IUL Crediting for Children
Because IUL for Dummies may result in copyright infringement allegations
I know a guy who had a way of asking for simplistic explanations for things. He would say “Bill, make me a crayon drawing.“
Given what I run across as a consultant in the life insurance industry, I’ve decided I have to make a crayon drawing to explain something. The crediting rates and methodology for indexed universal life (IUL) are among the most misunderstood and misrepresented aspects of the industry.
I will be regularly working with a client who relates some aspect of the sales process by telling me they were told that the crediting rates shown in the life insurance projections were unrealistically conservative. They would blame ridiculous regulations for restricting the ability to show projections that were realistic.
Of course, these prospective policy owners had no education or understanding of how these policies worked and had little choice but to take the agent’s representations at face value. When these products are continuously postured as a unique financial transaction able to participate in the upside of the market while protecting them from downside risk, and are labeled S&P 500 indexes, it doesn’t seem extraordinary that they would buy into the story.
After all, when the S&P 500 is continually bandied about, and the Illustration showed a 6% crediting rate, that certainly does sound conservative given the double-digit historical return of the S&P 500.
Mark Twain said “A half truth is the most cowardly of lies.” I’ve seen innumerable examples of an agent making a partial statement and letting it hang in the air for the consumer to come to their own conclusion rather than fully explaining it. I’ve often stated, “More can be communicated by what is left unsaid than by what is said.”
Once and for all, let’s put an end to this “conservative“ baloney. In order to do so, there is no room for opinion, only numbers. As with too many other things in life, I’m not sure that much of the sales and marketing process should be taken at face value. When even science is subject to manipulation, we need to work hard to keep the numbers from being tortured.
Take a look at this spreadsheet.
I’ve created a simplified version of the AG 49 look back calculations. The actual AG 49 regs go back 66 years and take 25 year rolling periods over that time. After the first 25 year rolling period, it advances by one day and then does it again, over and over again until we run out of periods. This results in over 10,000 data points. Then we take the geometric average of the arithmetic averages of all those calculations to come up with a cap rate for an IUL policy projection. The Benchmark Index Average (BIA) assumes an S&P 500 point to point index at the actual cap rate the carrier is offering at the time. This is the crediting rate that is often described as “conservative.” Let’s test it out.
The spreadsheet takes the actual S&P 500 return on an annual basis as a starting point.[1] It then excludes the dividends which brings the number down significantly. It then applies a cap to that reduced number. I’m showing caps from 8% to 12% with a 0% floor. A floor is a minimum rate credited to the policy in a given period, protecting against negative index performance, while a cap is the maximum rate a policy can be credited in that period, even if the index returns more. Let’s look at the 10% cap rate column. You can see the numbers very clearly. Every annual crediting rate is going to be between 0% and 10%. You’ll see that a vast majority of the years the crediting is either 0% or 10% with rather few crediting rates in between. Please note these calculations are for illustrative purposes only. These figures are hypothetical and are not actual investment results, projections, guarantees or policy illustrations.
We then grow a single contribution in this example to come up with an ending value. Note that using an annual contribution, like most life insurance policies do, will result in slightly different returns. Finally, we can back into what the annual rate would be to hit that end value. What should jump out to anybody looking at these numbers is that the ultimate rate is incredibly close to the crediting rates of IUL policies in the market for sale today. In other words, that crediting rate is not a mystery, it’s simply a matter of crunching easily obtainable numbers.
My calculations are very simplistic compared to the AG 49 calculations, but they’re quite close.
When one understands where these numbers come from, not only is the number proven not to be conservative, it should be understood that it’s quite aggressive. I say this because the maximum allowable crediting on the insurance projection assumes the S&P 500 will continue on a forward basis equal to its historical crediting, year in and year out on a level basis. In real life, sequencing of returns will likely result in lower values. Tell me how many policy owners would be willing to move forward on the transaction if they understood that the numbers were based on a level double-digit ongoing stock market. The reality of the transaction bears a little resemblance to their understanding of it.
If someone was utilizing an S&P 500 mutual fund or ETF for retirement funding, would they assume a double-digit return? For almost everyone the answer is of course not. Most people would lower the expected return for purposes of planning for retirement. Let’s say they were willing to do their planning based on 8%. 8% is roughly 3/4 of the actual S&P 500 return over that time. For an apples-to-apples calculation, wouldn’t it be more appropriate to then run the IUL projections at a lower crediting rate? Yes, it would be.
Available Monte Carlo modeling for IUL policies will show a rather low probability of success for the illustration at maximum allowable rates to pan out. Increasing the funding of a policy based on lower crediting assumptions substantively increases the probability of success. Results from Monte Carlo or other probability of success modeling vary with each use and over time based on the assumptions, criteria and methodology used. Results do not reflect actual policy results and are not a guarantee of future performance.
I would encourage anyone considering an IUL policy at the maximum allowable crediting rate to run their illustration through independent modeling before moving forward. In my experience, seeing those results often leads clients to rethink the original design.
That’s it. That’s all I wanted to relate. Now try to tear it apart. Good luck.
Bill Boersma is a CLU, AEP and LIC and the founder and owner of OC Consulting Group. More information can be found at www.OC-LIC.com, www.BillBoersmaOnLifeInsurance.info or email at bill@oc-lic.com or call at 616-456-1000.
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.
The opinions expressed in this article are those of the author and should not be construed as specific investment advice.
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.
The information provided has been derived from sources believed to be reliable but is not guaranteed as to accuracy and does not purport to be complete analysis of the material discussed.
[1] https://dqydj.com/sp-500-return-calculator/
