There are considerable differences between Variable Universal Life insurance and Indexed Universal Life insurance. Perhaps the best way to approach this would be to start with a definition of Indexed Universal Life Insurance:
Equity Indexed Universal Life Insurance may be defined as Life Insurance in which most of the premium (generally 80 to 90%) is invested in traditional fixed income securities. The remainder of the premium is invested in call option contracts tied to a stipulated stock index. In those instances where there is an increase in the market, exercising of the option contracts takes place and a given percentage of the gain is then credited to the policy. Conversely, should the market decline, the option contracts are said to expire worthlessly and the policy is credited with the minimum guaranteed rate. This type of policy may be suitable for that person who has an interest in purchasing a Variable Life Insurance policy but is not at ease in participating in the equities market. This type of person could have the best of both worlds: the potential high returns of the equities market without the risk to the initial investment (principal).
Please note that there are, as one may expect with a relatively new product, several variations on the market and this type of plan described here is just an example.
Universal Life Insurance is now about 30 years old, and with this type of insurance, came flexibility in premium payments, death benefit options, coverage amounts and all kinds of variations as designed by the creative and inventive minds of the insurance sales force and the cadre of actuaries who excitedly found ways to provide the kind of flexibility that was needed and which would still be accepted by various State Departments of insurance.
Now, comes 1997 when the first indexed UL was introduced. It was presented as just another Universal Life product, EXCEPT it had a different way of crediting interest which was based on the performance of an external index (such as the S&P 500) which by now, can constitute several combinations of indices.
How well was it received? Not too well as seven carriers brought in just under $65 million in premium in 1998.
As expected, skeptics prophesized that the product line would not last long and according to some internet blogs, it still will not last long. What was forgotten early was that the appeal of the product's higher upside potential would keep consumers interested during low interest rate environments and that its downside guarantees would be especially important (particularly for those who saw the stock market tank after the turn of the century).
Move the clock ahead ten years, and one sees that sales are growing exponentially and carriers are running over each other to get into this market. Right now it seems that the EIUL product has forced insurers to revamp products so as to offer value-added benefits to their product line so as to catch the attention of agents.
At the close of 2005, sales nearly had tripled over 1998 levels-to $185.7 million. Today, approximately 22 carriers offer an EIUL product—almost doubled to what it was just a couple of years ago. A "bunch" more carriers are trying to decide whether they will enter the market soon, and there is indication that at least six may enter.
What has happened is that insurance companies that once pretty well controlled the market have found themselves in an all-out cutthroat battle for market share, with the result, as one would expect, of a wide variety of designs, including extended no-lapse guarantees, single premium plans, survivorship life policies and even a return-of-premium design. It would be safe to anticipate even more variety in coming years.
F An Equity Indexed Universal Life Insurance policy operates much like the traditional Universal Life policy with the exception that the equity-indexed policy allows the policyholder to allocate excess premium payments to an account that is indirectly linked to the movements of a stock index.
Depending upon the insurance carrier and their pricing level, there are various differences between the EIUL and the traditional UL. Some of the differences could be:
The EIUL has a company-declared rate on the fixed strategy (if any); such rate would be comparable to traditional UL rates. Fixed strategy rates on EIULs today range from 3.75% to 5.27%.
This is the minimum guaranteed interest to the basic guaranteed interest rate that can be credited on the policy. On a traditional UL, these minimum guarantees usually run 2% to 3%, but with EIULs, they typically credit 1 % to 2% because the EIUL has a higher potential for credited gains Note: Minimum EIUL guarantees are not always credited annually as some plans may credit over a (typically) five-year period or, in some plans, the lifetime of the policy.
The Index is the EIULs fundamental outside criterion upon which the crediting of excess interest is based. For example, many of the plans offer alternative or additional indexes to the S&P 500 on their product strategies. Some of these indices will be discussed later when discussing specific plans. Of course, traditional ULs do not have such criterion.
Similar to Equity Indexed Annuities, the Participation Rate is the percentage of positive index movement credited to the EIUL. As an example, if the index—S&P 500, for instance—increased by 10%, and the EIUL had an annual Participation Rate of 60%, the policy would receive interest credited of 6% at policy anniversary. In other words, the Participation Rate determines what part of the index receives the increase in value—in this case, since 60% is the Participation Rate, only 60% of the total value of the fund would receive the 10% increase, i.e., the total amount would be increased by 6%. Participation rates on EIULs today range from 60% to 135%. Traditional ULs do not have Participation Rates.
This is the maximum interest rate that will be credited to the EIUL for the year or period, or the maximum index growth upon which interest will be calculated. For instance, if the index —S&P 500 as example—increased 10% and the EIUL had an annual Participation Rate of 100% and a Cap of 8%, the policy would receive interest credited of 8% at the policy anniversary. Annual Point-to-Point Caps on EIULs today range from 7.75% to 14%. Traditional ULs do not have Caps.
If an unscheduled loan, withdrawal, or a transfer from the Indexed Account of some EIULs occurs before the end of a particular period of time (such as 5 years), there can be no transfer into the Indexed Account of this policy allowed for the subsequent 12 months (the lockout period).
This is the method that is used to determine the excess interest that is credited to the EIUL above the minimum guaranteed rate. It might be noted that there are fewer crediting methods in EIULs than with Indexed Annuities. Crediting methods include: annual Point-to-Point, inverse annual Point-to-Point, two-year Point-to-Point, monthly averaging, daily averaging, monthly Point-to-Point, fixed, and minor variations among these. Traditional ULs do not have such formulas.
