“There’s been a lot of discussion about the Kyle Busch lawsuit that was recently filed regarding their millions of dollars of premium and their IUL policies. It seems anyone for or against IUL is writing and posting and podcasting about it. I started writing and it kept evolving. I knew Bobby Samuelson’s piece was coming out and I was going to let that drop first anyway.
Many of the commentaries are coming down on one of two sides, with those who are anti-IUL using it as an example of why there should be more regulation or that it should even be outright banned, and alternately, that IUL is fundamentally good if it’s designed right and not abused. There are aspects of each argument I agree and disagree with, but that’s not what this piece will be about. I’ll discuss how these policies work in real life by relating a case study.”
Bill Boersma provides members with commentary on Indexed Universal Life Policies in relation to the Kyle Busch case.
Bill Boersma, CLU, AEP, is the founder and owner of OC Consulting Group. Bill has spent his entire career specializing in life insurance. He predominantly works with wealthy business owners and professionals regarding insurance for estate planning, business succession and charitable strategies. Bill is generally introduced by estate planning and business attorneys, CPAs, trust officers, family offices, non- profit leaders and various financial planning professionals.
Recognized nationally as an expert in life insurance, Bill utilizes his experience and expertise to be an effective ally for policy holders and their professional advisors. From designing strategies to implementing solutions to ongoing management and consulting, he tends to challenge industry orthodoxy and provides a refreshingly candid take on life insurance while benefitting clients through a pragmatic process.
Whether Bill is sought out for a simple second opinion or to provide the most thorough analysis available, his work is consistently recognized as bringing unparalleled value to policy owners and advisors. Another growing aspect of Bill’s practice is litigation support and expert witness testimony. While his work results in most cases avoiding trial, he has courtroom experience as well as FINRA arbitration experience. Bill has written for, been featured in or quoted by a number of financial and industry periodicals, websites, radio and television. He regularly speaks for estate planning councils, legal, accounting and trust management conferences and financial and insurance associations.
COMMENT:
An Analogous Situation
Like so many others, I read through the complaint and picked out the important information. I’ve dived deeply into enough of these cases that I understand them well and know how they are often designed. I went to various carriers’ software and started playing with numbers. I can make some assumptions, do some prorating and then compare it to other cases I’ve reviewed for insured individuals of similar age. Finally, I adjust the numbers for what I understand the flat extra would be for a professional race car driver. Regarding this last point, few people initially talked about it and it’s huge.
This other situation from my files was of similar magnitude to the Busch’s policy that Bobby Samuelson has reviewed. I assumed my case was similar and Bobby confirmed my hunch. There was $10 million of premium in a single policy over a handful of years. While we all understand there are expenses and they are heavily upfront loaded for life insurance policies, there’s a lot of different ways to build a policy that can result in a huge range of costs. Additionally, some policies are built so that despite the high early year expenses, even higher expenses are manifested through mortality charges in the later years.
In this particular example, the policy had a cash value at the ten year mark less than 50% of the premiums contributed over the first five years. In itself, that’s nuts. Furthermore, the cash value at year ten was even less than the cash value at the end of year five, which shows that expenses were outstripping the crediting during those years, even with meaninglessly low mortality charges. Even at the point when the projections were showing income starting, the cash value was significantly less than cumulative premiums. In other words, there was a negative rate of return on premium to cash value over multiple years from policy inception to the income years. Imagine starting retirement distributions from your 401(k) when your balance is less than your contributions.
It’s not uncommon for me to see insurance ledgers where the policy expenses over the first ten years are greater than the entire premium. Cash value at ten years is often less than cumulative premiums. I’ve seen cash value at year ten less than a quarter of what was put in, on accumulation style policies.
Purported Returns
The projection proceeded to show a few decades of significant dollars coming out of the policy as retirement income. In traditional financial planning there is an often used 4% income rule. In this analogous case, the income was 15% of the cash value the first year.
Over multiple decades, from policy inception through the end of the income years, the internal rate of return (IRR) on the transaction was about 5.50%. This doesn’t appear too bad given the gross crediting of the contract was illustrated only a little greater than that, similar to the Busch’s at 5.67%
If the early years are negative but the overall return is close to the gross crediting rate, this leads us to understand that the rate of return during the income distribution years must be pretty steep. As ridiculous as it sounds, the rate of return in the policy over the income years was 20%! This is taking the cash value the year income started at Present Value (PV) the income as Payment (PMT) and the cash value after the last income distribution as Future Value (FV).
