Monday September 19, 2011

Do You Know Rich White?

I hope your summer was full of rest and relaxation and you're raring to go. This month, we are featuring Rich White, our financial writer. Rich and I have worked together for over 15 years and we at RM Strategic Marketing prize his seasoned, critical eye. Click here for more infomation on Rich.

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Illustrating IUL Policies That Are Built to Last

Indexed Universal Life (IUL) is emerging as the life insurance industry’s most attractive product. With an interest rate linked to investment index performance and a guaranteed “floor rate” that protects against market declines, IUL has appeal for consumers who have: 1) become frustrated by low interest rates in universal life (UL); or 2)  been scared away from variable universal life (VUL) by market volatility.

Consumers also like the premiums, cash values and death benefits IUL agents are illustrating. Typically, these illustrations are based on long-term historical returns of the S&P 500 Index. For the period 1970-2010, the average annual return of U.S. large-cap stocks was about 10%, so many IUL illustrations assume an interest rate of 8-9%.

However, this may be an exaggeration that creates disappointment, and worse, for IUL policyholders over time. Under the NAIC Model Regulation for Life Insurance Illustrations, the interest rate used to determine illustrated non-guaranteed elements in IUL may not be greater than the Disciplined Current Scale, which should be based on recent historical experience of stock market indexes. Over the last decade, the S&P 500 Index returned just 1.88% per year.

How should a financial professional illustrate IUL? It’s not wrong to use 8%, provided it is discussed side-by-side with another illustration showing more conservative performance, such as 3-4%. This helps consumers comprehend a range of potential policy performance, including the upside and downside. By regulation, the illustration also must show the “worst-case scenario” of the guaranteed minimum interest rate, which can be zero in IUL.

Researcher Bobby Samuelson evaluated hypothetical historical performance of an IUL contract with a zero percent floor and a 12% cap over the period 1950 to 2010. He found that:

• In 44% of years, the interest rate would have hit the cap – 12%.
• In 29% of years the interest rate would have been at the floor – 0%.
• In 27% of years the interest rate would have been between 0% and 12%, with an average for those years of about 8%.

For all 61 years, the average IUL interest rate in this hypothetical contract would have been about 7.4%. In total, IUL caps and floors subtracted about 2% from the S&P 500 Index’s total annualized return. Based on this study, you might expect that if the S&P 500 averages a 5%-6% annual return over the next decade, average IUL interest rates could be in the 3-4% range. That’s why a 3-4% rate should be the “middle of the road” for illustrating IUL outcomes and setting buyer expectations that will keep policies in force long-term.

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