The illustrated rate is the rate that a carrier decides to project policy values hypothetically in a sales illustration, compared with a traditional UL illustration where the policy is projected at the new money or portfolio rate declared by the company to be credited annually (currently from 4.30% to 5.65%). With EIUL sales illustrations, the potential interest credited is based on fixed strategy rates, Participation Rates and Caps. In order to illustrate the plan, the insurer shows an "illustrated rate"— Such rates may range from 4.64% to 9.79%. It should be noted that the actual credited rates will be higher or lower than the illustrated rate on the sales illustration.
This is the rate basis used by the illustration as determined by the insurer, which takes into account current Participation Rates, current Caps and a review of the historical performance of the index measured. The illustrated rate basis varies from a S4-year guideline, a 25 to 35-year lookback, a 20-year lookback, a 15-year lookback, to, in a few cases, zero lookback.
As a point of interest, different carriers using a 15-year lookback do not necessarily use the same calculation for their illustrated rate basis.
The illustration rate basis is an interesting comparative feature of the EIUL. Universal Life products are illustrated at the company-declared rate credited annually (in the 4% to 6% range) while Variable ULs normally show illustrations in the 8% to 10% range—which are, incidentally, much less than the maximum imposed by the National Association of Insurance Commissioners. Since there are EIULs which are being illustrated almost as high as typical Variable Universal Life plans, and since and EIUL has a guaranteed Floor and a Cap on the maximum, then should the EIUL be illustrated at a comparable rate as that of the VUL plans?
F An EIUL plan needs to be monitored to make sure that it is being funded at an appropriate premium level based on the interest that is earned.
From the period of 1998 when there was first some meaningful statistics, through 2005, the indexed life insurance sales were as follows:
1998 $64,717,446
1999 $62,424,261
2000 $63,424,534
2001 $85,745,404
2002 $95,714,010
2003 $93,485,927
2004 $123,499,975
2005 $185,701,996
If there is a solid reason as to why the sales of indexed life insurance remained rather flat from 1998 through 2000, and then started to move, again leveling off in 2003, and then jumping 32% in 2004 and then by 50% in 2005 — just follow the stock market. Of course starting in 2004 there has been considerable promotion by life insurance companies in respect to the product, with gratifying results (to some).
So where are the IUL sales today? Sales are growing and more and more carriers are trying to latch onto the coattails of those already in the market, and those who are in the market are making changes so as to make the product more attractive to agents.
Today, there are some 22 carriers competing for the IUL which is astounding as there were only 12 carriers a year ago. Plus, there are another 20–or so– carriers that are seriously contemplating developing products for this market, and when push comes to shove, one can expect about 7 new companies in the market.
Those in the market have watched their market share either drop or remain relatively static, so they are hot at work designing new plans, including IUL with extended no-lapse guarantees, single premium plans, survivorship life policies and some even offer return-of-premium as a rider. Some are offering as many as three death benefit options, and no policy maturity date.
Typically, the big choice facing life insurance buyers is whether to go with a "safe" Universal Life policy that offers a minimum guaranteed rate but has a limited potential for cash accumulation—or to go with a more "risky" variable life policy that offers greater potential for earnings, but no protection against losses in the market.
The equity indexed products are an attempt to fill the gap between these two sides of the spectrum. The EIUL is still an insurance product—a Universal Life Insurance policy (as they have an interest crediting rate)—and the policyholder does not own shares in any kind of fund. Still, they have some of the appeal of a VUL policy as the crediting rate is determined by the performance of the index. They also offer guaranteed minimum rates similar (but almost always lower) than traditional Universal Life policies so that the policyholder does not lose money (as is possible with VUL).
EIUL insurance works similarly to traditional UL insurance with the exceptions that the equity indexed policy allows an individual to allocate excess premium payments to an account indirectly linked to the movements of a stock index.
Traditional Universal Life insurance offers a fixed interest rate option with a guaranteed minimum amount, usually 2% to 4% annually, depending upon the policy and the insurance company. The current interest rate for a traditional Universal Life policy may vary, but it can never be lower than the guaranteed minimum. An EIUL policy has a fixed interest rate component as well as an indexed account option that offers the potential to earn higher rates of interest similar to equity market type returns.
One primary advantage of a EIUL is the potential for higher interest crediting rates than available under the traditional UL product. Another advantage—perhaps the most significant—is that it offers greater protection from market downturns than available with VUL.
Agencies have reported success in emphasizing the fact that while these products are not a cure-all, they can offer an attractive middle ground for buyers who watched (often with dismay) the market downturn of 2001-2002 and are looking for some guarantees. These products can offer some peace of mind to buyers.
Regardless, there can be a disadvantage of having an equity indexed product—the chief disadvantage of an equity indexed product is that it has a with slightly higher risk than a traditional UL product. Plus, as described earlier, the Cap rate—the maximum rate the policyholder may earn—limits the upside potential compared to a variable product, and may be changed periodically by the insurance company.
At this time, the primary challenge for an agent offering an EIUL product is that the crediting rate system in these products is probably not familiar to would-be buyers and agents. Since the concept is new and there are so many "moving parts" to one of these products, it is sometimes difficult to figure out what the product actually does at first. This challenge can be overcome only if the agent is fully trained in the EIUL products he represents and he is able to describe and explain the policy accurately so that the prospective client fully understands it also.
Since these plans do fill a void between the traditional UL and the VUL, some critics of the plan feel that is it an overstatement to consider them the best of both worlds. This is probably true as they do not have the guaranteed rates of Universal Life or the true market participation of Variable Life. Regardless, they certainly do offer an attractive third option for buyers and may be ideal for a Segment of the population whose needs have been overlooked by existing insurance products.