I feel this is an incredibly important thing to take note of. If an advisor took time to run some numbers and saw a return manifested in the illustration that made no sense, hopefully they’d call a time out and urge some further analysis and explanation.
Some Details
Let’s look at some of the internal details. I could pull numbers out of the sales and in-force ledgers and do some calculations. The policy crediting in any given year was between 10% and greater than 15%. Remember, the gross crediting rate on the ledger per the AG49 Regs is less than 6%. The persistency credit and performance factor credit are both huge and used to end run the regs.
When you look at the crediting page of the ledger, it’s divided into base credits, persistency credits and performance factor credits. Base credits are driven by the crediting rate, and you can duplicate these credits by taking the cash value and multiplying it by the crediting rate. The persistency credits are on top of that and are not guaranteed and vary by year but can be quite significant. The performance factor credits are the largest portion of credits in the earlier years of the policy and remain a very significant percentage in the later years. Put all off these together and the crediting rate dictated by AG49 regs is meaningless.
Performance Factor & Charges
We can also extract the performance factor charge and calculate it as a percentage of the performance factor credit. Every year of the ledger I calculated shows that the charge is 75% of the credit. This performance charge that purports to result in the performance credit is the engine behind the fabulous projected returns. However, the charge is very significant. It ranges from roughly 3% to 7% of gross cash value annually. It’s hundreds of thousands of dollars a year, projected to grow to millions a year.
A real problem is that the projection assumes level positive crediting every single year and that won’t happen. In down or flat years, the expenses still come off the cash value. This significant expense doesn’t even include commissions, policy fees and mortality charges that add millions more.
In a recent case where I served in a litigation support capacity, the crediting was a fanciful 15% but the policy was falling apart because the expenses were 20%.
The Loans
As most of us understand, the “retirement income” consists of loans from the insurance company collateralized by the cash value of the policy. Just to be clear, a policy owner is not borrowing their own money, as people are often told. In this case the loans were not standard loans where the loan rate is generally slightly higher than the crediting rate the fist ten years followed by the two rates often being the same in years 11+. These loans are referred to as alternate loans, indexed loans or participating loans. This is some slight of hand allowed by the regulations. The carrier is allowed to assume perpetual positive arbitrage between the policy loan and crediting of the cash value collateralizing the loan. In other words, the bigger the loan, the better the projections look. I’ve heard agents tell policy owners to take more loans to make the policy perform better. When the loans grow to tens of millions of dollars, the projections are assuming hundreds of thousands of dollars of arbitrage crediting. While the Busch’s transaction was not premium financing, in a way it does incorporate arbitrage financing where success depends on a perpetual positive spread.
Furthermore, this particular case, as with the Busch case, is from before the AG49A tweaks that reduced the allowable loan arbitrage. They project a 100 basis point positive arbitrage on a level basis year in and year out. That’s huge and will not happen. Buried deep in the ledger is “This causes Alternate Loans to be significantly more volatile than Standard Loans”. How many policy owners do you guess have ever even seen that? This arbitrage credited interest pushes the projected return on the cash value over and above the multiple credits referenced above.
Deep in the ledger the pages can be found that show the loan details. The loan grows to $100 million! That’s not a typo. Do you think for a moment the policy owner would have moved forward with the transaction had they known that it would have put them a hundred million in debt? If things didn’t pan out as expected and the policy collapsed, as sometimes happens, that $100,000,000 in loans comes crashing down as taxable income, phantom taxable income. The policy has a $10 million basis as designed (all loans, no withdrawals, because loans look “better”) so $90 million of it is taxable at ordinary income rates.
Digging Into The AG49 Regs
Beyond all this, the maximum crediting rate allowed by AG49 is a 50/50 proposition. The number is based on 66 years of back-testing the S&P 500 and taking the arithmetic average of geometric means of over 10,000 data points. This means, given historical returns, half the time the numbers will better than shown and half the time worse. Do you think any policy owner understands that? Especially given the couching of the policy being driven by the S&P 500. A 6% crediting rate seems rather conservative to most.
That 6% crediting rate assumes the S&P 500 continues to perform at double digit returns indefinitely. Furthermore, it assumes it does so on a level basis year in and year out forever. In realty, sequencing of returns will likely have a negative effect on the actual crediting of the policy. Please reread this paragraph so you don’t miss the fact that the apparently conservative assumptions are actually based on an all equities portfolio continuing to perform at historic levels.
