Something to understand about IUL
By Bill Boersma
After doing a bit of analysis on another premium finance deal gone bad, I thought it would be a good idea to share it. The following is taken from my note to the client and trustee. The unique aspect of this engagement is that, unlike most situations where a client and advisor come to me already knowing there’s a problem, this time the advisor was trying to convince the client there was a problem, but the client and trustee were unaware and taking the original writing agent’s word that everything was fine. (There are no client, advisor or agent names connected to this article to protect client confidentiality. Additionally, the specific product vendor names have been removed as this is not a story line on a specific product, but rather a general confluence that often surrounds IUL in general. Any other names found in this article have been generated with their approval as a contributor to the situational review.)
Hello:
It was good talking the other day. We’re moving along on the things we discussed. I’ve updated the spreadsheets to show gross and net death benefit, cash value, debt, collateral, etc. under multiple lending rate assumptions and policy crediting rates.
I’ve also taken the opportunity to dissect some of the numbers, so you see where things are coming from. The pages and calcs I’m including below are from Policy A assuming the 6.28% crediting we were provided.[1]
I’ll start by comparing years 10 & 11. The cash value is projected to grow $997,872 in year 11. The end of year value in year 10 shows $17,049,816. This calculates to a 5.85% rate of return. Given the 6.28% gross crediting, that seems reasonable. But let’s look closer.
It turns out there are $1,423,761 of interest credits projected that year, which is 8.35% of end of year 10 cash value. That’s greater than the gross crediting rate. A lot more. The policy charges are $425,888 for the year. Let’s look at year 20 to 21. Crediting appears to be 5.15%, but with expenses of $936,109, it takes $2,470,059 of credits to come up with that cash value growth. Those credits represent 8.30% on the cash value.
[1] Source: Data from insurance carrier ledgers provided by client’s agent
Remember I mentioned that none of your cash value is in the market. It’s all in the general account of the insurance company, like with an old-fashioned whole life policy. They take the earnings of the general account, probably in the low fours now, to buy options. The options credit the upside according to the formula and subject to a cap for some of the indexes. What the insurance company is saying is that they are going to credit you eight point something with their four point something money… twice as much.
In the illustrious words of Bobby Samuelson, who we discussed the other day…[2]:
“I’m not sure how I can be clearer, so I’ll just say this again – if you are illustrating a 6% rate on an IUL with a 4% option budget, you are making the assumption that equity call options yield 50% annual profits on average over the life of the illustration.
You cannot illustrate IUL at a single basis point higher than the option budget without having a fundamental belief that systematically buying equity call options is profitable. And if you don’t have an opinion on option profitability, you shouldn’t be illustrating IUL at a rate higher than the option budget. That’s 373 words to try to correct the misperception that AG49 is about illustrated rates – it’s not. It’s all about option profits.”
He went on to discuss the chances of consistent profits in the options trading markets (doesn’t happen) and I did some of my own homework. Market consensus is generally skeptical of consistent profits through options trading. Retail traders lose money on average. Market makers who profit on spreads are profitable and some of the most sophisticated professional firms experience some success, but nothing close to the profits required to illustrate the numbers in IUL proposals utilizing the often illustrated maximum crediting rates.
Also remember that the indexes don’t include reinvested dividends. From June 2000 to June 2025 the S&P 500 is up 7.74% and 5.81% without the dividend reinvestment. Here’s more data.[3]
[2] Source: www.lifeproductreview.com with permission from the author
[3] Source: www.DQYDJ.com (need better source for this… the link goes to a home page site, this should link directly to the article or provide additional information where the reader can find it on their own.)
You can see that dividends are a meaningful portion of total returns. Keep this in mind when considering what a reasonable return expectation is for the policies.
The maximum crediting rate the guys are showing you is based off the AG49 regulations. The regs use averages and means of the S&P 500 of 25-year rolling periods going back 65 years. That crediting rate is the maximum allowable. This means to get the crediting rate they are using, the market has to continue performing how it has. Do you see that? The 6 point something crediting they showed may appear conservative for an S&P 500 linked product, but it assumes a double digit return ongoing forever.