Equity Indexed Universal life insurance may be right for a potential purchaser if they fit the following criteria:
If these conditions apply, then the EIUL may just be the right product for this person—at least, it is an avenue to explore.
With the EIUL, it is important to research the insurance company itself as the amount of interest that is credited is in the hands of the company, and whatever guarantees the product offers, such guarantees are only as good as the insurance company backing them. A check into A.M. Best, Moody's, Standard & Poors, etc., should be made so as to determine the financial strength of the company.
Interest earnings on the increase in the cash value has the same income tax deferral that is afforded other insurance products. This is a basic principal that is sometimes forgotten in presenting variable products, but it may not be so "elemental" to a potential client.
Combine the tax deferral with the insurance protection, and that is, in itself, a pretty potent package (as any MDRT members can attest).
Then combine the fact that the cash value will grow as the market grows and now the package becomes super-potent.
This, of course, is one of the major advantages over variable products as the cash value can be protected even if the market succumbs to another crash.
And, on top of all of that, there is a guaranteed minimum annual return regardless of any fluctuations or decline in the market or with any other investments.
2007 looks like a good year and the earnings will increase considerably, but prognosticators fear that there will be a tumble next year. Don't worry, any earning earned in 2007 will be "locked-in" and not even Microsoft going into receivership could affect that.
This is, after all, a Universal Life Insurance policy with all of its premium flexibilities.
The cash value of the plan is always available, however, there may be restrictions or penalties if the cash value is withdrawn without meeting certain criteria, depending upon the policy. Nevertheless, there is always money available.
Similar to most UL policies, when the equity indexed policyholder makes a premium payment, the insurance company first deducts a premium load. The premium load is a combination of a premium expense charge plus a premium tax charge and usually is 3% to 9% of the total premium (depending upon the insurance company).
After the premium load is deducted, the balance of the premium payment is deposited into a fixed account which earns fixed interest at a current prevailing rate, with a minimum guaranteed rate of usually 2.5% to 3% annually. On each monthly policy anniversary, deductions are taken from the fixed account for administration charges, expense charges, and costs for insurance, including riders.
After the monthly policy costs are deducted, then the policyholders have the option to maintain the fund balance in the fixed account at the current interest rate or to transfer a portion or all of the cash value balance directly to an indexed account. Most companies will allow transfers from the fixed account to the indexed account on a monthly or quarterly basis. When a premium transfer is made from the fixed account to the indexed account, an indexed account Segment or index period is created. Each indexed Segment has a Segment date where the beginning value of the underlying equity index is recorded. At the end of the designated Segment term or index period, an ending value of the index is recorded and the percentage change in the index value is calculated.
Segment terms and index periods vary by insurance company. Some companies offer a one year index period with Index Credits calculated at the end of every index Segment. Other companies will offer a five or six year Segment with an annual or bi-annual Segment anniversary, wherein with a bi-annual anniversary, the growth of the Segment is calculated annually or bi-annually at the anniversary of the Segment but the Segment term would not end until the end of the fifth or sixth Segment anniversary respectively.
The best way to approach the Index Crediting method is to think of it as the process of calculating the indexed growth rate at the end of the index period. There are two principal indexing methods currently used: the annual Point-to-Point method and the daily averaging method. (Other methods are mentioned in this text.)
Most companies that offer EIUL policies use the annual Point-to-Point method to calculate the index growth rate. With this method, the beginning equity index value is recorded and compared to the ending equity index value at the end of the index period. If the ending index value is higher, interest is credited annually subject to the Participation Rate and Growth Cap. If the ending index value is lower, then there is no interest credited.
The other method, used much less frequently, is where the daily averaging method calculates the average daily indexed value over the entire index period and compares this average with the beginning indexed value at the first day of the index Segment. If the average indexed value over the entire index period is greater than the beginning index value, interest is credited subject to the Participation Rate only (there is no Cap with daily averaging).
The daily averaging method may help smooth out the peaks and valleys of a volatile market, but there is no guarantee that one crediting method will consistently produce a higher interest credit. Because of this smoothing trend, the daily averaging method generally allows for a higher non-guaranteed Participation Rate and generally has no Growth Cap.
This is, of course, an extremely important point for the policyholder to make. While there are other crediting methods used in Indexed Annuities, at this point in time, most policies offer either the Annual Point-to-Point or the Daily Averaging methods. They each have their strong points.
To reiterate: The Annual Point-to-Point is where the index growth depends only on the difference between the beginning and ending index value. Daily Averaging is where the Index growth is found by averaging the Index value from each day within the Index Period. Using one company's requirements as an example, the differences can be better understood.
Since there is no "level" indexing methods, there is no one crediting method that is guaranteed to perform better from one year to the next. If the average Index Value throughout the year is greater than the Ending Index Value, then Daily Averaging will produce the largest Index Growth.
However, if the average Index Value throughout the year is less than the Ending Index Value, the Index Growth will be lower under Daily Averaging.
Note however, that with this plan, the Index Credit applied to the policy will never be less than zero (or possibly some other figure, even possibly negative percentage) even if the Index growth is negative.
On the other hand, it may be better to try both methods as there is always the possibility that one may yield a greater return than the other. Using this same logic, it would seem practical NOT to use only one crediting method—provided the plan allows both crediting methods.
The premiums that are allocated to the indexed account will earn interest that is based on the percentage change in the value of an underlying equity index. Once the percentage change or Segment growth rate is calculated for any given period, the actual Index Credit can be calculated by applying the Participation Rate and Growth Cap or Floor.
