You don't have to look far on the interwebs to stumble upon a blog post, video, or infographic that throws a little shade at indexed universal life insurance. The product is attacked relentlessly by both the “never-insurance” crowd and the “whole life insurance is the answer to everything (aka Nelson Nash posse)”.
I never thought that infinite bankers and Suze Orman would agree on everything. But they've found a common enemy in the undeniable fact that indexed universal life insurance is bad for you.
Why? Fees…mostly. You see, indexed universal life insurance is more doomed than the Titanic, the Hindenburg, and the Alamo.
The fees run out of control and you simply cannot escape them. There's proof of this, somewhere.
Where is the proof? Good question…as best I can tell…the agent in the office down the hall who has a brother who knows a guy who had an agent that told him about a cousin he had on his mother's side who once bought a universal life insurance policy that didn't work out.
Didn't work out you say?
Speak no more…I'm convinced!
Except for that One time…
Early in my insurance selling career, I hated indexed universal life insurance (actually all universal life insurance) and told tales of its ills. What was my evidence of universal life insurance's great offenses? See the story above about the guy down the hall. But a few years into my career I asked myself a silly little question.
What if I was wrong about universal life insurance?
If universal life insurance is so bad, why does it still exist?
So my annoying inquisitive nature forced me to investigate a bit further. I don't intend this blog post to be about how I found religion with universal life insurance, perhaps in an upcoming blog post.
But here's the short version of what I learned: way too many people bought universal life insurance because they thought it was cheaper than whole life insurance. The failure was operator error, not the product.
Thankfully I warmed up to universal life insurance after only a couple of years of lying to people about how awful it was. I even did something crazy. I sold a few.
Universal Life Insurance Expenses Shoot Up and Leave you Penniless
I admit it, I'm an insurance nerd so I watch insurance videos on YouTube. I giggle a bit at the ones staging an attack on indexed universal life insurance–mostly because I'm amused at how the hate-filled playbook never changes.
The haters are obsessed with the rising cost of insurance in an indexed universal life policy. What exactly are they talking about?
You see, universal life insurance pioneered the idea of transparency. I know I know, the world is going to hell in a hand-basket. We're gonna let people see what we're charging them for their insurance policy? Preposterous.
Apparently, prior to the existence of universal life insurance, everyone assumed that insurance companies had a magic way of preventing people who bought whole life insurance from dying.
Proving that no good deed goes unpunished, the full disclosure of fees leaves universal life insurance wide open to criticism. It's the cornerstone of any good argument against it, especially among the proponents of super transparent whole life insurance.
The problem, they say, is that universal life insurance is just yearly renewable term life insurance with a savings account. Somehow whole life insurance is magically different.
This rising cost of insurance eats away at your policy's cash value and eventually bankrupts the entire thing. Let me show you an example.
Using a 40-year-old super healthy insured, rated at preferred plus, a $1 million death benefit indexed universal life insurance policy with a $7,000 per year premium has cash value grow and decline as follows:
The cash value in the policy increases year-over-year until the 40th policy year. Then the cash begins to decline year-over-year–and those declines accelerate within a few years. Just 10 years later, the policy runs out of money and the policy owner would need to either put a lot more money into the policy or else let the policy terminate.
The policy owner would be age 90 at this point, so there's a good chance he'd be unwilling to fork over lots of money to keep the policy afloat. What's more, these numbers assume the highest possible assumed interest rate on the indexing feature. This thing is just designed to fail.
Except for one tiny detail…
A $1 million death benefit policy should have about twice the premium. A $1 million whole life policy would require roughly a $14,000 annual premium for the same super health insured. What happens if I go back and increase the premium to this amount?
It looks like this:
Well that doesn't seem so bad now does it?
Keep in mind that both of these policies have the same $1 million death benefit, the same insured, and the same “rising cost of insurance” (if you read the quoted text in a mocking tone, you read it correctly). The only difference is that one policy has half the premium paid as the other.
And this, my friends, is the epicenter of our problem.
Whole life insurance has rising costs as well, life insurers simply demand you pay them enough money to cover that rising cost. Years ago, I highlighted this notion in this article.
