The basics on indexed universal life

By Sheryl J. Moore

Moore Market Intelligence


It has been nearly 30 years since consumers were first offered the benefits of universal life (UL), and with UL came flexibility in premium payments, death benefit options, coverage amounts, and all sorts of other things that they had never dreamed of. UL was the beginning of a whole new world of product development in the insurance industry.

In 1997, the first indexed UL was introduced. This is a product that is just like any other universal life, but with a different way of crediting interest, based on the performance of an external index (such as the S&P 500). Sales of indexed universal life (IUL) were just a drop in the bucket, with seven carriers contributing to the nearly $65 million in premiums that came in for 1998. Skeptics postulated that the product line would not last long. Little did they realize that the appeal of the product’s higher upside potential would keep consumers interested during low interest rate environments, and the downside guarantees would be especially important (particularly for those who saw the stock market tank after the turn of the century and then again in 2008).

So where are we today? A new revolution has emerged in the world of IUL. Not only are sales burgeoning, but carriers are jumping at the chance to get into this emerging market. Active carriers are revamping product, doing what they can to offer value-added benefits to the consumer and trying to catch the attention of the agents.
 
At the close of 2009, sales had increased more than 800 percent over 1998 levels and reached $531 million. Today, 39 carriers compete – a remarkable increase considering only about half that number were offering products three years ago. Another dozen carriers are currently in research and development on IUL today. All of this excitement leaves the existing carriers who once had market shares of a smaller IUL market competing to differentiate themselves in an increasingly cutthroat landscape. Where we once had very few IUL designs, we now have many, including indexed universal life designs with extended no lapse guarantees, single premium plans, survivorship life policies, and even a return-of-premium structure. The market will only continue to intensify in terms of product design.

With so much happening in the IUL market, let’s go over some of the basics of indexed universal life that differentiate it from a traditional UL plan. There are several types of rates that can affect an IUL plan, depending on the carrier and what their pricing lever is.

Fixed strategy rate — The company-declared rate on the fixed strategy (if any), which would be comparable to traditional UL rates. Fixed strategy rates on IULs today range from 3.50 percent to 5.80 percent.

Guaranteed rate — The underlying minimum guaranteed interest to be credited on the policy. On a traditional UL, these minimum guarantees usually run 2 percent to 3 percent. On an IUL, minimum guarantees typically credit 1 percent to 2 percent due to their higher potential for credited gains. It is important to note that on IULs, minimum guarantees are not always credited annually; some credit the guarantee over a five-year period, or even over the lifetime of the policy.

Index — The underlying external benchmark upon which the crediting of excess interest is based. Fifteen of the 39 carriers in the market today offer an alternative index to the S&P 500 on their product strategies. Indices offered via IUL strategies include Barclay’s bond index, DJIA, Dow Jones World-Ex US, Euro Stoxx 50, Hang Seng, MSCI EAFE, MSCI EM, Nasdaq-100, Russell 2000, S&P 400, and S&P 500.

Crediting method — The formula used to determine the excess interest that is credited above the minimum guaranteed rate. There are far less crediting methods identified in the world of IUL than in the world of indexed annuities. Without getting too detailed on the calculations, clients today have the option of choosing among annual point-to-point, inverse annual point-to-point, two-year point-to-point, term end point, monthly averaging, daily averaging, monthly point-to-point, fixed and some minor variations among these strategies.

Participation rate— The percentage of positive index movement credited to the policy (i.e., if the S&P 500 increased 10 percent, and the IUL had an annual participation rate of 60 percent, the policy would receive interest credited of 6 percent on the policy anniversary). Participation rates on IULs today range from 45 percent to 160 percent.

Cap rate — The maximum interest rate that will be credited to the policy for the year or period, or the maximum index growth upon which interest will be calculated (i.e., if the S&P 500 increased 10 percent, and the IUL had an annual participation rate of 100 percent and a cap of 8 percent, the policy would receive interest credited of 8 percent on the policy anniversary.) Annual point-to-point caps on IULs today range from 8 percent to 17 percent.

Illustrated rate — The rate at which a carrier decides to hypothetically project the policy values in a sales illustration. On a traditional UL illustration, the policy is projected at the new money or portfolio rate that is declared by the company to be credited annually to the policy (currently around 5 percent). On an IUL sales illustration, the potential interest credited is based on fixed strategy rates, participation rates, and caps. So, how is the insurer to illustrate the plan? The solution is an “illustrated rate.” IUL illustrated rates today range from 4.30 percent to 10.00 percent. Agents and clients alike would be wise to note that actual credited rates on IUL will be higher or lower than the illustrated rate on the sales illustration.

Illustrated rate basis— The method upon which the carrier has determined their illustrated rate by taking into account current participation rates, current caps and a review of the historical performance of the index measured. The illustrated rate basis varies from a 20–30 year lookback, a 20-year lookback, a 23-year average, a 24-year lookback, a 25-year lookback, a 30-year lookback, a 40-year lookback, or even no lookback at all. It is crucial to note that two different carriers using a 20-year lookback do not necessarily use the same calculation for their illustrated rate basis.

This all raises an interesting discussion. Traditional UL plans are illustrated at the company-declared rate that is credited annually to the policy (in the 4 percent to 6 percent range). Variable UL plans, on the other hand, are usually illustrated in the 8 percent to 10 percent range; far below the NAIC-imposed maximum. However, there are indexed UL plans today that are being illustrated as high as their variable counterparts, and sometimes even higher. Should an IUL with a downside guarantee and an upside cap be illustrated at a rate comparable to a VUL product which has no downside guarantees and unlimited upside potential? Some class-action lawyers in the West think not. I would speculate that litigation will soon force other carriers to reconsider their IUL illustrated rates as well.

Indexed universal life, like any interest-sensitive life insurance, needs to be monitored to see that it is being funded at an appropriate premium level based on the interest earned.

IUL may be a growing product line, but it has the potential to overshadow sales of fixed UL and VUL, once producers are familiar with the basics.