As explained above, the Participation Rate is the percentage of index growth used in determining the Index Credit for each index period of Segment. Most insurance companies guarantee the Participation Rate to be 100%. Regardless, depending on the specific index selection, the Participation Rate may be changed at the whim of the company.
At the end of the Segment anniversary date or index period according to the policy, an Index Credit is calculated by multiplying the applicable Participation Rate by the Segment growth rate. If the ending value of the underlying index at the Segment anniversary is higher than the beginning value at the initial index Segment anniversary is higher than the beginning value at the initial index Segment date, interest is credited to the policy's cash value subject to the policy's Growth Cap. The Growth Cap is the maximum interest rate that can be credited to an index Segment. The actual Growth Cap varies for each insurance company but is currently around 10& - 14% annually. Growth Cap rates vary widely from company to company with most companies having contractually guaranteed minimum Cap rates at 3%-4& annually.
At the end of the index period, if the value of the underlying index is unchanged or is lower value than the value at the initial Segment date, the Index Account will be subject to the growth Floor which is guaranteed to be 0% (none, zero…). Therefore, in no case will the Index Account value ever receive less than a 0% credited interest rate.
For purposes of these three illustrations, the assumption are a 100% Participation Rate with a 12% Growth Cap and a 0% growth Floor, usually the annual point to point Index Crediting method.
Assumption One: The underlying index increases by 18% from the start of the index Segment date to the Segment anniversary date.
100% Participation Rate times 18% Segment growth rate = 18% return subject to the 12% Growth Cap. Therefore, the there will be a net 12% interest credit to the policy's cash value.
Assumption Two: The underlying index increased by 6% from the beginning index Segment date to the Segment anniversary date.
100% Participation Rate times 6% Segment growth rate = 6% return subject to the 12% Growth Cap. Therefore there will be a net 6% interest credit to the policy's cash value.
Assumption Three: The underlying index remains unchanged or decreased by 1% or more from the beginning index Segment date to the Segment anniversary date.
100% Participation Rate time 0% or minus-10% Segment growth rate - 0% or minus 10% subject to the growth Floor of 0%. Therefore, there will be a net zero interest credit to the policy's cash value—if the Segment growth rate was minus 10%, there would still be a net zero interest credit to the policy's cash value.
In addition to the growth Floor, most EIUL policies offer a cumulative minimum guarantee which provides for growth of cash values during a falling market and assures the policyholder that a minimum guaranteed effective annual interest rate is realized over a set period of time. One company, for example, guarantees that over a five year term, if the Segment growth value doesn't reflect at least a 2% minimum effective annual interest rate, the Segment value will be increased to that 2% level. This feature varies with each company but most companies offer a version of this guaranteed minimum. The cumulative guarantee is another feature that make EIUL such an effective cash accumulator.
At this point, the question should be: How can insurance companies offer equity type returns without any downside risk to the policyholder? This gets to the heart of the policy and its most unique feature. Indeed, how can they offer a policy that has the upside potential for stock market type gains without passing the risk off to the policyholder? The answer is that the insurance company is not actually investing policy premiums in an equity index. Instead, the insurance company invests policy premiums in fixed interest investments and uses the earnings from those investments to purchase call options.
F Call options provide the right, but not the obligations, to purchase a specific amount of a given index at a specified price within a specified period of time.
If the equity index increases, the insurance company can exercise the right to purchase the index at the previously agreed upon price and then credit interest to the policyholder. If the equity index decreases, the company is not obligated to exercise any options and has incurred no cost other than the cost of the actual options. So if the equity index values decrease, the insurance company does not need to credit a negative interest to the policyholder's account.
Participation rates and Growth Caps are essential components in determining the interest rate credited for any index period. Insurance companies use Participation Rates and Caps to adjust amounts of interest credited compared to the actual index growth. This usually has a limiting effect on the interest credited to an amount lower than the actual percentage change of the index.
As indicated previously, but needs repeating and discussing:
F The most important factor affecting Participation Rate and Growth Cap is the quality of the insurance company that is writing the insurance policy.
As indicated above, the EIUL policies require no direct investment in the equities market by the insurance company or the policyholder. Instead, call options are purchased by the insurance company which allows them to offer the upside potential of the EIUL to their insured without any downside financial risk. But, the price for call options varies based on the economic conditions and the interest rate environment. In order to have the necessary flexibility to match option costs with potential benefits to policyholders, the insurer must have the ability to limit the upside interest credited during times where market conditions so dictate. Therefore, when choosing between competing EIUL policies, both the Participation Rate and the Growth Cap, but, every bit as important is the integrity of the insurance company. Research and compare each company's history with respect to changing these two variables—good advice to prospective policyholders, but also good advice to agents in comparing products of the various companies.
A EIUL is a flexible premium UL which is designed to provide death-benefit protection. It provides a fixed account with a guaranteed minimum interest rate, plus it offers an opportunity to earn interest based on the upward movement of a stock market index. Policyholders can allocate their money to a fixed account that offers a fixed rate of return, to one or more of the plan's index selections which offers index-linked growth; or to a combination of both the fixed account and one or more of the index selections.
The fixed account offers a current interest rate, which is subject to change based on the current interest-rate environment. The current rate is guaranteed to never be less than the guaranteed minimum interest rate of a published percent—today a typical current interest rate could be 4.0% with a guaranteed minimum interest rate of 3.0%.
When an index and an Index Crediting method is used, it often is called an "Index Selection." Various plans have differing names, but for purposes of this illustration, the "Index Selection" will be used.