And if you go read that blog post from 2013 you might ask why I bothered rehashing this subject today? Because I want to focus in on the “rising cost of insurance” aspect of universal life insurance (again still using the mocking tone on a quoted section).
Theory Versus Reality
The majority of the doom and gloom stories that focus on the “rising cost of insurance” for universal life insurance speak in theoretical terms. They make references to the idea, declare that it will eventually bankrupt the policy, and then tell you it's no good. They lack specific examples. And I might know why.
Let's look back at an indexed universal life insurance policy I wrote several years ago, I want to share some key observations.
First, when I sold the policy, we assumed it would earn an effective 6% index crediting rate each year. At that time, the policy had a 12% cap rate. Today it has a 9.5% cap rate.
In fact, it only had a 12% cap rate for roughly a year and a half after I sold it. So for the majority of this policy's existence, the cap rate has been lower than 12%. Despite this, the policy is considerably ahead (by tens of thousands of dollars) of where the 6% assumption projected cash values to be at this point.
Total annual expenses on the policy equal a little over $2,000 by the end of the next policy year. At that same point, the policy is guaranteed to earn $10,500 (the indexing feature has a floor that is above 0).
Now here's the truly dramatic part. Looking at retirement age, age 67, the policy will have just over $3,800 in expenses that year (yup cost of insurance does go up every year). That roughly $3,800 in expenses will be about 0.09% of the total projected cash value at that time.
It's extremely difficult to find a passive index ETF with an expense ratio that low–let's not forget that this has a death benefit. That expense is all in. Everything. Net, net.
What's more, the costs of the policy never project expenses higher than 0.40% of the policy's cash value (they reach 0.40% around age 116…insured might live that long…who knows).
And don't forget that the cash value will grow between now and age 67. So the while the policy today earns guaranteed interest in excess of the expenses the policyholder will have at age 67, that guaranteed earning will be substantially higher at 67 than it is today.
The “horror stories” about universal life insurance are more a lesson on user error. When agents tried to sell unwitting clients “cheap permanent life insurance,” it resulted in a number of people who owned a poorly capitalized product.
Whole life insurance avoids this pitfall because the life insurer demands more money (i.e. it doesn't let agents sell it as cheap insurance), but the reality of the expenses exists just the same.
While it's absolutely correct to point out that whole life places the guarantee on the shoulders of the insurance company, an individual who buys universal life insurance and pays a premium commensurate to a whole life premium with the same death benefit has little to worry about as it relates to the rising cost of insurance.
But going beyond that, we see plenty of universal life insurance policies around today that are in no trouble at all. As you can see from the example above, indexed universal life insurance policies correctly designed will far outpace the costs and will very likely continue to do so forever.
This doesn't suggest one is bad and the other good.
In truth, we write about 10 whole life policies for every one universal life insurance policy these days. It just happens to be the case that whole life matches the needs better for a majority of people who choose us as their agents.
We clearly see the value in both, and we refuse to take a myopic approach to life insurance that suggests one approach rules them all just because we don't always see a benefit to one product or another.
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14 thoughts on “The Doomed Index Universal Life Insurance Policy”
Rising COIs are only part of the story. Other policy charges can create a situation where the charges exceed the interest credits. This is more true of some ULs than others. But even in situations where there is no charge-funded multiplier or bonus, interest credits can be less than policy charges. And those caps are going to continue coming down as insurers’ options budgets get squeezed. The alternative for the insurer is to increase policy charges to buy more options. That changes the IUL story quite a bit and makes it a somewhat more unpredictable animal.
This is the inherent risk— the non-guaranteed nature — of UL. Whole life never faces this problem. That doesn’t mean one is necessarily wrong. However, UL is objectively riskier than whole life.
Hi David, when we mention rising COI, we are lumping all other expenses into that as a catch-all term. While some might argue against that practice, we do it in the interest brevity.
