But it's guaranteed: IUL, illustrative rates and advisor responsiblity
By Jeff Reed
Kestler Financial Group
Sure, it's guaranteed. But what about the rest of the product? What product? Indexed universal life. One of the rather common features of these, as well as current assumption universal life products is an interest rate persistency bonus that kicks in at some point in the policy, usually around the tenth policy year. Nothing new here, as this has been common practice for quite some time.
The issue, however, is when we don't pay enough attention to what it does to our illustrative rates and what it may mean for the rest of the policy metrics like cap rates or participation rates.
Illustrative rates are certainly a hot topic currently. Everyone is trying to land the plane on the "right" illustrative rate. As I always say, maybe we should focus on being effective rather than being right. Being "right" implies that everyone else is wrong, and if there is one thing I know, it is that virtually every illustration we run that involves any kind of current assumption is going to be wrong. Rather than chase the impossible goal of being right, we need to turn our attention to effective illustrations. That means really understanding them.
Simply put, many of these products will end up with an illustrative rate of 9 percent or more on an S&P-based, annual point-to-point product using carrier guidelines. Sure, the initial rate may be 7.5 percent, but by the time you reach year 15 in one product I know of, the rate would balloon to 8.75 percent based on these bonuses. Which brings me to the title of today's piece: But it's guaranteed.
What is guaranteed? The bonus. What is not guaranteed? The cap or participation rate. All the bonus does is place downward pressure on the other elements of the policy. And if you think the insurance carrier will operate that product at a loss because the bonus is guaranteed, then I have a bridge to sell you. This only gets worse if the basis for the sale is the massive income stream based on the bonus and the resulting huge spread in a participating loan.
So, how do we deal with this in a responsible manner? We need to evaluate the product on its merits excluding the bonus. Adjust the illustrative rate on a year-by-year basis if necessary. Ask to see the expense report that most carrier software allows you to produce (and if their software can't, that tells you something, I think!). If it still hunts, then by all means, sell it. If the bonus comes through without a corresponding reduction in cap or participation rate, the client will be thrilled. If it does not come through, at least your sale was based on an effective illustration. In addition, client expectations have not been violated and the strategy has a shot at success.