Under this type of indexing, the policyholder can choose to allocate their money to any combination of the index selections contained in the plan. An example of the Index Selection may resemble the following:
Index Selection Current Rate Guaranteed
(2) S&P 500 Daily Averaging
Participation Rate 135% 40%
Cap No Cap No Cap
(3) S&P 500 Monthly Point-to-Point
Participation Rate 100% 100%
Cap 3.75% 1.25%
(4) S&P MidCap 400 Daily Averaging
Participation Rate 100% 100%
Cap 10% 3%
(5) S&P MidCap 400 Daily Averaging
Participation Rate 105% 30%
Cap No Cap No Cap
(6) Dow Jones Industrial Average Annual Point-to-Point
Participation Rate 100% 100%
Cap 13% 4%
(7) Dow Jones Industrial Average Daily Averaging
Participation Rate 130% 40%
Cap No Cap No Cap.
These Index Selections can also include such other selections as NASDAQ-100, Russell-2000, Dow Jones Euro Stoxx, etc.
Each index selection has a Participation Rate, which is a percentage of index growth that is credited to the index selection.
The Participation Rate can change but will never be less than the guaranteed rate (shown in the index selection chart).
Index selections that use the Annual Point-to-Point crediting method also have a Cap, which is the maximum rate that can be credited to an index selection during the index period. For the Monthly Point-to-Point crediting method, there is a monthly Cap which limits the monthly index return that is used in calculating the Index Credit given at the end of the 12-month index period. The Cap is subject to change but can never be below the guaranteed rate shown on the chart in the policy. Regardless of which index selections are used, the interest rate credited to the policyowner will never be less than zero percent.
Another feature offered by some companies—sometimes called "Systematic Premium Allocation— is an option which allows policyholders to have a designated amount of premium initially placed into the fixed account, such amount is then automatically allocated to the policyholder's Index Selections in pre-determined amounts (often there is a minimum of $200 per month minimum) until the balance is zero. These pre-determined premiums accrues interest at the Current Fixed Account interest rate (or some other similar mechanism) until the amount is transferred over to the designated index selections.
The company offering this option will have illustrations of Current Interest Rates, often broken down into Fixed Account (&/or Fixed-rate) loans; Fixed Account/Zero Cost Loans broken down into Policy Years; and Variable-Fate loans, also broken down into grouped policy years. Each of these may be further designated by Fixed Account Rate that are credited; loan rates that are charged; and Loan Rates that are credited—each of which is divided into Current percentages and Guaranteed percentages.
Companies often allows the policyholder to allocate premium to the Fixed Account, Indexed Account(s) or some combination of both.
The Index Account provides an interest rate that is linked to the movement of a stock index—usually onto the upward movement. The policyholder then has a choice of the stock market indexes, as shown in the Index Selection example above. The individual policyholder then should determine which Index Selection is the right one for them.
Policyholders can designate that their premium goes into a single index or, usually, any combination of those index offered by that particular plan. As a general rule, policyholders are allowed to change their allocations at any time, and they are also allowed to transfer money between the different indexes at the end of each Index Period.
If the policyholder wants to allocate premiums to more than one index, the policyholder can easily do well if one index performs well while others do not do so well, which is quite common. If there are several indexes it is safe to say that there is not one particular index that has always produces the best return on investments.
For instance, if the policyholder has chosen (say) 4 indexes and 2 perform well, and the other 3 do not perform so well, and if the same amount is allocated to each index, the policyholder would share in the average. For illustration, assume the indexes growth rate was10%, 6%, 2% and 6%, (the last two having Index Credits of zero under these plans). The two growth indexes total 16%, and since there are 4 indexes to which the growth is attributed, the average Index Credit would be 4%.
While this may seem convoluted at first blush, it accomplishes its purpose, which is that by distributing the premium among several (at least more than one) indexes, the policyholder benefits when one index is up while another is down. Using the above illustration percentages, if the policyholder had elected to put everything into the account that produced 2%, then there would not have been any credit to the Index Account.
"(Remember, though, is no debit to the account, i.e., the account would have just remained level—the primary advantage to Indexed products in most cases.)
If the policyholder is more conservative, then they may want to allocate more premium into the Fixed Account and less into the Index Accounts.
Some policies have an annual reset feature that locks-in to the Index Account at the end of each index period. The advantage of this feature is that it can never be taken away because of negative index performance and it will participate in future growth allowing the policyholder to participate in growth in the future and allows compounding then in subsequent years. The "reset" feature is so named because it automatically resets the starting index point at the end of each index period and is touted as a method of protecting the policyholder from severe downturns in the market while, at the same time, allows the policyholder to take advantage of any market gains from that point forward.
Not all Indexed Universal Life plans operate exactly the same and they may differ on terminology, but basically they operate very similar. In order to better explain the movement of the money, the terminology of one particular plan that is quite successful is used for this illustration.
Most policies of this type allow several transfer options to the indexed account or the fixed account.
The policyholder is usually given the option of transferring all or a portion of the fixed account to the indexed account on a certain specified date—such as the 1st or the 15th of the month. These transfers can be scheduled to occur automatically or by written request by the policyholder.
The transfer may be restricted to certain times, commonly a transfer to the indexed account can be made every three months, but on a current basis, the transfers may be allowed monthly. There is a difference among some insurers, so this point must be carefully researched.
If an unscheduled loan, withdrawal or transfer from the indexed account occurs before the end of a 5-year Segment term, no transfer into the indexed account may be made for the subsequent 12 months. This time is called the lock-out period.
As shown above, an Index Credit is the interest that is earned on a Segment, and are calculated once a year (on the Segment anniversary date). These credits are typically based on three things: the growth rate of the Segment, the Participation Rate; and the value of the Segment prior to the application of the Index Credits.
