typically meets its obligations by investing in the market and the expense of this directly affects the features the insurance company is able to offer.

The Cap is the limiting factor in the IUL.  It is part of the reason the issuing company can offer a protective floor.  Caps vary from company to company and while it might seem that higher is better, be aware that there may be limiting factors such as lower participation rates or longer required time in the index strategy that go along with a higher cap rate.

The floor is the protective feature that many clients find appealing about IUL.  They are willing to accept a cap on their interest in exchange for a floor with protection from market losses.  Most policies will offer 0 percent and some will even go as high as 3 percent.  Again, when the higher floor is in place, be aware that this has to be paid for and some other lever is likely being maneuvered to account for it, i.e. a lower cap or participation rate. Also, even though interest credited is typically limited to 0 percent loss, there are still expenses being charged for the cost of insurance protection and other fees associated with the product, so cash values may decrease.

The participation rate indicates the percentage of the return of the index that will be credited to the account.  For example, if the index return was 4 percent and there was a 100 percent participation rate, then the account would be credited 4 percent. If the participation rate was 125 percent though, the amount credited will be 5 percent.

Some companies offer a participation rate over 100 percent and some may limit the participation with a lower rate. As with the cap and floor, pay attention to the guaranteed rate as well as the current rate and be aware the insurance provider may make changes as their expenses dictate.

The cap, floor and participation rate are all applied to an index or indexes over a period of time.  There are many choices in the marketplace including domestic and foreign exchanges, annual or multi-year index strategies, point to point crediting or rolling averages.  You need to be familiar with the products you are recommending and they should be tailored to the particular clients’ comfort level.

Part of the appeal of cash growth is the ability to access that money for retirement or other income needs. Many IULs provide an opportunity to access the cash values through variable rate loans.  Unlike traditional loans that offer a fixed rate of interest charged with a similar fixed rate credited back to the account by the insurance company, variable rate loan charges are often based on a bond or loan rate index and then the account value is credited back at the index crediting rate. 

So, when the amount of interest being charged is less than the amount being credited, there is a potential for cash values in the account to grow while there is an outstanding loan balance.  Conversely, the crediting loan rates may work against the client and cause a decrease in cash value when the amount being charged exceeds the amount being credited.

The loan rate may vary over the period of the loan so when assessing the use of variable loans to access policy cash values keep in mind this possible negative outcome.  Some companies limit the percentage the account can be charged to help protect the insured from this negative effect.  Also, be certain that you can access the policy loans prior to withdrawals of basis in the policy, otherwise the ability to use a variable loan will be delayed.

As is the case with all permanent life insurance products, there will be an illustration that helps explain the details of the product and Illustrate to the client just how much death benefit protection and cash accumulation they might expect if using a certain rate of return. Be certain there is some reasonable methodology to use a particular rate, such as a 25 year look back at the index applying the caps, floors and participation rate of the index strategy.  To get a true comparison between products, use the same illustrative rate for all.

There are many options out there in the IUL world, but understanding these options and explaining them to your client does not have to be complicated.  Of course, always work with an insurance provider that you trust and you feel properly protects its insureds.  When choosing an IUL, be aware of not only the current caps, floors and participation rates but also what the guaranteed rates are. 

Make sure that your client is comfortable with the index or indexes their account crediting is based on and the strategy the company is using to credit their account.  Most importantly, make sure that your client has reasonable expectations. IUL can help you meet your clients’ cash accumulation needs, but like any other life insurance product, there are positive and negative factors that need to be explored.   

As your clients' personal situations change (i.e., marriage, birth of a child or job promotion), so will their life insurance needs. Care should be taken to ensure these strategies and products are suitable for long-term life insurance needs. You should weigh your clients' objectives, time horizon and risk tolerance as well as any associated costs before making a purchasing decision.

Also, be aware that interest crediting fluctuations can lead to the possibility of the need for additional premium in the policy.  Indexed universal life insurance has fees and charges associated with it that include costs of insurance that vary with such characteristics of the insured as gender, health and age, underlying fund charges and expenses, and additional charges for riders that customize a policy to fit your clients' individual needs.

 Derek Welch, J.D., is director of the Advanced Consulting Group at Nationwide Financial, Columbus, Ohio 

[1] According to AnnuitySpecs.com's  Indexed Sales Market Report for 2010 and LIMRA

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