A peek at the expenses of an IUL contract.
The Basics
To make sense of some of this we have to go back and review some basics. Most policy owners believe, or are led to believe, that the illustrated crediting rates are pretty conservative. After all, we’re talking about the S&P 500 that has returned double digits over time while looking at a projection with a crediting assumption typically half that. As we discussed, the S&P 500 Index doesn’t include dividends, which is major. There have been entire decades where the majority of the S&P 500 return was the reinvested dividends.
Several years ago, there were some carriers with index calculators on their websites. These calculators would equate the crediting on a policy to a market return, and for a 6% policy crediting, similar as assumed on the original ledger we’re discussing, it would equate to at least a 10% market return. Does anyone anywhere consider a 10% market return conservative?
Sequencing of Returns
The annual statements for the policy include, in large print on the first page, the average annual return since policy inception (exclusive of expenses). Starting in year 2018, the numbers are 3.0%, 5.55%, 7.03%, 6.97% and 5.02%. We know a life insurance policy isn’t an investment portfolio, but so many of these policies have been sold this way that no one can fault policy owners for viewing them as such. If you received an annual statement with the “since inception” numbers boldly proclaimed on the front page, how likely are you to dig deep to understand your policy is really losing money every year and is destined for failure? Furthermore, most policy owners don’t understand how the crediting and timing of the crediting works. From September 2022 to September 2023 the average annual return for the entirety of the policy from inception went from 6.97% to 5.02%. You’d assume the stock market was way down at that point, but the market return during that period was 16.41% with a 14.51% return exclusive of dividends.
This shows that the effect sequence of returns can be significant. To understand, take an online S&P 500 calculator and choose a period to see the return, then change the period only a little bit to see how much the return can change. Sometimes it’s significant. I looked at the history of the segment maturities for this policy over the years and that answered the above referenced 2022 to 2023 weirdness where the “since inception” return dropped so much. It turns out the segments with large gains had no cash values in them and the segments with large cash values had 0.00% returns. That’ll make a difference.
Between sequencing/variability of returns and what segment you happen to have your money in (one year vs. two years in this case) returns can be surprising… and unsettling.
Marketing vs. Reality
Check out the table below. Is it a wonder that policy owners are so often surprised? They’ve been getting annual statements that show decent returns while their policy values are plummeting. Sure, they can take out a calculator and run the numbers themselves, but we all know that doesn’t happen and there’s an element of trust in the carriers and the agents. I mean, in the most recent policy year, when the S&P 500 was up close to 30%, the policy is down thousands in cash value after a couple thousand of premium was added!
As an aside, when I’m working with policy owners who have discovered their very large premium financed IUL transactions are tanking, I regularly hear “My agent said the policy was doing better than expected, but I had to add more collateral than expected.” What?!!
An associate was talking with someone very close to the premium finance market and asked what the agents and promoters are telling the policy owners when updated projections are showing poor results. The answer? “Oh, they’re not showing them.”
Finally, this same associate related that he was once giving a presentation warning of all the ways IUL policies can be manipulated. After the presentation, some attendees came up to him asking more about it. He realized they were agents trying to learn more about how to manipulate the projections to look better rather than take away from the talk how to do things responsibly.
| Policy Year | Statement Return from Inception | Cash Value | Actual Policy Return from Inception | Annual Policy Return | S&P 500 Return* | S&P 500 Return w/o Dividends* |
| 2018-2019 | 3.00% | $155,904 | -14.03 | -14.03% | 4.81% | 2.78% |
| 2019-2020 | 5.55% | $150,779 | -9.37 | -4.51% | 15.02% | 12.85% |
| 2020-2021 | 7.03% | $150,110 | -6.86 | -1.75% | 34.04% | 32.09% |
| 2021-2022 | 3.63% | $146,642 | -6.04 | -3.59% | -12.11% | -13.39% |
| 2022-2023 | 5.02% | $132,216 | -7.09 | -11.05% | 16.41% | 14.51% |
| 2023-2024 | 5.18% | $128,889 | -6.56 | -3.97% | 28.88% | 27.49% |
Based on $181,353 1035 exchange and $2,000 annual premium starting in year 2
* S&P 500 returns obtained from S&P 500 Calculator on www.DQYDJ.com. Returns are based on policy date and not calendar year returns. Policy date is September 2018.
