Battling the Seduction of IUL
Aug 15, 2024Battling the Seduction of IUL
By Tom Wall, Ph.D., MBA, MSFS, CLU, ChFC
These are just a couple of the phrases that proponents of IUL will use to sell clients on the product. I honestly believe the vast majority of advisors are seeking new ways to serve their clients in creative ways. In the investment and annuity space, there are a number of indexed or buffered options that provide the necessary security for many investors to feel comfortable with ample market exposure. Any dismissal of these options as overly expensive fails to recognize the psychological impact they have on clients, giving them the courage to implement financial strategies they otherwise may have been too nervous to employ.
Indexed Universal Life is different. Unlike the aforementioned options, there are rising mortality charges inside of the contract due to its nature as life insurance. As such, underfunded or underperforming contracts can quickly experience solvency concerns, and the caps on performance can make it nearly impossible for market returns to help performance catch up during inevitable periods of underperformance.
In next week’s members-only Whole Life Masterminds session on Wednesday, January 31st at 2:00pm EST, I’ll spend a whole hour going through the inner workings of IUL and how whole life compares. Here’s a preview:
1. The Risk is on YOU.
Universal life allows for flexible premium payments, as long as minimums are met and there is enough account value to cover monthly internal charges. This is often touted as its most attractive feature relative to other forms of permanent insurance. However, to obtain that flexibility, a policy owner generally accepts all performance risk. If the policy is under-funded or the projected returns are under-performed, the client must remain aware and add additional capital to the plan to catch up. Often, the realization of such underperformance comes many years down the road, when the problem has compounded into a challenging situation.
2. Caps, Floors, Multipliers.
Having a zero percent crediting floor in years where the underlying index (such as the S&P 500) goes down is an attractive feature. And that index has lost value about one out of every 3.7 years over the last 100 years or so. But the cost of that is severely limited upside through crediting caps. Insurance companies don’t actually invest in the index; rather, they buy a call option spread that captures performance between the floor and cap rate.
3. It’s a Math Problem
If one were to get credited 0%, perhaps even for a couple years in a row, but were illustrated to earn a static 6-7% every year on the illustration, the capped upside makes it extraordinarily difficult to catch up. In those scenarios, it’s almost certain that clients will need to contribute additional capital to make the plan work as illustrated. So, “zero is your hero,” but the cap is the trap. On top of that, getting your money out for retirement income can be extremely problematic and multiply the risk of insolvency.
4. A Better Alternative with Guarantees
Over long periods of time, your best case scenario in indexed universal life is probably what you would have gotten in whole life anyway. This is because the budget for the options spread is based on what the company is earning in their general investment account. If one believes in market efficiency (and with sophisticated algorithms being deployed on Wall Street, you should), then it stands to reason that options wouldn’t provide a meaningful advantage over what the insurance company is earning on their general investment account on those same dollars. In a nutshell, you can get similar performance with whole life, but since dividend interest rates are not capped, you have truly unlimited upside potential in rising rate environments. More important, whole life is guaranteed to work, the only question is how well those guarantees are enhanced by dividends. Dividends that have often been paid since the civil war era.
In Conclusion:
IUL can work, but I don’t see the point. It’s been said that every product has a market it serves, but in my opinion based on all that I’ve seen and studied, the odds are stacked against you with IUL. The company has all the control, can change caps, guarantees nothing over time, and your best case scenario even if they honor those projections is what you’re likely to get in whole life insurance anyway. Insurance should create greater certainty and control, not less.
