Is Indexed Universal Life Insurance an Alternative to Stocks?

Indexed Universal Life InsuranceIndexed universal life insurance showed up in the early 90's to a somewhat mixed reception. For years it was a relatively obscure product, made available by a minority of insurance companies. But then, the 00's turned out to be a really boring decade and the buy-and-hold mantra was starting to show signs of ware.

So, many companies that threw mutuality to curb in the 90's and early 00's (and even a few that didn't) turned to a new idea that would entice market hungry “investors” whose stomaches were turned inside out by a decade with not one but two recession. Actually, in all fairness the second recession came a few years after the popular adoption of the new product.

We Stand for S-a-f-e-t-y…oh you don't want that…Nevermind then

For well over a century insurance stood for safety, security, and prosperity (hey I've heard that somewhere before!). But then the 90's came along and with it came the decision among a mass of the population that we were investors. And when the market is benefiting from an unusual expansion spanning several years, it's hard to accept the notion that all that money you made was dumb luck rather than carefully acquired skill. Hard until the disco ball stops spinning and the easy money days disappear–along with your money.

Something snapped in the heads of insurance agents and even the industry itself and suddenly variable insurance products (a once regarded putrid idea only offered to the insane) became the insurance product of the decade. Of course, in truth, we can't fault the insurance industry as it was only doing what all good MBA students learn: go where the money is. So the industry known for company branding that alluded to “rock solid” safety for you and your family was now at the forefront of a nasty bubble ready to wreak havoc on everyone's finances. But, they made a lot of money doing it so all's well that ends…well not so well for you.

The 00's, when being a “Financial Advisor” Suddenly Stopped being Fun

Have you ever wondered why so many advisors seem to be such a fan of buy-and-hold? I mean, most of them think they are market wizards so why all the defeatist attitude when it comes to picking out stocks and making moves on a daily, weekly, or monthly basis. Could it be because legally they aren't allowed to do it? 😯

Unless your financial guy holds a FINRA registration series 65 or 66 he or she cannot “advise” you on your investments. He or she can only offer ideas on where you could put your money. There are certain variation to state rules that allow someone who has certain credentials (e.g. a Certified Financial Planner) to offer up advice, but outside of this, your “advisor”–legally they aren't supposed to be using that term, and that's why there are so many “financial professionals” out there–cannot tell you to dump one position and pick up another one.

Alas, if one makes the majority of his or her money selling financial products but is not credentialed to offer advice, buy and hold is the advice because trading advice isn't a service they can legally render.

So what to do when buy and hold returns nothing? Most “advisors” ignored popular sentiment and stood the course, insurance agents had a trickier plan.

Market Returns WITHOUT Market Risk!

After the first market crash and rumors of another bubble that could ravage trading accounts in a way that would make the first bubble pop looks like a minor mishap, American's were understandably hungry for a solution that brought them back to the days of a market that seemingly knew only one direction, up. Insurance agents, armed with newly popular indexed products were ready to answer the call.

They beat the streets and hosted seminars from coast to coast singing praises for a form of annuities and universal life insurance that could earn market like returns without the risk of going backwards. Some even brought along ratchets to tear a page from Dale Carnegie's book and “dramatized their ideas.”

Even the ill conceived 7702 Private Plan good a turbo booster as it could boast 401k like returns without the risk.

And for all of this, the industry found itself in a nasty battle with the SEC over proposed rule 151a. A fight it rightfully won.

Just Like all Parties, there's always an End

Unfortunately for agents majoring in the annuity side of the indexed product line, low interest rates have dashed the days of comparing indexing caps to stock market returns. Instead of 8% plus cap rates, agent bemoan the now paltry 2% caps. Ouch.

Universal life insurance hasn't suffered the same fate, and due to higher loading available (i.e. the insurance companies ability to charge for other things not found in an annuity contract) it likely won't. But, universal life insurance contracts have seen caps fall. But the cap discussion is mostly smoke and mirrors (more on that in a bit).

