The Problem High Inflation Poses for Indexed Universal Life Insurance

We've talked a good bit about how inflation might impact whole life insurance, but we've been much less vocal about how it might affect indexed universal life insurance.

In theory, the products operate in a similar world and so should face similar consequences.


IUL may have some short-term advantages.

Since the interest earnings are tied to the performance of various indices, the movement in those indices will ultimately dictate how much interest one earns.  Unlike whole life which is largely dependent on higher interest rates to achieve a higher return on cash value.  Throughout this sustained period of low-interest rates, indexed universal life insurance products achieved higher interest payments vs. whole life policies.  Some IUL products paid double-digit interest payments on cash value.

Inflation Could Cause Higher Stock Prices

But if inflation persists, that could also lead to a run-up in asset prices, which would benefit the indexing feature of IUL–so long as the index segment is shorter than the run-up.  This is likely something we witness unfolding last year.  In other words, inflation puts upward pressure on asset values–potentially creating a bubble–and this appreciation in asset prices moves the index higher.  So long as the index segment period ends before the run-up caused by inflation, the IUL policyholders earn the commensurate interest payment.

This typically ends in a market crash, but IUL doesn't really care since it doesn't participate in the fall per se and will simply start over again at some point lower.  From there it will continue to track the one-year change in the index and credit accordingly.  This one-year change could be substantial as the markets seek to recover from the correction.  And, interest rate conditions might set the stage for higher cap rates on the index options within the life insurance policy,

Additionally, if sentiment on market conditions is negative overall, that might also help IUL through cheaper options pricing for long strategy options trading–e.g. if sentiment is negative, then there aren't as many people trying to buy puts and calls that benefit when the market rises, this potentially makes buying them cheaper.

Is there a downside?

Really erratic markets do tend to cause options pricing to rise, and this could put more pressure on cap rates if interest rates don't rise.

Also, erratic markets could cause the timing of index segments to miss certain increases in the market index because they turn around and go the opposite direction too quickly.  There are a couple of IUL products that might have a strategic way of dealing with this.

The Fixed Account Remains on the Table

If interest rates really rise and this causes a stall in the market, it might put using the fixed account back on the table.  All IUL policies have a fixed account option that pays an interest rate on cash value; this rate is guaranteed for 1 year.  It is then re-assessed and potentially changed the following year.  The rate is tied to market interest rates, so if interest rates rise to combat inflation then we expect to see much higher interest rate offerings on these accounts.

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