Indexed universal life
was brought to market in 1997. Sales for this product have grown substantially
each year. In 2014 alone, sales of index universal life were reported by LIMRA
to exceed 2 billion of annualized premium, which is a 23% increase from 2013
(1.63 billion).There is a level of risk associated with every investment. The challenge for most investors is in understanding the actual risks involved. With so many financial experts competing for your business it can be difficult to get to the truth. Listed below are the answers to the most common criticisms of Indexed Universal Life. Helping you understand the actual risks versus the perceived risks will help you decide if an IUL is the right investment for you.
Answers to Common Criticisms of Indexed Universal Life
How accurate are the illustrated rates of return?
Although historical returns won't always
represent what will happen in the future, it is one of the most common tools
used to determine an average return over a period of time.
If you look at the 20 yr. best, worst, and
middle you can see that the IUL would not have earned less than 7%. In fact,
new regulation, AG 49, limits illustrated rates to between 6% - 7.25% (depending
on the Insurance Company).
“A National Association of Insurance Commissioners’ panel has approved a guideline that would provide insurers with a standard means of calculating illustrated rates for indexed universal life policies. AG 49 will provide a more realistic illustration of rates for increasingly popular universal life products.” Read more
If an IUL is structured correctly and reviewed yearly, there is no reason for you not to get the returns that are illustrated.
“A National Association of Insurance Commissioners’ panel has approved a guideline that would provide insurers with a standard means of calculating illustrated rates for indexed universal life policies. AG 49 will provide a more realistic illustration of rates for increasingly popular universal life products.” Read more
If an IUL is structured correctly and reviewed yearly, there is no reason for you not to get the returns that are illustrated.
What is the risk of a
contract lapse causing a tax disaster?
This is another scare tactic that is thrown
out there by advisers competing against cash value life insurance. A properly
designed IUL will ensure that there is always enough cash value to prevent a
contract lapse. Not only are there “no lapse guarantee” riders available but
you will also be notified by the insurance company of the potential lapse to
allow you the opportunity to turn the policy into a “reduced paid-up policy” in
order to prevent any risk of a taxable event.
How will Indexed
Universal Life outperform the bond market?
Industry regulators have chosen to use a 25
year historical performance as the method of choice to determine the future
performance of Indexed Universal Life. The 25 year historical rate of return on
IUL’s is between 7% - 8.5% (depending on the carrier). During this time,
fixed products paying bond like returns have been averaging between 3% –
5%.
Universal Life was launched in the 1980’s, during a time of high interest rates. The UL’s illustrated at the high rate back then (which had to come down) have not performed as originally illustrated due to the declining interest rates. However, if interest rates go up, as economists predict will happen over the next 10-15 years, then in all likelihood caps will follow.
The case can be made that an IUL illustrated today will likely assume a lower cap than would statistically be the case over the next 15-20 years. The historically low bond rates have driven caps to a level significantly below their historical average. If the actual cap was used for each year the measurement was taken, the IUL look-back averages would typically be 25-35% higher than is currently being shown.
Not only does historical data support the current illustrated rate of return, but it also indicates that we may see returns 25-35% higher than current illustrated returns.
Universal Life was launched in the 1980’s, during a time of high interest rates. The UL’s illustrated at the high rate back then (which had to come down) have not performed as originally illustrated due to the declining interest rates. However, if interest rates go up, as economists predict will happen over the next 10-15 years, then in all likelihood caps will follow.
The case can be made that an IUL illustrated today will likely assume a lower cap than would statistically be the case over the next 15-20 years. The historically low bond rates have driven caps to a level significantly below their historical average. If the actual cap was used for each year the measurement was taken, the IUL look-back averages would typically be 25-35% higher than is currently being shown.
Not only does historical data support the current illustrated rate of return, but it also indicates that we may see returns 25-35% higher than current illustrated returns.
What is the danger of
insurance carriers changing the policy fees?
Every investment has fees associated with it.
The main difference with the IUL is that those fees are paying for an immediate
death benefit. The fees cover the difference between the death benefit and the
cash value. The more cash that goes into the policy, the lower the fees become.
One of the benefits of an IUL policy is the flexibility to adjust the death
benefit in order to reduce insurance costs. In comparison, a whole life policy
has much higher insurance fees in order to provide the guaranteed fixed death
benefit. If you compare either of these products to a 401k or IRA with a
management fee of 1.5%, you can see that although the insurance
fees appear high during the initial contribution, they drop to .15%
once a policy accumulates $1,000,000.
This is assuming that your 401k or IRA is actually charging
1.5%. By the US Department of Labor's count there are at least 17
different fees they can be charged to your plan. Bloomberg BusinessWeek
concludes that, "Right now you'd be lucky to find even one of them
identified by name on your account statement and what you don't know can hurt
you." Retirement investment expert Matt Hutchinson (who
testified in front of congress in March 2006, about the danger of hidden fees)
told Bloomberg news that most American are paying 17 times more fees than what
is disclosed on their account statement.
If the participation rate changes will it
affect my return?
Although there may be carriers where this is true, it is not true for a
majority of the insurance companies that offer Indexed Universal
Life. It is important to read through the product brochure to verify whether or
not the participation rate is guaranteed.
"All
of the Indexed Account options available with Accumulation Builder Advantage
Indexed Universal Life offer a guaranteed minimum participation rate of
100%"
What are the risks of the insurance carrier lowering the cap rate?
This is one of the few adjustments that
insurance carriers are able to make to be able to maintain the guaranteed
minimum return. However, the opposition continues to grossly exaggerate the
frequency and degree in which an insurance carrier will actually adjust the cap
rate. It also fails to consider that the insurance carrier is subject to the
guaranteed minimum. However, the non-guaranteed nature of IUL crediting levers
should be put in perspective. Traditional UL current crediting rates and whole life
(WL) dividends are also not guaranteed and subject to a guaranteed minimum.
Additionally, insurance companies (especially mutual companies) have a financial obligation to their policy holders and have been one of the most stable institutions in the financial market. A-rated companies like Penn Mutual have lasted over 150 years in business by maintaining the benefits to their policy holders.
In summary, IUL crediting levers may indeed be non-guaranteed components. However, they are subject to guaranteed minimums and are based on disciplined pricing, which is similar to a traditional UL crediting rate and Whole Life dividend scales.
Additionally, insurance companies (especially mutual companies) have a financial obligation to their policy holders and have been one of the most stable institutions in the financial market. A-rated companies like Penn Mutual have lasted over 150 years in business by maintaining the benefits to their policy holders.
In summary, IUL crediting levers may indeed be non-guaranteed components. However, they are subject to guaranteed minimums and are based on disciplined pricing, which is similar to a traditional UL crediting rate and Whole Life dividend scales.
Additional Articles:
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The following are common considerations when purchasing an IUL policy:
1. Index crediting levers may not be guaranteed.
2. Index returns do not include dividends.
3. Underlying IUL insurance charges may be higher than traditional UL.
4. Required rate of return on index call option package – aggressive or sustainable?
5. Comparing historical IUL crediting rates to a traditional UL current crediting rate offered today may not be appropriate.
6. What is an appropriate IUL crediting rate assumption?
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