Therefore, the Indexed account part of the accumulated value (which may be called the "cash value") has the chance for greater growth (up to the growth "Cap") if the index performs well. The growth "Floor" places a limit on the impact of negative performance in the index to a very low percentage—usually zero.
Typically the S&P 500, is used as the index; the returns (excluding dividends) determines the calculation of the Index Credit, taking into consideration the current non-guaranteed Growth Cap and the guaranteed Growth Floor. (It may be noted that it is typical that the Growth Cap is not guaranteed, which allows for the Cap to be adjusted upward to keep up with the market—and competition—if the market consistently exceeds the present Cap. Conversely, the growth "Floor" is normally guaranteed, particularly if the Floor is zero.)
On a current basis, but not guaranteed, any authorized deduction—deduction from the Indexed Account due to monthly deductions, a systematic distribution program, or any excess that is removed from the policy as of the date of its payment in accordance with federal tax law—will be then credited the current Fixed Account interest rate that is in effect at the beginning of the Segment year to the date of the deduction. Other than specific deduction, values that are deducted or transferred from a Segment before the end of the Segment year will not receive an Index Credit for that year and these values will not be considered in calculating the Cumulative Guarantee.
This guarantee is where each Segment in the Indexed Account will be increased with an additional Index Credit at the end of its five-year Segment Term, if necessary, to bring its annual effective interest rate to a pre-determined amount—usually 2%—which is them adjusted for deductions.
Since this is basically a Universal Life Insurance policy, the policyholder can set the amount of each premium payment based on the policy's death benefit and the policyholder's own financial objectives. Usually, there will be a minimum premium payment is the policy has enough accumulated value to cover the monthly expenses—usually the minimum payment would be in the $50 range.
The policyholder also has the right under most of these policies, to choose the premium schedule and can request to have premium payment notices sent on an annual, semi-annual, or quarterly basis. The insurer may send monthly statement but usually only if there is a monthly bank draft.
The coverage amount is also flexible as after the policy's first anniversary, the policyholder may increase or decrease the face amount–usually limited to once a year. Normally, there is no charge for a face amount decrease, but sometimes there can be an additional charge for an increase in coverage and medical information may be required . In some cases, there could be an increase in the insurance charges.
As most Universal Life policies allow, there are choices for the death benefit based upon the Net Amount at Risk—defined as the Face Amount less the Accumulated Value that increases with time…or death benefit amount that exceeds the Accumulated Value.
There are always two death benefit options: a "level benefit which would equal the policy's face amount. The second option (often called "Option B") is an "increasing" death benefit, where the death benefit would equal the policy face amount plus its accumulated value.
There often is a third option—a "return of premium" option where the death benefit equals the policy face amount, plus all premium paid in, less any distributions taken from the accumulated value (such as withdrawals)
Regardless of which option is chosen, the death benefits from the policy are, in most cases, paid to the beneficiary with no federal income taxes due.
Companies often offer some additional flexibility, such as the ability to change the option but usually with a restriction as to the number of times the policyholder can change the option, or with some time restrictions, such as once per calendar year.
One point that should be pointed out to the client is that changes in death benefit options of increase the face amount of the policy, may affect the monthly insurance charges in many policies, and if the insured increases the death benefit, the insurer may ask for medical underwriting and could ask for current evidence of insurability–not to mention the possibility of tax consequences. While life insurance death benefits are usually excludable from the beneficiary's income for federal income tax purposes, in certain situations the death benefit proceeds may be partially or wholly taxable. These include, but are not limited to, situations involving the transfer of a life insurance policy for valuable consideration outside of a valid exception, and arrangements that lack an insurable interest based on state law.
Similar to other types of policies, the policyholder may access the accumulated value of the policy by either policy loan or by partial withdrawals.
The policy loans allows the policyholder to borrow money from the accumulated value while, technically, using the policy as collateral. The cost of the loan in generally the difference between the interest rate charged by the policy and the interest rate that is credited to the amount of the loan.
There usually is a minimum policy loan of amount, $200 - $500. They are usually available at an interest rate that exceeds that interest credited to the loan amount, such amount is usually guaranteed for the life of the policy. However, the policy may reduce the policy loan interest to that of the interest credited to the loan amount. Therefore, if the policy loan interest is 2.5% and the interest credited to the loaned amount is 2%, then the cost of the loan would be .5%, but in many policies this amount eventually–after the policy has been in force for 5 years, for instance–is the same as the interest credited to the loaned amount, therefore the net cost of the loan would be 0%.
A withdrawal from these policies is treated as just taking part of the policy's accumulated value. If there is enough accumulated value remaining in the policy so that it would be able to meet the monthly charges and other costs, then the policy remains in force.
As a general rule, partial withdrawals are available after the first policy year, but there is a fee often charged for each partial withdrawal (such as $25 - $50). There is a minimum amount that can with withdrawn and often there is also a minimum net cash surrender value after withdrawal–$500 or so.
While loan and withdrawal features are attractive to policyholders for such things as income supplement, the policyholder must be informed that using these features will reduce the policy values and may reduce death benefits.
Also, many policies state that if the fixed account does not have sufficient values to process a policy loan/withdrawal or other deductions, the accumulated value will automatically be deducted from the indexed account.
Some policies have an option where the insurer will set up a series of automatic loans and withdrawals. This option may have a time-in-force and minimum accumulated value stipulations. The insurer is authorized by the policyholder to deposit planned policy loans and partial withdrawals directly into the policyholder's bank account at a regular basis.