It’s important to understand that the crediting rate is also based off the insurance company’s current cap rate. If the cap rate goes down, the performance of the policy suffers. Additionally, the guaranteed minimum cap rates are very low compared to what is generally being assumed.
How Does an IUL Driven by The S&P 500 Compare to the S&P 500?
If $1,000 was invested in the S&P 500 in 1960 (chosen because it aligns with AG49 backtesting mechanics) it would grow to $642,000 by the end of 2024. But the S&P 500 and the S&P 500 Index as credited in an IUL policy are not the same thing. In the policy it is based off only the price and doesn’t include dividends. If I invested the same $1,000 in 1960 and excluded dividends, it would grow to $97,000.
If I put a 0% floor and a 10% cap on the S&P 500 without dividends, the final number would be $50,000. $642,000 compared to $50,000 driven by the “same” engine. Remember, this is based on the straight S&P 500 that doesn’t include policy fees, commissions and mortality expenses.
It should also be remembered that IUL policies have none of the policy cash value in the market, it’s all in the general account of the insurance company, just like with traditional whole life. A portion of the yield is used to purchase options to credit the upside, up to the cap, when the market is up. If the market is flat or down, the options expire worthless. If you really want to be surprised, dig into the allowable 45% profit assumption on options trading.
Since options are more expensive in volatile markets and in a modest rate environment there is not much yield to purchase options, the cap rates have come down over the years. In order to combat this, engineered indexes and volatility controlled indexes have been introduced.
Many of these indexes have had unbelievably poor results. Some were built on cherry picked and back tested data. The volatility controlled indexes can have a significant amount of cash and other non-securities investments, up to 100% at times. This begs the questions of how these indexes are going to deliver the purported securities like returns if the index isn’t even all in on securities? Spoiler alert… they can’t.
Recently reviewing a policy for a consulting client showed an index with a 5 year return that was negative over the same time the S&P 500 was up almost 12%. For another the 20 year return barely beat inflation.
The 2020-2024 S&P 500 returns are 18.40%, 28.71%, -18.11%, 26.29% and 25.02%. Doesn’t this seem custom built for a product that advertises the upside of the market without the downside risk? Yet here we are.
Product Build and Commissions
Much of the conversation now is centered on how the policy was built. The anti-IUL crowd is using this as an example of how bad IUL is while the pro-IUL crowd is focusing on the importance of building a policy right. As I opened with, I have agreements and disagreements with both camps.
While not insinuating details of the Busch case, I’ll share what I know does happen too often. There are a gazillion ways to run a policy. Most people have no idea how many choices there are to be made when you open the software for a product. There is no such thing as hitting a button to come up with a premium for a give individual and death benefit. This is necessary because there are multiple themes to insurances sales and strategies. Some focus on death benefit while others focus on cash value. There are different payment options, index options, rider options, different tests to satisfy regulations, etc. Because of all this optionality, it also opens things up to manipulation. Also, these policies are so complicated, almost no policy owner has the ability to understand the machinations of the build.
When the theme of a case is cash value accumulation for retirement income, there is common methodology to follow to maximize growth. However, this methodology may also result in lower commissions. Bad actors can manipulate the policy to result in much higher commissions at the expense of the client. For example, since the commissionable premium is a factor of the death benefit rather than the premium, running a higher death benefit pays more, though it also results in a less efficient policy. In this case the death benefit was much higher than necessary.
As an aside, when I was trying to duplicate Kyle’s policy in my software, I was coming up with the same $45 million of death benefit. However, under today’s rules, the death benefit could have been less than half that, and most of the savings would’ve gone straight to the bottom line for the policy owner.
There is also the question of blending the policy to reduce commissions. I’m going to leave that one alone because I’m not in favor of mandating an agent construct a policy to minimize comp every time. That being said, if there is an option to lower comp and the agent chooses not to do so, I feel there should be disclosure. If there is true disclosure, it would be interesting to see how that conversation goes. “By the way, Mr. & Mrs. Policy Owner, I have the ability to reduce my compensation, and it would improve the performance of the policy and provide benefit for you, but I’m choosing not to. You don’t have a problem with that, do you?”
