Avoid lawsuits when selling EIULArticle added by Roccy DeFrancesco on October 28, 2010
Roccy Defrancesco

Roccy DeFrancesco


Joined: May 24, 2006

It is very exciting to announce that an insurance company that sells equity indexed universal life (EIUL) policies has come out with a GIB rider on its product. Why is this exciting? Because a GIB rider removes two huge variables when using an EIUL policy as a supplemental retirement tool. Those variables are the crediting rate on growth and lending rate on policy loans.

I’m a huge believer in EIUL as a protective and tax-favorable wealth building tool. However, there is no perfect retirement tool, and the potential problems with EIUL policies in the retirement phase (when clients take tax-free loans from the policy) is that we don’t know what the returns will be and we don’t know what the lending rate on variable loans will be*. You see I have an * at the end of the last sentence. Recently, one company removed one of these variables by offering a product with a fixed loan of 6 percent on the variable loan, and another company is now offering a product with a maximum loan rate of 5 percent.

Avoiding lawsuits
Most advisors illustrate EIUL policies using the default rates of the insurance company. That means the crediting rate is back tested 20–25 years using historic returns and today’s current caps on the products. What’s problematic is that agents are showing illustrations with today’s artificially low variable lending rates and forward projecting those rates 20, 30, 40 and even 50 years into the future. This is total nonsense and could lead to lawsuits down the road. Again, if an advisor used a policy with a maximum loan rate of 5 percent to 6 percent that is contractually guaranteed by the insurance company, then it makes sense to project that lending rate going forward. And since only a few companies have low maximum lending rates, advisors selling other products may be setting their clients up for heartache down the road.

Guaranteed income riders on EIUL policies
As stated, an insurance company has come up with a GIB rider on an EIUL policy. That’s great, because it removes risk when the client is in the income phase (borrowing phase) of using the policy.
How does a GIB rider in an EIUL policy work?
It’s actually fairly simple and I’ll show you with an example.

Assume you had a client pay a $15,000 a year premium into an EIUL policy from ages 45–65. The policy cash surrender value at age 66 might be as high as $640,000. With the GIB rider, the company would look at the CSV at the time the rider is activated and would base the GIB off of that value. Then the policy will pay the client in the form of a loan X amount of dollars every year until death with the remaining DB paying income tax free to the heirs with a no-lapse guarantee).

There is no guarantee on the accumulation value. Unlike a fixed indexed annuity (FIA) that will guarantee both a rate of return on an “accumulation value” and a guaranteed income benefit, the GIB rider on this EIUL policy simply takes whatever the CSV is at the time of activating the rider and uses that to drive the GIB payment.

A real example from the software
To drive home the usefulness of the rider, I will look at examples that credit returns of either 5 percent, 6.5 percent or 8 percent when in the income phase. As stated, we have no idea what the return will be over a given period of time when a client starts borrowing from the policy. Remember, from 1998–2008, the S&P 500 averaged a negative rate of return and an EIUL with a 15 percent cap returned 5.91 percent. It could do the same, better or worse when your clients reach the borrowing phase in retirement.

I will use a male in good health, age 45, who funds $9,047 each year into the policy until age 59. Assume he activates the GIB rider at age 60. For the first example, I’m going to assume the policy used an artificially low lending rate of 5.80 percent.

Credited interest rate 8.00% 6.50% 5.00%
Loans with GIB rider 9,485 7,975 6,704
Variable loans with no GIB rider 14,977 8,450 1,176
Fixed/wash loans with no GIB rider 11,529 7,652 1,217

What do you notice? You can see that if the policy returns slightly less than the 20-year historical average of 8 percent, he would be better off simply taking wash loans in the borrowing phase and much better off using variable loans. If the policy returns are more like what they have been for the last 10 years, the client is still better off with variable loans and slightly worse off with fixed/wash loan (I’m taking about the center column numbers). If the policy returns are not very good (5 percent), the client is going to thank his lucky stars that he had an EIUL policy with a GIB rider on it.
It is for this reason that I believe you must offer this product to every client you sell an EIUL policy to. Now that it is on the market as a viable product, not to offer it to your clients could bring you a lawsuit (see the numbers in the right hand corner of the earlier chart).

It’s not nearly as important that the client actually buy this product. What’s important from a legal perspective is that you offer it to clients.

Example two — more real world

Let’s look at an example which is more real world if you are not using an EIUL product with a maximum lending rate of 5 percent to 6 percent in the policy. For this example, I’m going to assume the same as the first example, except I’m going to use a lending rate on the variable loan that is closer to its 50-year historical average. I’m going to use a lending rate of 7 percent (the historical average is 7.7 percent).

Credited interest rate 8.00% 6.50% 5.00%
Loans with GIB rider 9,485 7,975 6,704
Variable loans with no GIB rider 13,348 7,131 1,176
Fixed/wash loans with no GIB rider 11,457 7,648 1,307

What do you notice about this chart that is different? When the returns in the product in the borrowing phase are more moderate (6.5 percent in the middle column), the GIB rider option beats the variable loan option.

Tax ramifications of using a GIB rider in a life policy
When I talk with most advisors about this new GIB rider, they ask me how the loans from the policy are treated for income tax purposes. It’s pretty simple. Loans up to the cash surrender value of the policy at the time the policy rider is activated will be non-taxable loans. Loans after that amount has been reached will be taxable as ordinary income. It is possible that the policy will continue to grow wealth after the income rider is activated. This would mitigate the issue somewhat, although I don’t think the likelihood of that happen is significant.
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