These deductions from the indexed account as part of this option are generally not subject to the lock-out period (discussed earlier). In addition, on a non-guaranteed basis, accumulated values that are withdrawn or loaned by the application of this option, will be credited interest—which is tantamount to the interest that is credited in the fixed account—for the period of time that they are in the indexed account.
Loans and withdrawals through this option, may be based on either amount or duration. The insurer will usually provide annual illustrations that keeps the policyholder abreast of the accumulated value of the policy. This option can be changed subject to certain specified restrictions as some changes in the amount and timing can trigger the lock-out feature.
This option, usually offered as a Rider, can be quite attractive since policy loans may put the policy at risk, i.e., if the policy debt exceeds the accumulated value of the policy, the policy will lapse. While this may be fully understood at the time of application, it is a strange affliction of many (most) policyholders that they do not read the policy, and worse yet, they tend to forget what was told them at point-of-sale.
So that this never happens to the policyholder, many companies offer a loan protection option/Rider that guarantees that the policy will not lapse even if the loans exceed the accumulated value. This is similar to an overdraft-protection for a life insurance policy. Certain conditions are required in order to take advantage of the option/Rider, and usually, there is a one-time option/Rider charge.
Almost always sold as a Rider, this Rider provides that the life insurance policy will not enter the grace period or lapse up to the duration that is specified by the company, as long as the Lapse Protection Guarantee Rider premiums are paid by the end of the guarantee period and certain minimum requirements are met—the policyholder must pay an annual "no-lapse" premium or its equivalent to keep the guarantee in effect.
Payment of the no-lapse premium annually will guarantee that the death benefit of the policy will continue for the policy duration, but if the policy is maintained only by the no-lapse guarantee, the policyholder will no longer have the advantage of building the policy's accumulated values. If this happens, the policy's accumulated value less policy loans, will be (actually) zero, and at the end of the no-lapse guarantee duration, the policy enters the grace period and will eventually lapse.
If the policy has so lapsed, in order to restore a positive net accumulated value and to keep the policy from entering the grace period and eventually lapsing, there must be an additional amount paid (which represents the uncollected monthly deductions with interest). This amount and future premiums will be considerably higher than the premiums required to keep the no-lapse guarantee in force.
The Rider will show the guarantee period in years at age-at issue, and the guarantee period at age-at-issue. As an example, one company guarantees the period of 18 years for age-at-issue 18- 50, 13 years for ages 51-60, 9 years guaranteed for 61-75 and 5 years for ages 76-80. The guarantee period is 4 years for age-at-issue of 18-85, reducing to 3 and 2 years thereafter.
The Cost of Insurance (COI) is a charge that is deducted from the policy each month. Policies are available where there is a guarantee that the current rates for the base coverage and certain riders will not increase for a specified time period.
For example, one policy states that if the policyholder's issue age is 75 or younger, there is a 5-year guarantee of the current COI rates for the policy's entire face amount, including any additional insurance from selected riders. If the policyholder is age 60 and under, and is not rated and there are no flat extra charges for insurability, then there is an option to extend the COI guarantee to 10 years. For ages 76 and higher, this guarantee applies only for the first three policy years.
Other Riders or provisions offered can include a guarantee that the monthly deductions are guaranteed to be zero……………..when the insured reaches age 100.
Another allows conversion at specified times, to other permanent life insurance policies offered by the insurer for such conversions and is issued at the same risk class as the original policy.
One company (there may be others) offers a Indexed Account Bailout Option Rider whereby the insured may choose to transfer any portion of the Segment's accumulated value into the fixed account if the declared Growth Cap for that Segment is lowered below its Growth Cap threshold.
The "Growth Cap threshold" is defined as being the lesser of (1) the initial Growth Cap that appears on the policy specifications page at the time the policy is issued, or the Segment's Prior Growth Cap less 2%.
The insurer will notify the insured (in writing) if the bailout option would apply to the policyholder's particular policy at that time. Then the policyholder will have 30 days to provide a written request to use the Rider and make the transfer.
If such Rider is implemented, the amount of the accumulated value in that Segment that is transferred into the fixed account will be credited interest which based on the Bailout Bonus. The Bonus is calculated based on many factors, including the amount transferred, the Growth Cap and the Growth Cap threshold.
One other point—this transfer will prompt the lock-out period. The amount transferred will be credited (current basis but not guaranteed) the current fixed account interest rate in effect at the beginning of the Segment year to the date of the transfer for the purpose of calculating the Cumulative Guarantee.
In addition to the above, a prospective purchaser can "customize" the policy in many cases, in order to better serve his needs or to meet specific financial goals by using various Riders. Some of these Riders are discussed here, and it should be noted that not all available Riders are included as there are undoubtedly other Riders available for different purposes, particularly since these policies are changing frequently and oftentimes it is better (not to mention easier and cheaper) to add Riders to a portfolio of products instead of having to get new policy forms approved by the Insurance Departments when changes in the product are needed for whatever reason. Please note that these Riders may be named differently by each company, those described here are primarily from one insurer.
This Rider gives the policyholder access to a portion of the death benefits if the insured is diagnosed as terminally ill with 12 months or less to life. In some states the benefits under this Rider will be available even if the life expectancy is longer than 12 months. Some states may require such a Rider or policy provision.
Seems like a policy would not be a life insurance policy if there were no ADB Rider offered. This pays an additional benefit if the death of the insured is accidental.
This Rider provides a death benefit and established higher early year cash surrender values, relative premiums paid, but generally less surrender value after the 10th policy year compared to base coverage only.
Also known as "Spouse Term Rider" when applied only on the spouse, this Rider provides term life insurance on any member of the primary insured's immediate family, and is renewable annually.
