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Life
Index Universal Life Insurance
Offers Greater Upside Potential
with Downside Protection
by Bill Tate
Although stock market returns have improved over the past several years, many consumers still remember the significant slide in the market from 2000 to 2001, especially those with variable universal life policies. Many consumers returned to the stock market in recent years, while the variable life insurance market hasn’t seen a similar up-tick.
Variable universal life insurance may not be rebounding because consumers don't have the risk tolerance to ride out stock market downturns; they lack the investment expertise; and they don’t have access to financial advisors to manage the sub-accounts in their variable policies. Simply put, policyholders don’t want to manage their own life insurance.
An Overview of Index Universal Life
Index Universal Life (IUL) insurance is an attractive alternative for consumers who spurn the volatility of variable universal life while seeking higher returns on cash value than those offered with fixed life insurance products. With IUL, consumers could have greater upside potential with downside protection.
In the past, consumers had to choose between a universal life policy with a minimum guaranteed rate and a variable life policy with potential for greater earnings, but no protection against market losses. IUL can be a bridge between traditional universal life and variable universal life. As more life insurance companies add IUL to their product offerings, producers are less concerned about IUL being complex and difficult to understand. Most of today’s IULs are fixed universal life insurance policies with a minimum interest rate guarantee and an interest rate. The interest rate is partly credited based on any growth in an equity index. (The policyholder never purchases securities.) With IUL, policyholders can direct their premiums into an index interest account and a traditional fixed-interest rate account. The index interest account tracks indexes, such as the S&P 500, in calculating interest credits.
IUL policies can provide many of the same features as traditional universal life policies, including the following:
• Flexible premiums.
• A company-set guaranteed minimum interest rate.
• Cash value protection against market declines.
• Loan provisions for borrowing against the policy’s cash values.
• Guaranteed death benefit.
• Tax-deferred cash value.
• Tax-advantaged no-lapse loan protection.
Producers don’t need to be registered with the National Association of Securities Dealers (NASD) in order to sell IUL since index insurance policies generally aren’t securities. Producers need to have a comprehensive understanding of index interest crediting, including the concepts of participation rates, caps and crediting methods. They must also be able to communicate the product’s design clearly to their clients.
The Market for Index Universal Life
Estimated annual IUL premium was about $186 million for 2005 and $242 million through the first three quarters in 2006, according to Advantage Compendium. Although this market share is minimal, it is the fastest growing product segment in the life insurance industry, easily outpacing term, traditional universal life, variable universal life, and whole life.
Much of the recent interest is driven by producers who have observed the success of equity-index annuities during the past several years and consumers who want higher interest rates on cash value than those credited by insurance companies. Better interest rates on a typical universal life policy could mean cheaper premiums or a higher death benefit over the life of a policy. In addition, policyholders can use the cash accumulation in an IUL to help pay college education costs or supplement retirement income through policy loans.
Clients who experienced the 20-plus percent returns of the 1990s and the corresponding negative return rates in the early 2000s are more cautious about investing. Here are a few questions to ask:
• Is the client looking for a life insurance policy that builds cash value?
• What are the client's expectations for the cash value growth?
• What is the client's risk profile?
• How financially sophisticated is the client?
Prospective Clients for IUL
Prospective clients are typically somewhat affluent, between 40 and 60 years old, and have a basic-to more sophisticated understanding of insurance and investing. With a moderate risk profile, they’re looking for a life insurance policy that provides protection and builds cash value potentially at a higher rate than traditional universal life. These clients want the potential of growth during good times and the minimum interest rate guarantee of a fixed product during bad times.
Other prospective clients include business owners who appreciate a product that offers the possibility of higher cash values to fund business transition programs and executive bonus structures. IUL could also be an attractive option for premium financing scenarios.
All prospective clients must clearly understand the design and features of an IUL.
Features Differentiate Products
Producers should consider a number of features when considering competing products. What index is being used? One of the first considerations is the index or indexes being tracked. Most IUL policies use the S&P 500. But, as more companies offer IULs, some policies may use different indexes or several that are bundled together.
How is the policy crediting rate determined? The cash value of an IUL policy does not reflect the exact movement of the index. Companies may offer one or more methods to determine the amount credited to the cash value. These methods include crediting the values using asset fees or spreads, which may be subject to interest rates caps or participation rates. The minimum guaranteed interest rate on IUL policies will vary.
Many IUL policies have a cap on index returns (often around 12%). The cash values of other policies are determined by percentages, which are deducted from the positive increases in the indexes being used. Some policies use a participation rate, in which a percentage of the increase of the index determines the amount to be credited to the cash value.
When is the index account credited? Some policies have annual crediting dates and others may transfer the funds to the index account on a monthly basis, which may offer the same benefits as dollar-cost averaging.
Some policies offer a cumulative guarantee – the cash surrender value will never be less than what it would have been if net premiums had been accumulating at a predetermined interest rate established by the company in all policy years since the policy’s inception Consumers should also be aware that policies offer fixed or variable loan rates, which could affect the cash build-up in a policy.
Opportunities for IUL
With limited downside potential, IUL clients can get guaranteed death-benefit protection and participate in stock market gains. (Guarantees are tied to the claims paying ability of the insurer.) Although IUL is not the product for everyone, it has significant potential for affluent clients who want a better growth opportunity than what traditional universal life insurance has to offer.
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Bill Tate is senior vice president and chief marketing officer for Transamerica Occidental Life Insurance Company. He can be reached at Bill.Tate@transamerica.com.
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