Life Insurance
New Options in the Universe of Indexed Life
by Ashley Snyder
Universal life insurance was revolutionary when it was introduced about 30 years ago with its flexible premium payments, death benefit options, coverage amounts, and a plethora of extras.
Indexed universal life insurance (IUL) came along in 1997. It gave consumers the potential to increase the policy’s cash value by tying the interest earned to an external investment index. The most popular index is the S&P 500.
IUL is different from traditional universal life (UL) and variable universal life (VUL) policies. With traditional universal life, the policy’s cash value increases at a pre-determined fixed interest rate. Variable universal life policies offer the potential for increased earnings, but no protection against investment downturns.
IUL offers the advantages of both. The policy’s cash value would go higher than the guaranteed interest rate if the index was higher at the end of the year. However, if the index was flat or down, the policy’s cash value would increase according to a minimum guaranteed interest rate.
The minimum guaranteed interest rate is a modified version of traditional UL policies. For example, if a traditional UL policy offered a 2% to 3% return, the IUL policy might offer 1% to 2% due to its potential for increased gains.
Positive market performance can generate higher returns, but a policyholder’s cash value usually increases at a rate below the index. Dividend benefits do not enhance policy performance since they are often excluded from the index.
Some IUL policies contain a cap. A cap is the maximum interest rate increase that is allowed for the reporting period, regardless of how much the index increases. This limits the upside potential when the equities index is increasing rapidly. IUL policies without a cap limit the upside potential by limiting the participation rates to less than 100%. These features do not apply to non-indexed variable life or variable universal life policies.
Many IUL policies also contain a participation rate, which is the percentage of an index increase that is credited to a policy. IUL policyholders may also be subject to spreads or asset fees, which are deducted from the annual increases of the index.
New, cooperative formulas have been created for the crediting methods in IUL. They include annual point-to-point, two-year point-to-point, fixed, monthly averaging, daily averaging, monthly point-to-point, and other minor variations. None of these formulas would be possible without indexed universal life insurance.
The most common crediting options are point-to-point and the monthly average. With point-to-point, the amount credited to the policyholder’s cash value is determined by comparing the value of the stock index at the beginning of the contract to its value at a set point in the future. It is not important what happens between these two points.
The monthly average crediting option looks at the performance of the index each month, adds the up the figures, and divides them by 12 at the end of the year. This method tends to reduce the effect of market volatility on an indexed universal life policy. A policyholder could earn higher returns by using point-to-point if the selected period coincided with a market upswing.
Six of the 22 carriers in the IUL market offer an alternative index to the S&P 500 including the NASDAQ-100, the Russell 2000, and the Dow Jones Industrial Average.
IULs also include an illustrated rate at which the carrier projects policy values hypothetically through a sales illustration.
The Benefits and Challenges of Indexed Universal Life
Consumers who want a product that provides death benefits with increased upside potential and protection from market downturns should consider IUL. They would not be subject to the same downside risk as they would with a VUL since IUL policies do not invest directly in equities. The insurance company assumes all of that risk. A consumer could be involved in growth as the market went up, but their policy would not suffer if the market went down.
Flexibility is a key advantage. Consumers can increase premiums, decrease premiums, or stop them all together. The death benefit can also be increased or decreased as situations change.
There are challenges. Because the IUL policy includes a cap, it may not generate returns, over the long-term, that are equal to the returns of a variable universal life policy. Also, the IUL policy carries more risk than does a traditional universal life policy since it’s tied to market performance.
Consumer Interest
Sales are escalating rapidly and carriers are jumping to get a piece of the pie. The annual growth rate for IUL policies has averaged 24% since 2000. In 2006, sales rose to $352 million -- up 89% from 2005, according Advantage Compendium, a St. Louis based consulting firm.
Although sales are high, the IUL premium still makes up only 1% of the industry’s total annual sales for individual life insurance. But growth is expected. The large outreach in sales shows that indexed policy writers and producers are comfortable with the product designs.
Financial service providers have been able to leverage their experience with equity-indexed annuities to gain the hedging knowledge and infrastructure that’s necessary for indexed universal life, according to Dale Visser, a consulting actuary with Milliman Inc. That includes dynamic hedging, which could reduce costs. These abilities have led to more product designs that can illustrate well to prospects.
Indexed universal life offers appealing options to consumers who want better performance and are willing to assume limited risk. With room to grow, this product may become enormously popular.
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Ashley Snyder is a public relations associate at The American College. To learn more about The American College, professional education in life insurance and the institution’s prestigious Chartered Life Underwriter (CLU) program, visit www.TheAmericanCollege.edu.
