Indexed Universal Life Must Be Contained: It’s Getting Out of Hand

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According to a recent article penned by Leslie Scism at the Wall Street Journal, “sales of a life-insurance policy tied to the longest bull market in U.S. history are soaring.” There’s a lot to unpack from that statement. But that’s the opening statement and it gives you a taste of what you can expect if you keep reading.

This post is not any kind of attack on the writer or the publication. I’m sure that she’s a perfectly nice person and she’s certainly a veteran journalist who has covered insurance for a while.

But this is the second time in the last few years that I recall seeing one of her pieces in the WSJ discussing matters surrounding universal life insurance. The first piece goes back a couple of years and we talked about it in the past.

News is Better Than No News

It’s good to see a mainstream news outlet cover anything about life insurance. Most financial journalism ignores it completely or marginalizes it by pointing out that term insurance is the only product that's worth buying. All other life insurance products are engineered to pay salespeople higher commissions.

Why the renewed interest in universal life insurance and indexed universal life insurance in particular?

In the last few weeks, we’ve seen a few pieces published in the media and by insurance company marketing departments that suggest an explosion in the sales of indexed universal life insurance. Of course, that grabbed our attention.

We do our best to keep our finger on the pulse of the life insurance industry. Most of the time, you can barely find a heartbeat.

What’s more curious to us though is that within our own practice of selling life insurance, we’re not seeing an increased interest in IUL at all. The explosion has passed us by.

Potential Clients Are Less Interested in IUL

Over the last few years, we’ve seen the lineup of indexed universal life products in the market decrease index cap rates across the board. And we’ve seen an increased interest from clients that would rather purchase participating whole life insurance.

Yes, our data is anecdotal, we admit without qualification that our audience is self-selecting.

But as we discussed in our post and on our podcast last week, the data from LIMRA (source of insinuations that IUL growth has exploded) doesn’t really show that we’re having an explosion of IUL sales.

More that other types of universal life–namely current assumption universal life and guaranteed UL sales have been steadily shrinking in the last few years.  Much of the contraction can be blamed on market forces and newer reserving requirements that make it more costly for insurance companies to offer these products.

To be clear, new requirements don’t prohibit life insurance companies from offering guaranteed universal life (GUL) policies for example. But the industry has decided that the reserving requirements would make the products too expensive to manufacture and that consumers won’t pay for it.

I suspect that life insurance companies could still sell  GUL and there would be a group of clients to happily pay for it. However, that’s probably too small a market for the companies to be interested in making and servicing the product. It’s not good business to pursue.

But Universal Life Insurance Is Ruining Lives

As we’ve discussed in the past, there is no big problem with universal life insurance. But the facts don’t seem to slow down the sensational fear-mongering from continuing. It sounds good to make life insurance the bad guy. Everybody knows it’s just a big scam 😉

Universal life insurance has been the whipping boy for my entire career. Not that I’ve been around forever but almost 20 years at this point.

At first, I joined along with the chorus. I figured if these grizzled life insurance industry veterans who are training me say it’s bad, it must be bad.

All the people I learned from worked for a mutual company that despised universal life. “If they hate it, it must be terrible and I wouldn’t want to do something terrible for my clients,” I told myself.

Of course, as time marched on and I became a bit more enlightened, I did my own research. It didn’t take much digging for me to connect a few dots. What I should’ve known, is something we should all keep in mind whenever we’re looking at an issue that’s polarizing:

It’s not near as bad as the detractors make it out to be and it’s not near as great as the cheerleaders want to believe it is.

Universal life insurance is just a product and the actuaries that conceived it did not design it fail.

Getting back to the initial focus here…

The Assumed Interest Rate Is Patient Zero

The problem with indexed universal life insurance is the same problem that plagues the original universal life contracts that were sold back in the 1980s that are now causing such heartache as the WSJ points out.

Those policies back in the 80s were sold assuming that double-digit fixed interest rates were the new normal. As such, they would continue to be a reality that fueled the growth in cash value and would keep the premiums needed to cover the cost of insurance low into the future.

If you understand even a little bit about the mechanics of universal life insurance, you know the problem. Turns out that all types of universal life insurance (VUL, SGUL, CAUL, IUL, etc.) are constructed with the interest rate assumption at their core.

The required premium to support or sustain the death benefit in a universal life policy is dependent upon the interest rate that the policy cash value earns over time. If you wrap your head around that, it’s not too much of a stretch to imagine a policy back in the 80s that was sold and assumed a 10% interest rate was probably underfunded for the past couple of decades.

I know that we’ve pointed out versions of this problem dozens of times over the last 8 years but I’ll beat the drum one more time. Universal life and subsequently indexed universal life is not a cheap alternative to whole life insurance. That was a selling point of UL when it hit the scene. That’s why it has problems today. Not because it’s a flawed product.

