If it looks too good to be true...

If it looks too good to be true...

By Tom Wall, Ph.D., MBA, MSFS, CLU, ChFC

Universal life has been around for a long time, and was popularized in the 1980s as a way to take advantage of the high interest rates of the time while providing policy owners or flexibility with their premium payments. The way it works is that the policy is generally issued with a level face amount, and account values grow throughout one’s life, replacing that death benefit with cash value. In a perfect world, that cash value will equal the death benefit at age 100, a point referred to as endowment.  Prior to the 1980s the only form of permanent life insurance that was widely sold was whole life. The introduction and subsequent proliferation of universal life over the last four decades was the result of illustration warfare based on one's ability to project values into the future at lofty rates, using either historical market averages as an assumption or the high interest rates of the time. 

The problem with this design is that it shifts risks to the policy owner. In order for that cash value to equal the death benefit by age 100, the policy owner must fund the contract enough over the course of their life even though they have the flexibility to skip premium payments, and have account values perform as illustrated. That performance is based on crediting rates driven by the underlying investment. In the case of universal life in the 1980s that was a stable fixed-income rate, and then in the 90s the trend moved to variable universal life, where a variety of investments (usually equities) drove the performance of those contracts. Most recently, indexed universal life has become popular as a way to get upside potential and downside protection.  The policy is credited with performance based on an index, most commonly the S&P 500, with caps and floors to keep that crediting in a specified corridor.

The floor on these contracts is generally zero percent, meaning that no matter how much an index loses value, the contract cannot be credited with less than zero percent.  Some will even say “zero is your hero,” referring to the downside protection.  And that downside protection is coupled with upside potential, meaning one can participate in the performance of the index up to a cap.  But the cap is the trap.  Historically, the S&P 500 lost value about 1/4 of the time.  But it has exceeded 10% (a commonly found cap today) roughly 50% of the time.  So you’re limiting your growth twice as often as you’re protecting your downside.  And with the other 1/4 of the time being between 0% and 10%, your best case scenario historically would be between 6-7%.  AND, don’t misunderstand that the zero percent floor is generally only for one year at a time.  Mortality and expense charges continue and will result in a net loss those years, meaning over longer periods of time, the policy can absolutely lapse if it underperforms.

Where IUL falls apart is when the policy is credited with zero multiple times in quick succession.  In such a case, the policy is underperforming what was illustrated - typically a static, yearly, non-volatile 6-ish percent.  When underperforming, the cap makes it mathematically impossible to catch up unless the policy owner achieves that cap for several years in a row, and even if that happens, they are now due for more market corrections and losses.

The bottom line is that IUL has a sexy sales pitch, but it’s best-case scenario is likely to be what you’ll get with whole life anyway (for a lot of very technical reasons that are too much to get into here).  Why take the risk of losing hundreds of thousands of dollars in contributions, when whole life insurance has real downside protection with cash values that are guaranteed to rise.  And on top of those guarantees, we are now entering an environment where whole life insurance will shine again, enjoying its best economic setup in over 80 years relative to fixed income and other conservative vehicles.  The upside is immense as companies take advantage of higher rates.

Positioning Tip:

I call it the power of percentage.  When positioning whole life insurance, it’s technically correct to tell the client that they are paying a required annual premium payment toward a life insurance contract.  And that annual required payment, for example, may be $10,000.  Nobody wants to sign up for a $10,000 annual bill.

Instead, consider positioning that premium as an asset shift or contribution.  For a client with a total net worth of $1M, a $10,000 premium represents only 1% of their total net worth.  Thus, instead, you could tell your client that you recommend they allocate 1% of their net worth annually to a strategic asset that isn’t correlated to the market and protects their family and retirement income in a variety of ways.  This language has comforted countless clients over the years, and has led to a tremendous amount of business that may have otherwise been lost.