We see in the table that the positive numbers that are highlighted on the annual statement are baloney in reality. Sure, you can rationalize how the indexed account really preformed that way, but does “Don’t piss on my boots and tell me it’s raining” ring a bell?
Loan Options
To raise the bar another peg on the scale of ridiculousness, there’s something that needs to be understood about the original sales ledger the policy owner signed off on. Most IUL policies have the option of a standard loan or a participating/alternate/indexed loan. A standard loan takes the cash value that’s collateralizing the loan and puts it in the fixed account. An alternate loan allows the collateralizing cash value to stay in the indexed accounts. With standard loans the loan interest rate is much lower and the cash value crediting is never greater than the loan rate. With an alternate loan, the policy can assume higher cash value crediting and greater than the loan interest. In other words, the projections can artificially assume an annual perpetual positive spread between the loan interest and the crediting on the cash value collateralizing the loan. This is why the loan is usually the alternate type… it illustrates better.
While the standard loan is 2.25%, the alternate loan is 4.65%. However, in the original ledger it assumes the loan from year two on is 5.09%. Why would they do that? Because the regs in place at the time the policy was issued allowed crediting to be 100 basis points greater than the loan… every year forever. Remember, virtually every sales ledger assumes level crediting with no down years… entirely unrealistic. Since the maximum allowable crediting per the regs was 6.09% when the sales ledger was run, the loan is assumed to be 5.09%. The loan wouldn’t actually be 5.09%, it’s just illustrated at 5.09% to maximize the illustrated performance. However, when the policy isn’t getting any positive crediting, the higher alternate loan interest is still applied and this definitionally will happen but is almost never illustrated.
There is bold type on the loan page that says, “This causes alternate loans to be significantly more volatile than standard loans.” It also states, “Your choice of a standard loan or an alternate loan can have a significant impact on policy values and the cost of the loan.” Finally, “The actual alternate loan interest may be higher or lower than the interest credited. The net result can vary significantly from year to year. It is important to illustrate this volatility.” I have never once seen a ledger illustrating this volatility and few policy owners have read this language.
On the most recent in-force ledger, the positive spread of crediting over loan interest is 10 basis points, not 100, because the maximum allowable crediting rate is so reduced. This is contributing to the disappointment
Not a Security
As a reminder, I’ll mention one more thing most policy owners don’t understand. None of their premium or cash value is in the market, even though the S&P 500 is bandied about constantly. All the money is in the general account of the insurance company, just like with whole life and traditional universal life. How are they projecting these fantastical returns? Options. They take the income earned on the general account and buy options. If the options expire out of the money, then the policy gets credited nothing. If they are in the money the profits credit the market upside.
Do you know what the regs allow the insurance carrier to assume the profit margin is on the options trading? 45%. Really. Look it up. Doesn’t this beg the question of why they would even bother with the complications of the life insurance business and the pesky policy owners and agents if they could simply make 45% trading options day in and day out? Ridiculousness exponentialized.
The end results…build a product with untenable assumptions that no one understands (including too many agents) and sell it to consumers who have no idea what they are getting in to so that the money they were shown to grow like a bad weed actually goes down the pooper even though the market is performing better than anticipated until the policy lapses with no value.
Sign me up! A rapacious consumer of cash indeed.
To be clear, this product isn’t every IUL product, but it was an incredibly popular one. There are 1.2 gazzilion of these policies in force in the market today and more IULs than that with all the other carriers. Unfortunately, too many of the products incorporate features that are unlikely to work out as understood by policy owners.
Securities offered through Valmark Securities, Inc. Member FINRA, SIPC. Investment Advisory Services offered through Valmark Advisers, Inc. a SEC Registered Investment Advisor. OC Consulting Group and its affiliates are separate entities from Valmark Securities, Inc. and Valmark Advisers, Inc. Guarantees are based on the claims-paying ability of the issuing company. Indices are unmanaged and do not incur fees. One cannot directly invest in an index.