Here’s an example of the problem for you to look at by comparing two illustrations. I think this short video will help you understand the problem more clearly.
Hopefully, that makes things more clear for you. Again, the problem, despite the press that suggests otherwise, is not indexed universal life insurance. The problem is that the product is often used incorrectly and applied to situations where it shouldn't be used.

If you or your client is looking for a specific death benefit amount for the lowest possible cost it’s not a good idea to inflate the interest rate assumption. When you do that, the required premium to have the policy death benefit stay in force to age 100, for example, will appear very affordable. That's a trap.

Remember, just because it’s printed on the illustration doesn’t make it true.

In fact, I’d argue that it’s no different than the investment return assumptions we are all subject to on a daily basis. You know the stuff I’m talking about…

“If Bob puts $200 in his Roth IRA every month from 25 to 65, invests in low-cost index funds, and earns an average annual return of 10% he’ll be a gazillionaire when he retires”

I’m not arguing with the math, it’s true that all those things will happen if Bob does his part and the market gives him those sorts of returns. I’m just suggesting its no more a fantasy for people to illustrate 8% on an IUL policy.

Bad assumptions when saving, investing, and buying life insurance are just bad assumptions. They’re not badder because it was a current assumption universal life insurance policy in the 80s, an IUL in the 2020s or any of the 1000s of investment blogs/YouTube channels on the internet.

That being said, does the life insurance industry have some responsibility in the matter? You betcha.

Agents are turned loose on the public with poor training and incomplete information every day.

Are Multipliers the New Double Digit Interest Rate Assumption?

In the WSJ article, there is mention of new index multipliers or bonuses depending on what insurance company you’re looking at. I’m sure that my hate mailbox will overflow for saying this but it won’t be the first time.

I’d suggest that we all see them for what they are…nice to get but never be a deciding factor to buy or not buy. If you get a bump from them, great, if not so what. With one added caveat–be aware of added costs for having the “benefit”.

I’ve seen some products that have added significant costs for providing the multiplier. And of course, the new feature shouldn’t be allowed to show overly optimistic illustrated values, that’s a given in my world.

Those of us that plan to be around to serve our clients long-term have to focus on setting realistic expectations. Illustrated values never prove to be 100% accurate, however, we should do our best to explain that and establish procedures to illustrate something that’s as realistic as possible.

Market Crash Catastrophe for IUL

Nothing that relates to IUL happens in a vacuum. But I’m not sure that a market crash is necessarily trouble for all indexed universal life policies.

They all have a 0% return floor on the indexed accounts. Some have guaranteed minimum return at 1% or 2% on some older contracts. And every IUL I know of also offers a fixed account that pays a guaranteed interest rate for the policy year.

Not to be snarky but you know what will get crushed in a market collapse? Everything you or I have invested in the market. Just bringing that up because articles that rail on IUL being crushed in a down market act as if it will somehow behave differently.

I don’t like drawing parallels between indexed universal life insurance and investing in the stock market. It’s not the same thing or even close the same thing. Let me stress that based on historical evidence, an investment in the market should offer higher returns over long periods.

Anyone that represents IUL as a market-like investment is either ignorant or dishonest. Both are pretty dangerous and there are all sorts of problems with the comparison (which is why I don’t like it when people want me to do it).

But a market fall or flattening does not mean that vast swath of people who own indexed UL will be left with “an unaffordable insurance bill” as the WSJ article suggests.

If the intention of the policy is understood and the policy is implemented correctly, a zero year or even a succession of zero return years fails to make anybody’s policy unaffordable. My opinion based on reading the WSJ article and most other critiques on IUL is that there’s a fundamental misunderstanding of how the product works.

IUL Returns Are Not About Averages, It’s About Movement

Indexed universal life insurance cash value is not invested in the market…ever.

In fact, if the market goes down your IUL policy will begin moving forward (earning index credits i.e. “interest”) long before a parallel investment in an index fund gets back to zero.

Why is that?

The cash value in an index account of an indexed universal life policy isn’t invested in the market. The index account only participates in the movement of the index.

Your policy doesn’t have to wait for the index to recover to the high point pre-crash for you to benefit. At whatever point the index begins to head in the right direction, your IUL policy cash value will begin to rise.

This basic characteristic is often overlooked because it’s such a fundamental part of all indexed UL contracts. In fact, we think it’s the most undersold feature of indexed universal life insurance. Many of us fall short of adequately educating our clients to appreciate its significance.

It’s unfortunate that there continues to be so much confusion about IUL and of universal life insurance as a category. The policies themselves are not to blame. A lack of competent explanation and incomplete education are the culprits.

We all have to focus on matching clients with appropriate and suitable products coupled with responsible illustration design. If not, regulatory scrutiny will come down like Thor’s hammer. Doing the right things for our clients will keep the misinformation campaigns to a minimum and toothless.