Additional Indexed Universal Life Commentary - $250 IUL Charity Challenge

Published on 05/06/2020

On April 2, 2020, “A Critical Review of Indexed Universal Life” was made available through various outlets, including Joe Belth’s blog. (Belth's summary of the original piece can be found here. His follow-up blog containing this article can be found here.) Not surprisingly, that piece generated significant comments and criticism. While this response is not all-encompassing, this should help shed additional light on the most common discussion points surrounding my Indexed Universal Life (IUL) commentary.

“The Author is Biased”

Some dismissed my comments as being “brainwashed” from my time working for Northwestern Mutual as a home office actuary from 1995 to 2005 – “typical whole lifer” and “biased against” products such as IUL.

There is no disputing that I worked for Northwestern Mutual. I enjoyed my time there; I hold the company, its employees, its products, and its mutual philosophy in high regard; and I’m grateful for all of the lessons I learned while employed there. But make no mistake, I have no allegiance to them or any other company in the industry.

I am a fee-only insurance advisor, and I have a fiduciary obligation to look out for the best interests of my clients. By definition, I do not have a bias toward any sort of product, and in fact if I discover that IUL makes sense for a client, then I have an obligation to not only present but recommend that option. I receive ZERO compensation from the policies my clients decide to buy, and I'm paid the same no matter if they buy, what product, what company, etc.

I always strive to put the best foot forward for my clients, which means utilizing designs that minimize or eliminate commission to the greatest extent possible within that particular policy/product. That doesn't always mean recommending the policy with the lowest compensation as insurance is far more complicated than simply comparing compensation (and sometimes with products like term or Guaranteed Universal Life there simply is no commission flexibility). I'm also in favor of as much product disclosure as possible, including agent compensation, but again it's not as simple as choosing the policy with the most disclosure.

“The Author is Too Emotional”

Some suggested that my level of passion was clouding my judgement. I love the life insurance industry – or at least what it could and should be. And yes, I have an incredible amount of passion when it comes to hoping that the industry does not get yet another black eye with overly optimistic illustrations that set consumers up for disappointment or worse.

The industry time and time again has reinvented itself with new products that initially look amazing but ultimately disappoint (and often bring about lawsuits). The high-interest environment of the late 1970s and early 1980s sparked the development of UL products that could take advantage of a “new money” rather than “portfolio” crediting strategy; the rising portfolio rates throughout the 1980s popularized WL products with “vanishing premium” illustrations (that failed to vanish when illustrated dividend interest rates proved to be unsustainable); and the roaring bull market of the 1980s and 1990s focused attention on Variable UL products (where the policyholder controlled the investment allocation) that could assume double digit investment returns in each and every year.

The combination of creative product design and unrealistic/unsustainable assumptions time and again created a perfect storm for agents/companies to oversell the anticipated benefits of such policies and undersell the risks – and not surprisingly, that’s a message that far too many consumers found irresistible.

And now history is repeating itself once again with IUL. Over-promise now and under-deliver later. The more things change, the more they stay the same.

I may not be able to change or save the industry from itself with respect to IUL products, and frankly that’s not my goal. I want to help my clients maximize value and avoid critical mistakes – and there are consumers out there every day making poor decisions with respect to life insurance and particularly IUL. Maybe those consumers would make the same decisions if they had better information and understood the inherent risks within those illustrations and the likelihood of disappointment – but many would not.

“Universal Life (UL) and Whole Life (WL) Have the Same Problems as IUL”

Some people misconstrued my criticism of IUL as a blanket endorsement of all things non-IUL. This could not be further from the truth. I would not personally recommend the vast majority of life insurance policies in the marketplace for my clients, and it is rare to find an existing UL or WL policy (or proposal) where the presence of a fee-only insurance advisor would not add significant client value. The UL and WL designs I use are NOT representative of the average UL or WL policy that a consumer would typically be presented with in the general marketplace.

Some pointed out that there are also commonly problems with UL and WL illustrations being hard to understand, overly optimistic, borderline abusive, etc. – and I completely agree! One could write a critical piece on the unreliability of life insurance illustrations in the UL and WL marketplace as well - in my opinion, IUL just happens to be the most active and aggressive battleground in the illustration wars.

Also, premium financing arrangements and policy loans are not unique to IUL - there are plenty of non-IUL proposals that utilize these elements, and they can range from compelling to foolhardy.

“Agent Compensation on IUL is Smaller Than UL or WL”

Some took issue with me suggesting that agent compensation was relatively high on IUL policies, and some suggested that the typical IUL policy was configured such that the agent compensation was lower than the typical UL or WL policy because most IUL policies are heavily funded policies with an accumulation orientation.

