If you ask me, indexed universal life insurance is the perfect life insurance product. It’s permanent, it can never lose value as a result of market declines, and it has the potential to earn greater interest than traditional UL products.
However, some alarming trends are occurring in this market that needs attention–and correction.
If not addressed now, these issues will surely catch the eye of lawyers, legislators, and outside regulatory entities, for IUL’s problems are very similar to those plaguing the index annuity industry in recent years.
To unpack this, one must understand the differences between types of UL plans. Traditional UL is a type of fixed life insurance that is regulated by the state insurance divisions. It credits a minimum guaranteed interest rate, as well as a stated fixed interest rate on an annual basis. It is generally known for its high guarantees, and steady, lower credited rates.
IUL is also a type of fixed life insurance, regulated by the insurance divisions. It credits a minimum guarantee usually less than annually, although there is an annual 0% floor on all IUL plans. The credited interest rate on IUL is based on the performance of an outside index, such as the Standard and Poor’s 500 (S&P 500). Potential index interest is limited through the use of participation rates or caps.
IUL is generally known for its lower guarantees, but also for its ability to earn interest that is higher than that found in traditional UL (although it may be on an inconsistent basis).
Variable UL, by contrast, is a type of securities product that is regulated by the Securities and Exchange Commission. VUL typically has no minimum guarantee, except on any fixed bucket strategies. The credited interest rate on a VUL is based on the performance of stocks, bonds, or mutual funds that the consumer selects.
Consumers cannot lose any of the money they have in a fixed UL or IUL as a result of market performance, but they could lose funds in a VUL as a result of market performance.
The problems with IUL all boil down to one single issue: illustrated rates.
What is an illustrated rate? First, recall that an illustration is a projection of future policy values; it answers the question, “what will my policy cash values and death benefit be in  years?” The National Association of Insurance Commissioners mandates that all permanent life insurance policies must have an illustration that is signed by the purchaser at point-of-sale.
The “illustrated rate” on the illustration is the interest rate at which the policy values are projected.
For traditional UL, the illustrated rate is the current credited interest rate on the policy (presently 4%-5.5%). This rate represents what the insurance company is currently crediting on the UL for new business. In-force ULs may receive higher or lower renewal rates. However, most ULs sold today are illustrated at a rate that is constant throughout the policy.
For VUL policies, the illustrated rate is a hypothetical gross rate (presently 8%, but cannot exceed 12%, as per the Securities and Exchange Commission). This rate is supposed to be a reasonable expectation of what the VUL may be credited as a result of market, fund, or bond performance (based on the policyholder’s premium allocation).
Here again, VULs may receive a higher or lower rate in future policy years, but most VULs sold today are illustrated at a consistent rate throughout the policy.
For IULs, the illustrated rate is a hypothetical rate selected by the insurance company. This rate is supposed to be a reasonable expectation of what the IUL may be credited as a result of the outside index’s performance. Although IUL illustrations may assume a varying rate in the early years, this rate usually levels out to a constant illustrated rate in later policy durations.
Keep in mind that IULs are priced to return about 1%-2% greater interest potential than traditional fixed UL, so a reasonable expectation is that today’s IUL credited rates would be 6.5%-7.5% at best.
The concept of illustrated rates is important because interest-sensitive life insurance products, such as UL, IUL, and VUL, can have dramatically different policy performance compared to what is illustrated at point-of-sale. Changing renewal rates, premium payments, policy loans and withdrawals all have an effect on future policy values. Consumers may not realize how dramatically their future policy values can change from what was illustrated to them at policy purchase.
While most VUL policies are compared on an even keel at 8%, the fixed and indexed UL markets have become victims to a numbers game.
The fixed and indexed products are nearly impossible to compare on an apples-to-apples basis, making judgment of the insurance charges nearly unattainable for purchaser and agent.
The IUL market in particular has become a “race” to illustrate the highest policy values, with some plans illustrating as high as 10.58%. (To be fair, a few companies are illustrating at rates as low as 4.19 %.)
Insurance agents across the country are looking for products that can illustrate the highest cash values and death benefits, while losing sight of the fact that actual policy results may be different than illustrated. In fact, from the day any interest-sensitive policy is sold, what is illustrated will never come to fruition. After all, what is the likelihood that interest rates, premium payments, and loan rates will never vary?
Even more alarming is the recent trend for insurance companies to reduce IUL policy minimum guarantees to 0%, in order to maintain higher illustrated rates in today’s low-interest rate environment. These policies will never receive a guaranteed minimum interest rate other than zero!
Those who remember how blocks of UL business were illustrated at 12% in the 1980s can comprehend the firestorm that awaits IUL. Those old ULs are now crediting their minimum guaranteed 3% and 4% rates, not the double-digit returns illustrated at time of purchase. Hundreds of thousands of underfunded ULs have lapsed, and many policyholders have lost their insurance. (Don’t forget how difficult it can be to qualify for preferred underwriting, if a person needs new insurance in the event of an underfunded policy.) Many class action suits have ensued.
To avoid similar scenarios involving IUL, the NAIC needs merely to adopt standardizations for IUL illustrated rates.
Is there any reason why insurance companies should be using 11 different methods for calculating IUL illustrated rates? Whether it be a 20-year look-back of the S&P 500 or a 54-year guideline, the buyer still does not know what the actual credited interest will be on any IUL.
Furthermore, why should insurance companies have the discretion to select which method they will use to calculate their IUL illustrated rates? In a market where companies are vying for the same distributors and policyholders, doesn’t it seem like a conflict of interest to allow methods that perpetuate cherry-picking the most favorable calculations?
My suggestion is: Since no one knows what the actual credited rates on IUL plans will be, there should be enforcement of a maximum illustrated rate of 8%.
No one knows what percentage will get credited to VUL policies, and these policies must be illustrated at a flat illustrated rate as well. This is not to say that IUL is a securities product; rather, it merely recognizes that the credited rate is unknown on both types of insurance.
An 8% proposed illustrated rate is reasonable as compared to traditional UL’s 6.5% illustrated rates. It is also feasible as compared to VUL’s 8%-10% rates.
There is no reason why a fixed insurance product should be illustrating at a rate of over 10%, when products without similar principal protection features are being illustrated below 8%.
Ultimately, insurance companies should have the ability to offer illustrated rates that are lower than 8% on their IUL plans should they wish, but maximum illustrated rates should be strictly enforced.
Standardization of illustrated rates on IUL would aid insurance agents who sell these products, by providing them with the ability to compare different plans on the same basis. Let insurance charges speak for themselves on IUL.
Standardization would also provide more reasonable expectations of actual IUL policy performance. I love this product; I don’t want to see it harmed irreparably. Let’s not give the lawyers any more fodder: tell the regulators that they must consider illustrated rates on IUL.
Sheryl Moore is president and chief executive officer of AnnuitySpecs.com and LifeSpecs.com, an indexed product resource in Des Moines, Iowa. Her e-mail address is firstname.lastname@example.org