David, wouldn’t the reduced budget affecting cap rates in IUL also affect whole life dividend returns, as budgets are based heavily on interest rates? For example, Mass Mutual just reduced their dividend for 2020. Would it be fair to say that both whole life and IUL are under performing in this low interest rate environment?
Well put! Both Current Assumption/IUL and Par WL can work IF properly funded. It’s prudent to acknowledge the flaws in the insurance agent tribes. You once said (paraphrasing) on a podcast “that with overfunded WL, the insurance company provides a guarantee that in effect holds the client’s hand” – I think that’s a good thing – especially if the client loses the original soliciting agent.
The burden to educate and reeducate policyholders on proper funding falls on the agent and that is reliant on the training received and the agent surviving in the business. Site’s like this help agents keep things in perspective, provide non-sales policy know-how, and hopefully survive another year to help our clients make prudent decisions! I wish more advisors knew this stuff. Bravo guys.
Hi Rob – agents need IUL carriers to provide annual notices of options and needs to adjust premiums and benefits particularly in retirement. In retirement, the default for underfunded policies should be to reduce the benefit rather than change perm to term and make it a gamble.
Regulators and carriers need to take the lead in having policies sold as perm serviced as perm.
I’m a fan of yours but with IUL my experiences has been these policies are really for the affluent. They buy the least amount of insurance and over fund the hell out of it. Plus I enjoy the leveraging capabilities the IUL offers that a Whole life doesn’t have. I’ve done living trust where the wealthy place their IUL’s inside Irrovocable Life Insurance Trust. They liquidate the estate down below the estate tax limit and dump the liquid inside IUL’s with the least amount insurance it can buy. The thing grows all by itself and can be leveraged years to come. The trust is used because life insurance is taxed in estates so the trust allows complete tax free benefits.
So if you would have started an IUL and a WL policy 20 years ago with the same premium, who do you think would have more money? On the IUL example you mentioned, you said that the policy performed much better than the assumed 6% rate. If that is true, then I would think an IUL will outperform a WL policy. And if that is the case, I am wondering why you guys open more WL than IULs (10 against 1) . What would a WL offer that an IUL doesn’t? I am not trying to be “sneaky” with these questions. I am really interested in the subject. Thank you!
Hi Ivan, sometimes it’s not just about the “return.” As we’ve shown before, there are times that the lower absolute return option ends up netting more benefit due to various circumstances. Even if IUL can achieve an effective interest credit above 6%, that won’t always put it ahead of whole life insurance.
Additionally, IUL will often lag whole life in available cash value for several years (a decade or two, especially due to surrender charge). While we don’t have a lot of clients who turn around and begin taking policy loans from a policy immediately, a lot of them find greater peace of mind in having the cash value available just in case. This tips the scales in favor of whole life for some people.
Hi Ivan – to add to Brandon’s comments, WL is much more stable. IUL has a much wider range of results not only due to lower minimum credit rates, but also due to how it becomes stealth term insurance when underfunded. Many who plan to properly fund the policy get to the point where they cannot do so or give into a temptation to do so. IUL is sold as perm with an adjustable benefit but companies do not guide the client on how to adjust the benefit when underfunded. In contrast, WL stabilizes the policy to keep a perm portion by reducing the benefit to keep a balance between risk and value. This happens with PUA surrenders or conversion to RPU or surrenders of base cash value. Dividends to pay the premium do not invade the base value. The client has to make a choice to convert to extended term. In IUL it is the default option of underfunding. IUL could be greatly stabilized if companies guided benefit adjustments.
If the customer can choose whether to pay or not pay, he will often choose to not pay.
Hi David, If that is the case, then this person isn’t a candidate. At the vert least, though, he should be given the chance to make a choice at the outset.
Hi Brandon, thanks for the info, how much does the annual renewable term cost within an IUL especially in one’s older age? If the net amount at risk is not small enough in those years, the COI will bump up pretty quickly no?
Hi Johnny, I understand your question if I interpret it in a certain way, but the lack of specifics in your question cause me to withhold such assumptions. This might be a function of your desire to be brief. Or it’s driven by a lack of overall understanding. If you’d like to elaborate more, I’d be more than happy to discuss this further.