So are Indexed Products a Stock Alternative?

I won't attempt to build any sort of excitement or drama, the answer is no. But then again, for the most part, life insurance isn't an alternative to stocks. Sure there are several career agents at all of the big name mutuals who try to convince people that whole life insurance will yield a higher return than the stock market on an after tax basis–we hate them just as much if not more than the layperson.

The design to indexed universal life–or any indexed product for that matter–is to average a yield of a few 100 basis points higher than rates paid on fixed (aka current assumption) products. This doesn't mean indexed products are bad or that you should avoid them, quite the contrary. But the suggestion that one will match or even beat the market with an indexed universal life insurance products is not only insane, it's intellectually dishonest. Further, we're in possession of internal insurance company communications that specifically speak to the need to reduce expectations about indexed universal life yields (i.e. we need to dump that ridiculous 8% assumed crediting rate).

The Money is in the Trade

I've said before that the money is in the trade. And I mean it. If you want to make serious money investing in stocks (or investments tangential to stocks, like stock derivatives) you have to be willing to assume the risk of trading. A $2,000 investment in 2 month Apple puts at $475/share the week before last would have been worth around $30,000 by the end of last week (and I'm kicking myself insanely hard for not pulling the trigger on that one). Indexed universal life insurance is never going to compete with a 1,400% return. And that's okay, we don't need or want it to. It's supposed to be safe money.

the problem that most people don't understand this important nuance to the market. And the mutual fund industry would rather you didn't. But even using the mutual fund industry as a bad surrogate to get you access to the market, there are still some that might do better than the market as a whole and therefore do better than we'd expect insurance products to do.

And, because Brantley can willy-nilly place videos in his articles for his own amusement, I will too. Only mine will be at least marginally apropos (WARNING! NSFW):

It's not an Alternative, but that Doesn't Make it Bad

Life is often about setting expectations correctly. The fact that indexed universal life insurance isn't an alternative to the stock market doesn't make it bad. There are many attractive features that make it a worthy choice for those looking to add a low risk asset to their portfolio, especially those who understand our highly regarded idea of using life insurance as a low risk asset class.

In fact, there are things one can do with universal life insurance that cannot be done with whole life insurance. And this fact gives universal life insurance a leg up in certain circumstances. But buying into indexed universal life insurance because you think it's going to yield better than the fixed account expectations of whole life insurance is a bad idea (and those pitching it that way are in for a bad time long term).


2 Responses to “Is Indexed Universal Life Insurance an Alternative to Stocks?”

  1. Jeff Hexter says:

    1) What things can one do with UL but not do with WL? So in which circumstances does this give it the advantage?
    2) If this can be done, and I’m not sure it can be, can you show some historic actual results of IUL vs the actual index? I mean, over the past 5 or 10 or 15 or 20 years (if the products existed), and if the IUL did not participate in the losses during the loss years (zero gain) but only partially participated in the gain years (due to caps), how does it actually perform?
    3) What sort of upside caps do these IUL policy now have? What sort of minimum returns do they offer? Ar they beating inflation rates?

    • Brandon Roberts says:

      Hi Jeff,

      1) Because universal life insurance can make use of the guideline premium test, we can place a higher premium into the policy relative to the death benefit. This potentially reduces expenses. Universal life is a good bit more flexible so there are options to adjust premiums down or suspend them with much lower impact on the policy (to be fair to whole life, you can also reduce or suspend premiums on whole life and as long as your willing to make up that reduction not impact the policy).

      2. Yes this is possible. Most carriers have a historical to their indexing methods. In fact, we addressed this–sort of–on this post.

      3. Caps tend to max out around 12 to 14%. Minimums are around 0 and 1%. Long term average right now is a couple 100 basis points above current assumption universal life, which is a little under 7% at the moment. We cap all of our indexed universal life illustrations at 6% at this time.

Leave a Reply

  • RSS RSS

  • Archives

  • Categories