In my experience, I don’t find IUL compensation to be lower than for comparably designed UL or WL policies, but more importantly, for my clients this is absolutely not true. For heavily funded policies, the non-IUL policies I design do have lower agent compensation than similarly designed IUL policies. For instance, typical breakeven periods for the cash surrender value on VUL, UL, and WL policies I design are 1-2, 2-3, and 3-4 years, respectively, for most situations. In contrast, it can often take 10 or more years for an IUL policy’s cash surrender value to eclipse the sum of premiums paid, even on an illustrated basis. To my knowledge, there is not a low or no-commission IUL widely available. Eliminating agent compensation on indexed annuities allows for significantly higher illustrated and actual cap rates (though still markedly lower than the cap rates for IUL policies), and no doubt a no-commission IUL policy would push illustrated and actual cap rates higher as well.

As an aside, it is still possible to have a contract that is very rich in agent compensation have high early cash surrender values. Through designs that spread out heavy agent compensation over several years and/or have some commission “chargebacks” in the event of early policy surrender, high-commission designs may mistakenly appear to be low-commission designs.

“IUL Returns Have Been Historically Better Than UL or WL Returns”

I will concede that it is at least theoretically POSSIBLE that there is an IUL policy out there issued 15 or 20 years ago that has delivered returns that are superior to WL or UL returns (more on this below), but it’s important to better understand what an appropriate comparison would entail.

Let’s first narrow the focus to the relatively vanilla IUL policies that have most commonly been used in illustrations over the years (including today) – one-year point-to-point definition on a common index such as the S&P 500 with a 0% floor. These policies typically have one lever that can be set at the company’s discretion each year – either there is a cap rate that defines the maximum crediting rate in that particular year or there is a participation rate that defines what percentage of any positive gain in the index will be passed along to the policy in that particular year.

These relatively vanilla IUL policies are typically described as having upside potential with downside protection. And while I generally agree with that characterization based on the mechanics of the policy, where I take issue with IUL proponents is when they characterize IUL as having superior returns to WL. Many IUL proponents take it a step further and point to “historical” data that seems to support their claims.

But let’s first understand three critical points. First, there are IUL policies in existence that carry more risk, and based on risk/reward principles, those policies should have higher expected and actual returns. (Whether they actually do is a matter for serious debate – but companies are using this approach to help justify higher illustrated returns.) For example, some IUL policies “double down” on the hedging strategy and assess an additional fee on the policy each year; this fee is then used to increase the options budget; and then in a year when there is a positive market return, the returns are amplified. That’s one way you can end up with illustrations that purportedly use a 6% illustrated rate but effectively assume double-digit credited rates. (Critically, in my experience, consumers do not understand that products with this extra leverage will perform much worse than unleveraged products if future stock market returns or cap rates are not as high as assumed.)

Second, taking a current crediting strategy (say a 9% cap rate with a 0% floor on a 1-year point-to-point S&P 500) and backcasting that strategy over a historical period DOES NOT constitute an actual history.

Third, the credited rate on a policy is NOT the policy’s rate of return. Consider this: It is possible (and in fact likely) for an IUL policy that averages a credited rate of say 6% over its first 10 years to still have an overall negative rate of return during that time due to high charges. So many times, I find that agents or consumers that brag about the performance of their IUL policies are confusing the credited rate of return with a return that properly reflects all of the policy charges as well.

Consider that an IUL policyholder that purchased a vanilla IUL policy (with a one-year point-to-point S&P 500 index definition) at the start of 2012 enjoyed a wonderful 8-year period where the cap rate was hit 5 or possibly 6 times with only 2 years of negative returns (which would have been floored at a 0% credited rate). If we assume a steady cap rate of 11%, then the average credited rate over this 8-year period would have been roughly 8%, which at first blush seems worth celebrating. However, it’s extremely likely that the ACTUAL policy rate of return over that 8-year period was negative, meaning that the cash surrender value had not yet caught up to the sum of premiums paid into the policy.

The IUL History Challenge

To the first person that can provide a complete history of a vanilla IUL policy purchased between 2000 and 2005 that has utilized a 1-year point-to-point S&P 500 strategy with a cap, I will make a $250 contribution to the charity of your choice. Ideally, we will find a policy where someone utilized a maximum funding approach (while still avoiding Modified Endowment Contract status) and continued to pay premiums into the policy over time. I want the actual IUL history to be as good as possible – and 15 to 20 years of experience with a strong and consistent bull market should be long enough to allow the IUL policy to put its best foot forward.

Your anonymity will be preserved, but with your permission, I would like to publish a year-by-year accounting based on what actually happened. That would also be a good opportunity for a side-by-side comparison with an optimally designed WL policy during that same time.

When purchasing a non-guaranteed policy such as WL, UL or IUL, clients have to decide if they would rather win the illustration battle or the long-term value war. Ultimately, original sales illustrations say more about policyholder expectations than actual long-term policy performance – and I believe that many (most?) IUL illustrations used to make sales today are most likely setting policyholders up for major disappointment down the road.