It’s also interesting to note that during the period that indexed life insurance products have been the most prevalent, the market has done very well. But, also interesting, during this fabulous stock market stretch, most of these policies I review are underperforming original projections, even though the market has done better than the original projections accounted for.
Finally, to game the system there have been many engineered indices created for index policies. Some have cherry picked back tested data to show fantastic performance only to perform poorly after launching. There are also many volatility-controlled indices. This is because the insurance carriers must pay more for options in more volatile markets. If they can limit volatility then the options cost less and they can take the extra and use it to show better returns (show, not necessarily get). This may sound good, but volatility-controlled indices aren’t all equities based. To reduce volatility, they incorporate bonds and other conservative assets. Therefore, as you can imagine, their return isn’t as high as a fully equities-based index.
Here’s one famous (infamous) index that tells quite the story.
I mean… WOW! Over the past decade a Money Market account would have done better! A Money Market account would have been much better recently and only a little off since 1996. 100% bonds would have done better. Inflation would have done better over 10 years. I don’t know what they’re paying those people, but if they pay it to me, I’ll take a shot at it. I should think about starting my own index if this is the bar to be cleared.
Three of the five indices you are in with Policy A are engineered, volatility-controlled indices. Policy B appears to be in a S&P 500 Index account with an 8.75% cap rate.
Here’s a look at the returns of these types of indexes.[4]
[4] Source: Forum 400 presentation
If this is any indication, it’s just more data to show how unreasonable it is to expect the policies to perform how they are projected. The most intelligent people I know in this market propose a return in indexed products to be less than a half percent better than what the crediting is in their non-indexed UL products, which is considerably lower.
A couple of your indexes are negative YTD for 1 year and one is even negative for 5 years while the S&P 500 is up nicely. Index A is currently invested 23% in US large cap equity futures and 77% in US fixed income. No wonder it’s trailing the S&P 500 badly. You can’t make up a nice sounding story about limiting volatility and still propose to get the same kind of returns, yet that’s exactly what they do. It’s preposterous. It’s like proposing you’ll get S&P 500 returns in your retirement plan while investing heavily in bonds.
This graph is a hypothetical historical representation (the actual Index didn’t exist that far back) of the allocation of stocks vs, bonds for one of your indexes.[5] It ranges from having 100% stocks during low volatility periods to almost 100% bonds during high volatility periods.
[5] Source: www.myannuitystore.com
I’m not trying to drown you in data, but I believe it’s important to make decisions based on facts that are provable and can be backed up.
I’m not including all of the spreadsheets now. I can pull out a few scenarios and discuss when we talk again. The bottom line is that there are scenarios where the net death benefit can be positive $50 million or negative $50 million, depending on lending and crediting rates. In many of the scenarios, contrary to what you expected, the collateral will never go away under realistic conditions. Even in the scenarios culminating with a decent death benefit, I don’t believe you’ll be willing to tie up that much collateral. For example, I think you’d be satisfied with an ultimate $30 million death benefit, but if it meant $5 to $10 million of excess collateral above cash value, I’m pretty sure I know what you’ll say.
Leverage equals risk. You know that. It’s your business. But you understand and have some control over your business. You don’t understand or have control over the markets, and if they go the wrong way it’ll be next to impossible to buy your way out of trouble. This is why we’ve been working so hard to get this information.
I look forward to the meeting with your agent. It’ll be interesting to see how he attempts to counter this data.
Bill
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 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. Bobby Samuelson’s name is referenced as a third-party who is not affiliated with Bill Boersma, OC Consulting Group, Valmark Securities, Inc. or Valmark Advisers, Inc. Bobby is a recognized leader in the insurance analysis space and while he did not contribute to the review of this client situation, his quotes were used with approval to contribute to this article.
