Reps are turning to index universal life insurance to bridge the risk gap between low-rate permanent life insurance and riskier variable universal life. With variable universal life policies, the cash value is invested, typically in mutual funds.
With index universal life insurance, on the other hand, the interest rate credited to the cash value is based on the performance of a market index, such as the S&P 500. The cash value interest rate, for example, may be 70 percent of the price gain on the S&P 500. Or, it may be the full gain of the index, with an interest-rate cap of, say 12 percent. On the downside, no matter how the stock market performs, the insurers pay a minimum guaranteed rate, often ranging from 1 or 2 percent. As with all universal life insurance, index universal life insurance policyholders can make flexible premium payments.
Sales of index universal life insurance have grown 192 percent from 2006 through 2010--an average of 38 percent annually, according to LIMRA in Windsor, Conn.
Although 59 percent of 70 life insurance executives surveyed by LIMRA in January 2011 predicted sluggish sales for life insurance, index universal life insurance had the most growth potential. The majority of those polled expected the greatest growth to be in the middle income market.
“Index life has the greatest growth potential,” says Robert Baranoff, LIMRA senior vice president. Rising sales, he says, are due to the fact that reps can sell it without a securities license, thanks to the Securities and Exchange Commission’s failure to enact “Rule 151A.” That rule, struck down last year, would have required a securities license to sell index annuities and certain similar types of life insurance.
As a result, reps that sold variable universal life have begun selling equity index policies.
“A lot of reps that sold variable universal life insurance got their ears boxed when the financial market collapsed,” adds Daniel Mulheran, president of ING U.S. retail life insurance distribution. “Reps lost their appetite for variable life insurance and don’t want to risk getting slapped again. Equity index life brings some upside of the stock market and has downside protection.”
Insurance company equity index portfolios are generally made up of target maturity investment grade bonds and equity index options. This investment mix covers the rate paid on the policy and the guaranteed return if the stock market performs poorly.
The insurance company’s expense and mortality fee are deducted from the universal life insurance policyholder’s first premium. The result is considered the policyholder’s cash value. After that, expense and mortality charges are subtracted from the sum of the previous period’s cash value and any premium payment. Guaranteed interest is credited daily. The excess interest earned based on the equity index return is then credited to the cash value when the index block matures.
ING’s Hypothetical Index Strategy Calculator, based on an equity index life insurance policy tied to the S&P 500, shows that a policyholder earned an average annual return of 5.4 percent annually over the past ten years ending in 2010.
Mulheran suggests that reps use thecalculator to illustrate the policy based on a variety of returns, including the guaranteed rate. That way, the client can understand the relative historical performance differences between the different policies based on the time periods compared as well as the deductions for fees, the potential death benefit and cash value returns
Jack Marrion, president of Advantage Compendium, St. Louis, says there is not much difference between how index life insurance and index annuities invest to determine policy rates. They have similar performance based on credited interest rates. But compared with an annuity, life insurance policies have higher fees. There is no readily available data on index life insurance performance. As a proxy, advisors can look at index annuity performance to get an idea how the life insurance would perform.
Over the past five years ending in 2010, the average index annuity credited a 3.9 percent annualized interest rate, with index universal life rates performing similarly, according to Marrion. By contrast, one-year CDs yielded 2.8 percent annually and five-year CDs yielded 3.8 percent. The S&P 500 index grew at just a 0.65 percent annual rate.
Greg Womack, an Edmond, OK-based financial planner, says he uses equity index universal life as long as there is lapse protection, and guaranteed rates and maximum policy costs are attractive.
“I like some of the indexed contracts out there,” he says “I think it is wise to have a portion of permanent insurance to carry into retirement—overfunding it during the higher earnings years to have it paid up if possible.”
There are other factors to consider with an index universal life policy aside from the interest participation rate and interest rate cap. For example:
· Sometimes, the percentages, caps or margins can change during the contract term.
· The index return excludes the reinvestment of dividends.
· The way the insurance company calculates interest is important. Whether it is simple interest or compounded interest affects the index’s return.
· Life underwriters say that the most judicious crediting method is the point-to-point with a periodic reset. The annual reset, for example, compares the change in the index from the beginning of the year to the end of the year. So the gain is always locked in.
· Minimum guarantees are not always credited annually. Some carriers may credit the guaranteed interest rate every five years.
· Advisors need to look at the internal rate of return on the cash surrender values in the illustration. This shows the policy’s return net of its costs.
· The cost per thousand dollars of life insurance coverage as well as the financial strength of the insurer also should be considered.
Although equity index universal life is billed as a safe way to earn stock market returns with a guaranteed rate, high insurance fees eat into policy returns. A working paper coauthored by James Slaydon, finance professor at Lamar University, Beaumont, Tex., analyzed the returns of equity index universal life compared with buying term insurance and investing the difference in an equity index mutual fund. The back-tested analysis was between January 1977 and December 2007.
“The client was better off choosing a traditional term insurance policy with the premium difference invested in an equity index mutual fund,” Slaydon says.