Finally, some product have quirks not everyone knows about that can further increase comp at the expense of the policy besides what I referenced above. I assumed, and Bobby confirmed, that there were multiple steps taken to maximize commissions on this case and this is a major reason for the failure of the policies.
Bobby shares a story of once giving a presentation highlighting the possible manipulations of an IUL policy to make it look better on paper. Afterwards people were lining up to talk to him. He figured he had really struck a chord until he realized they weren’t asking about how to do things responsibly, they were trying to make sure they understood how to manipulate the policy so their own sales presentations looked better.
Carrier Culpability
An ongoing conversation regarding the bad actors in the market is about the responsibility of the insurance carriers. Of course, the carriers generally argue they don’t have any oversight responsibilities regarding the agents.
We often see that the carriers aren’t playing by even their own rules. We’ve seen them ignore their own published training requirements, financial underwriting rules, premium financing guidelines and more.
In large cases carrier personnel are more likely to be involved with design and sales. The complaint reflects the same in this case.
The Other Advisors
Commenters keep bringing up the fact that other advisors were certainly involved, so how did this happen. I don’t know that detail and I’m not throwing shade at others when I say this, but estate planning attorneys, CPAs, family offices and even the trustees generally have little understanding of how these policies work. And it’s usually not their job either. That’s why the Prudent Investor Act allows the appointment of specialists.
Others have surmised that no one really throws millions of dollars at a transaction like this without a lot of advice and vetting. Well… you’d be surprised. I see it all the time, and from people worth a lot more than Kyle and his wife.
To Fiduciary or Not Fiduciary, That Is the Question
As would be expected, this case is bringing up a lot of questions about fiduciary duty. In the securities world, an investment advisor has fiduciary responsibility, and a registered rep may have the same. There are a number of professional designations that require designees to act in a fiduciary capacity. However, in the life insurance world, the closest we get is a Best Interest Standard, and this is only applicable in states that specifically adopt it, and so far, only New York has.
The NAIC model regulation has a Suitability Standard, but this is entirely different. Suitability only means the product is suitable for someone, not that it’s in their best interest for what they’re trying to accomplish. These two standards are entirely different from each other.
I feel there needs to be a higher standard than what is in force now. I see the bad happening because of my role in the market. I’m usually brought in by the professional advisors to pick up the pieces after a train wreck. It has proven difficult to get policy owners and advisors to bring me in before disaster strikes, though my work can often stave off debacles.
When a life insurance agent is using words like financial planning and retirement planning and/or is advocating for taking money out of a 401(k) or IRA to put in an IUL policy instead, how can anyone be taken seriously who is resisting a higher standard. Real people are suffering at the hands of uneducated and irresponsible agents who hold themselves out as advisors.
Apportionment Of Blame
In trials there is sometimes an apportionment of blame to determine who should be responsible for what damages when the plaintiff is awarded. On a LinkedIn comment last week, I answered when someone was asking what caused the failure. I want to expand on that.
If there are a multitude of things that could go wrong, which ones are most impactful. I imagine it would be different in various cases, but what about this one? Below are ten choices. What might I be forgetting?
I include the AG49 Regs / National Association of Insurance Commissioners (NAIC) because many argue they’re not doing their job. If the carrier is to shoulder some of the blame, it is because they were involved or because they created the animal that can go wild? There was one off year in the market while the policy was in force. Was that enough to throw it for a loop?
The Bottom Line
I’m not enough of a statistician to know the statistical probability of a policy like the Busch’s or the one from my file panning out, but I know it is effectively impossible to accomplish.
If Mr. Busch’s polices are anything like the one I’ve related here, none of this is a surprise. Long ago I wrote an article titled “We Have Calculators So Why Don’t Use Them?” If someone involved knew what to look for, like how a policy with less than a 6% crediting rate can show a 20% return, something that outlandish would certainly (hopefully) drive some tough questions.
Imagine if you saw some 401(k) modeling that showed a loss over all of the contribution years but somehow ended up showing a competitive equites return over all the years from plan inception to participant death. Would you ask questions? What if you then calculated the return from the first income distribution at age 65 to death at age 95 at 20%? You would laugh out loud and question the hypothetical return calculation of approximately double what the historical averages have been? Tell me I’m wrong.
Without making it a commonplace practice to hire a life insurance specialist, who is being compensated by a fee rather than a commission to vet these deals, don’t expect much to change.
HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!
Bill Boersma
