Recent articles have appeared to claim that premium financed indexed universal life insurance (IUL) is a risky bet with odds that favor the insurance companies and banks rather than the policyholders. However, as with any technique, there is a right way and a wrong way to employ it.
Any financial instrument that promises to provide potential upside (think financed IUL) compared to a relatively safe instrument (think non-financed whole life) obviously involves an increase in risk. And, there are no doubt individuals in our industry who use these products and financing programs to mask the potential volatility in the plans and the results that could ensue should the projections not work out as planned. But blaming the life insurance carriers that design the products, the banks that provide the financing and the agents who make the recommendations does not provide a full or fair picture, where the answers or solutions are not as simple and one-dimensional as some would suggest. Critics draw their conclusions based on several flawed (I believe) assumptions.
Assumption #1: The majority of IUL sales are premium-financed.
Some authors estimate that as much as 60% of all IUL is premium financed. But when we ask the top carriers themselves, their own estimates range between 5% and 16% (by premium). These carriers represent approximately 50 percent of the IUL marketplace, so it seems highly unlikely that the estimated percentages are anywhere near that high.
Assumption #2: Most clients who buy financed IUL are naïve as to the risks inherent in the transaction.
Those same life carriers will also tell you that clients who choose premium financing represent the very high end of the consumer market. Our average client is between the ages of 47-63, has a net worth of $25 million, and purchases between $18-20 million of death benefit. These clients all have financial and legal advisors watching over their affairs, and trustees for due diligence.
Assumption #3: Premium financed IUL plans will never work out in the long run.
We can certainly agree that no cash-value life insurance policy performs exactly as planned. But this is true of Whole Life, Guaranteed UL, VUL and IUL. Not only will interest rates, equity returns, cap rates and borrowing rates change, but clients will skip premiums, pay premiums late, pay less than they originally planned and make unplanned changes or distributions. However, proper due diligence and policy maintenance on the part of the carrier can significantly reduce the risk of lapses and defaults—regardless of the product a client chooses.
Assumption #4: Life insurance carriers, lender banks and insurance agents bear little to no risk in these transactions—all the risk is borne by the client.
Every case we sell requires a significant obligation from all parties to the transaction, cash or financed. When financing is involved, (1) the clients are expected to pay loan interest and post collateral; (2) the lender is expected to fund the premiums and renew the loans in good faith; (3) the insurance company is expected to provide a strong and reliable product to last a lifetime, and be there to provide the benefits under that contract; (4) the producer is expected to service their client year after year. If a transaction ultimately fails, every party pays a price. The carriers don’t recover their acquisition costs, lenders don’t recover their full loan principal, and producers get hit with commission chargebacks.
Assumption #5: The cash-on-cash returns for IUL products utilized in these plans are wildly optimistic, and often projected to be in the double digits.
Here, I think the critics may be confusing the gross illustrated rates with the actual net rates of return, as any sophisticated client or lender would immediately call into question the credibility of such projections. The newer “multiplier” products sold by John Hancock, Lincoln Financial and Pacific Life can be an attractive alternative for clients as long as the client understands the risks. These products carry significant asset-based charges, as high as 5%-7% of the policy’s accumulated value, in exchange for a multiplier on the indexed credit. The multipliers produce higher gross illustrated rates in some durations, but most plans—even those with the multipliers employed—generally show cash-on-cash returns in the later durations of between 6% and 8%.
Assumption #6: Level-rate IUL illustrations do a poor job of projecting the actual risks of a financed IUL.
This assumption is actually true. Everyone agrees that level-rate illustrations don’t show the client how IUL policies perform in the real world. Until the regulators modify the illustration model rules we are stuck with these level-rate illustrations.
Some IUL critics will try to show the riskiness of the IUL product by showing severe reductions in the level illustrated rate. This certainly highlights the downside of the plan. But if the client wants to see the upside, there is no way to do that under current guidelines. Regulation only allows the clients to see rates that are equal to or lower than the AG49 max rate. Remember, the AG49 max rate represents a historical average. This means that over the same era used to generate the AG49 rate, half of the historical samples would have returned a rate greater than the AG49 max illustrated rate.
I think we should be able to show clients illustrations that reflect varying rates of interest over time, where at least one illustration uses a series of rates where the average rate is historically low, and at least one where the average rate is historically high. In this way, a client could make an informed, balanced decision as to whether or not the full risks at the product level and their interaction with the financed elements makes sense for their overall risk tolerance.
Assumption #7: Financed IUL illustrations are the most abusive and aggressive in the history of the industry.
As I’ve discussed throughout this article, there’s a right way to sell financed IUL and a wrong way. Agents certainly bear much of the responsibility as to how “responsible” they are in the design of the case. There are certainly products and product features that can be structured in such a way as to give the client the impression of a frictionless transaction.
But most buyers in this market are extremely sophisticated clients who understand the full range of risk and reward with leveraged transactions and most advisors do a thorough job of answering the questions and showing a range of options that give the client sufficient information to make a purchasing decision. A few may indeed be structuring illustrations that utilize multipliers, variable rate loans, low level projected bank borrowing costs, rolling up of loan interest, and AG49 maximum rates forever. All these elements are optional and should be used with care by agents. They should NOT (in my opinion) be demonized simply due to the potential for abuse by a relatively small number of agents.
Generalizing and demonizing premium financed IUL doesn’t address the issues. Removing client choices doesn’t serve the public or the industry. Complex problems require complex solutions and disciplined, deliberate hard work by carrier, bank, agent and client. We know it’s not easy, but it can and does work for our clients.
Julian Movesian is the president and CEO of Succession Capital Alliance.