Don’t believe the hype: FIUL is too good to be true!
This seems to be the common refrain from the majority of articles and commentary directed toward fixed index universal life insurance (FIUL), usually made in response to claims that sales people too often promise the moon whenever FIUL is discussed as an option for their client’s financial portfolio.
True, FIUL has been over-hyped at times and its reputation has suffered as a result of hyperbole from those who lack a complete understanding of the product and the value it can bring to a holistic financial strategy. This can make it difficult for both financial professionals and consumers to get a clear picture of whether or not FIUL is a good fit for their situation.
In addition to offering an income-tax-free death benefit that can help address immediate and future needs, FIUL also has the potential to accumulate tax-deferred cash accumulation. Clearly, this combination of benefits is answering a need in the marketplace.
Since it was first introduced, FIUL sales have been steadily growing. New carriers have been entering the market and launching new products that continue to drive sales each year.
New guidelines have also been introduced, such as Actuarial Guideline 49 (AG 49), to address past inconsistencies among carriers with how FIUL policies are illustrated and sold. Yet, as the market grows, so do the misconceptions about FIUL insurance.
A closer look at some of these myths can help bring clarity to this topic and demonstrate the opportunities FIUL may offer your clients.
Most FIUL insurance policies offer the potential for cash value accumulation, which is protected from negative index performance. (Photo: Thinkstock)
Myth 1: The ability to offer cash value accumulation potential with a level of protection is too good to be true.
Reality: Most FIUL insurance policies offer the potential for cash value accumulation, which is protected from negative index performance (however, fees and charges will reduce cash value). The insurer achieves this by putting a portion of the premium into a general portfolio.
Related: 10 advantages of term life insurance
Generally, this portfolio is conservative and made up mostly of bonds. This helps the life insurer provide a level of protection with the policy; if the index performance is flat or negative, the client will not lose cash value due to the index performance.
A smaller portion of the premium is used to purchase options. These options help provide the insurer with the ability to offer cash value accumulation potential based on the positive performance of an external market index. When the external market index has positive performance, the cash value is credited with indexed interest (typically subject to a cap or participation rate).
The insurer generally spends the same amount regardless of the index allocations chosen. If the chosen index increases, the option will provide a return that is equal to the amount needed for the policy. If the chosen index decreases, the option will not provide credited interest to the policy.
Another misconception in the industry is that, if the external market’s performance is greater than the cap on the life insurance policy, the carrier makes money. This is not true.
Most carriers transfer away their investment risk with hedging, either internally or through investment banks. The carriers’ goal is to immunize themselves from market movements, focusing on their core business: insurance risk.
AG 49 sets parameters for calculating a carrier’s maximum illustrated rate, but insurers are still competing to offer the highest cap. (Photo: Thinkstock)
Myth 2: The product with the highest cap has the most accumulation potential.
Reality: Even though a carrier offers the highest cap, it may not yield the most cash value accumulation potential. With the goal to standardize illustrations across the life insurance industry, AG 49 set parameters for calculating a carrier’s maximum illustrated rate; however, carriers are still competing to offer the highest cap.
There are ways that the carrier’s options budget may be unrealistically inflated. For example:
Artificially inflating caps, which can cause a product to have high charges or poor benefits.
Aggressive investing, which is risky, and the carrier may not be able to sustain the caps in times of crisis.
Minimizing the investment component, which can create an unbalanced product.
The cap is no indication of future cash value accumulation that a client could realize.
Another aspect of the discussion about index allocation is the importance of diversification. In addition to index choices, each crediting method offered has a different risk and return profile, which should be considered in conjunction with your clients’ needs.
With FIUL crediting methods, indexed interest may be applied annually to the policy based on the performance of the chosen index allocations. Each crediting method has strengths and weaknesses depending on the index performance.
No choice is best in all scenarios so that’s why it’s important to help your clients create a diversified strategy. Diversifying your allocations in an FIUL policy does not ensure the policy will earn interest.
Related: IUL product sales on the upswing
Cash accumulation bonuses are becoming more common in FIUL, but not all bonuses work the same. (Photo: Thinkstock)
Myth 3: All accumulation bonuses are designed the same
Reality: Accumulation bonuses are becoming more common in FIUL, but not all bonuses work the same. A few facts about bonuses that are important to consider:
Some bonuses are only applied to unloaned values, while others may be applied to both loaned and un-loaned values.
Not all bonuses are guaranteed, meaning the insurance company may have the right to change the amount of the bonus or remove it entirely in the future.
Products with a bonus may also have caps and participation rates adjusted to take the bonus into account.
Some bonuses require allocation to a specific account or index; others may be applied to both the fixed and index accounts.
In addition to these considerations, it’s important to understand the different types of bonus designs that carriers use:
Multiplier factor: Instead of having a set bonus rate, another type of bonus design links the bonus rate to positive changes in an index. A multiplier applies a factor to the annual index accumulation, and may be subject to a cap.
Flat rate bonus: The insurance company applies a flat rate bonus to the cash value of the policy monthly or annually.
Look-back bonus: Another type of bonus that is linked to the indexed interest credit looks back at the past index credits to the policy. This method has a specified bonus rate and is based on the total amount of index credits to the policy over the previous specified period.
Monthly charges earn interest: In most FIUL policies, monthly charges are taken out before interest is calculated. This type of bonus applied interest to any monthly deductions.
Clearly, many variables exist regarding bonuses within FIUL products. While no bonus can be ideal in every situation, it is important to understand how a carrier’s bonus is designed so your clients can be similarly informed when deciding which product is right for them.
To provide insight into how an illustrated rate can impact cash accumulation potential, many carriers provide historical back-casting in policy illustrations. (Photo: Thinkstock)
Myth 4: Illustrations demonstrate how the policy will perform while in force.
Reality: Illustrations are a snapshot of how the product and features could work and are often based on a flat illustrated rate. To provide clients and financial professionals with insight into how an illustrated rate can impact the accumulation potential of a product, many carriers provide historical back-casting in policy illustrations.
While back-casting does not guarantee future interest credits to a policy, it does provide some understanding of how the policy could react in different market environments.
There are also several other variables to consider that would affect how a policy would perform and why it may vary from the original illustration.
Clients generally have the flexibility to change allocation selections yearly. They are not locked in to the initial allocation options they select. Perhaps the client would like to change or diversify their allocation selections.
Different allocation selections perform differently; this would affect the original policy illustration. Assuming there is any available cash value, clients may also take policy loans or withdrawals.
No one can be sure of what their future needs will be. If they borrow more or less than they originally anticipated, that would also differ from the original policy illustration.
Some policies offer chronic illness protection. While some clients may anticipate and prepare for future health needs, we can’t foresee the cost of future medical and living expense that would be covered.
FIUL provides great flexibility and these are just a few features that clients could take advantage of. However, this flexibility means that their policy may not perform as their illustration at one point in time suggested.
While it’s usually wise to avoid the hype when it comes to recommending financial products — particularly something as important as life insurance — make sure you take the time to separate myth from reality before you come to your own conclusions.
Where clients have the need for death benefit protection, FIUL products may be appropriate for current economic conditions because they offer features and flexibility, so policies can be designed to meet a variety of consumer needs.
Although an FIUL policy will never be the right fit for every situation, it’s important for financial professionals to understand the different aspects of FIUL so they can have informed conversations with clients about whether or not the product is a good fit for their specific financial situation.