There is also a Rider that provides term insurance coverage on the insured in addition to the base policy that is renewable annually.
This Rider provides higher early year cash surrender value upon a qualifying termination of the policy.
This Rider provides term coverage on the lives of the insured's children.
A monthly disability benefit allocated to the policy's accumulated value during the insured's qualifying disability, restricted to ages under 65.
This Rider provides an option for the insured to purchase additional insurance on the life of the insured without proof of insurability at specified ages up to (usually) 40 years old.
This Rider waives certain charges if the policyholder—who is not the insured—becomes totally disabled before age 60.
Waives certain charges on a child's policy upon death or total disability of an adult payor.
Waives certain charges in the event of the total disability of the insurance and following a 3- month qualifying period.
From the Accumulated Value, the loan collateral account (the part of the accumulated value that is set aside to secure a policy loan) is drawn.
The insurance company then deducts from the accumulated value on a monthly basis, the cost of insurance, the coverage charge, the administrative charge and the applicable Rider charges.
If the policyholder makes a withdrawal, the insurer also will then deduct the applicable withdrawal charge.
If the policyholder surrenders the policy, then the insurer deducts policy debt and applicable surrender charges.
The premium load cannot exceed the maximum guaranteed rate (such rate varies by company and by plan, hovers presently around 9%) and it is deducted from each premium payment that is made.
Deductions for monthly charges mentioned above are taken from the policy's accumulated value in the fixed account. However, if there is insufficient accumulated value in the fixed account to cover the monthly deductions, policy loans or withdrawals, they typically are deducted proportionately from each of the Segments (or however the particular policy segregates the account) in the indexed account.
The monthly deduction usually consists of an administration charge (flat dollar amount for stipulated time, often to age 100); Coverage Charge (a rate per $1,000 based on face amount, age and risk class); Cost of Insurance Charge (as indicated above, usually based on the net amount at risk, age and risk class); and the cost of any Riders added to the policy.
A surrender charge is assessed if the policyholder surrenders the policy within a stipulated, usually the first ten years of the policy. During the first policy year, the surrender charge is level, then decreases monthly starting in the second year, until it reaches zero at the end of the (usually ten year) period.
The surrender charge is equal to a specified amount that varies with the age and risk classification of the insured, along with the policy fact amount.
New face amount increases are usually subject to a new surrender charge.
Insurers may offer accumulation account growth based upon the performance of various indices and/or values. The five indices normally used are NASDAQ-100; S&P 500; S&P MidCap 400; Russell 2000; and DJIA (Dow Jones Industrial Averages). One important fact to remember is
F The rankings by performance of the various indexes over the past 15 years has shown that no particular index consistently provides the highest or lowest return.
While it is often believed that the S&P 500 produces the best results, over the past 10 years NASDAQ 100 has performed best for 5 of the 10 years, with S&P MidCap performing best for 2 years, Russell performing best for 2 years, and S&P 500 performing best only in 1997.
STUDY QUESTIONS
1. With an Equity Indexed Universal Life (EIUL) policy, most of the premium
A. is invested in call options tied to a stipulated stock market.
B. is invested in traditional fixed income securities.
C. is used to purchase term life reinsurance.
D. is used for commissions, issue, underwriting and other administrative costs.
2. An EIUL policy is much like traditional Universal Life (UL) except that
A. it pays much higher commissions.
B. the EIUL allows the policyholder to allocate excess premium payments to an account that is indirectly liked to the movement of a stock index.
C. agents who sell EIUL policies must be licensed by the NASD.
D. there is no fluctuation of the death benefit.
3. With an EIUL, the Participation Rate is
A. the percentage of positive index movement credited to the EIUL.
B. the percentage of premium that is allocated for expenses.
C. the number of participants in a group.
D. any portion of the policy that is reinsured.
4. If an unscheduled loan, withdrawal, or a transfer from the Indexed Account of some EIULs occurs before the end of a particular period of time (such as 5 years), there can be no transfer into the Indexed Account of this policy allowed for the subsequent 12 months—this is called
A. the crediting method.
B. the withdrawal requirements.
C. the lockout period.
D. the indexed period.
5. An EIUL plan needs to be monitored to make sure that
A. the insurance company is not stealing any of the funds.
B. it is not being replaced by another type of investment/insurance scheme.
C. all commissions due are being paid.
D. it is being funded at an appropriate premium level based on the earned interest rate.
6. One of the biggest advantages of the EIUL over Variable Life is
A. that it offers greater protection from market downturns.
B. that it offers higher commissions.
C. that it is entirely flexible.
D. the agent must be dually licensed, insurance and securities, to sell EIUL.
7. The EIUL offers, among other things,
A. the right to change the premium at any time.
B. a flexible face amount.
C. higher earnings than mutual funds or any other insurance product.
D. guaranteed minimum annual return.
8. Where the index growth depends only on the difference between the beginning and end index value, this is called
A. dollar averaging.
B. annual Point-to-Point crediting method.
C. daily averaging crediting method.
D. Universal Life Option B.
9. The right to purchase a specific amount of a given index at a specified price within a specified period of time, is
A. call option.
B. monolithic withdrawal technique.
C. used only with mutual funds.
D. a derivative of dollar averaging.
10. Some EIUL policies have a feature that locks-in to the Index Account at the end of each index period. This is called
A. a Point-to-Point indexing method.
B. an annual reset feature.
C. the retribution feature.
D. asset management.
ANSWERS TO STUDY QUESTIONS
1B 2B 3A 4C 5D 6A 7D 8B 9A 10B