Diving into a case where a client wanted me to help them understand what they had, I dissected an Indexed Universal Life (IUL) policy, as I often do, and discovered numbers that didn’t make a lot of sense.
In the course of the analysis, I took every number from the ledger and input it into an Excel spreadsheet and ran calculations. What I found was interesting. Let’s start out with the understanding that the crediting rate at the top of the column of numbers was 5.76%. As I’ve written about numerous times, I have my issues with that number, but after diving in, that number was as innocent as a baby sleeping in a bassinet. But as every seasoned parent knows, that sweet little thing may grow up to be an incorrigible teenager.
The Four Credits
The credits I refer to are:
- Basic Interest Credit
- Persistency Credit
- Performance Factor or Bonus Credit
- Loan Interest Arbitrage Credit
It’s important to understand that not all contracts or specific policies have all four credits.
The last column of the spreadsheet takes the sum of the four credits and divides that number into the beginning of year cash value. For the math nerds, I understand this won’t be exact for a product that calculates everything on a monthly basis, but it will be very close.
The lowest credit to cash value ration is 9.91%. Interesting. Recall that the stated crediting rate is 5.76% that is dictated by the AG 49 regulations that mandate the rate is based on the past 66 years of the S&P 500, the yield of the carrier’s general account and the stated cap rate of the product.
The year with the highest crediting rates reflects 17.64%, over three times the maximum allowed crediting rate listed in the ledger. The higher figure represents multiple policy credit components rather than the base indexed crediting rate. Here’s how it breaks down.
- 5.52% Basic Interest
- 2.29% Persistency Credit
- 9.41% Performance Factor Credit
- 0.29% Loan Interest Arbitrage
The Basis Credit is what it is, no surprise there. The Persistency Credit is a bit of a surprise. Persistency credits are common in life insurance contracts, but they are generally a fraction of one percent, not multiple percents. In some years this credit topped 300 basis points.
The Performance Credit is even more of a shocker. Here we have a credit that is 160% of the base credit. Some might be tempted to ask why it matters. After all, isn’t higher the better? Theoretically yes, but it matter how that high credit gets to be that credit. The answer is through expenses. There is a performance factor expense every year of three quarters of the credit. In other words, that 9.41% credit is made possible by a 7% charge. The reason this is an issue is because that 7% charge is still there in down years when the policy crediting is 0%. That charge alone can result in a 7% loss of cash value before we look at all the other policy fees, expenses and mortality charges.
The Loan Interest Arbitrage is obviously only applied if there is a policy loan. This is a factor of the regulations allowing an assumed positive arbitrage on the cash value collateralizing the loan. For example, if there is a million-dollar loan with a loan interest rate of 5%, the million dollars of cash value collateralizing the loan can be illustrated as crediting 5.5% resulting in a $5,000 arbitrage crediting.
It’s no secret in the industry which product this is, and I’ve done this analysis many times over the years. But here’s the surprise many didn’t see coming. In many of those situations the policy underperformed in a booming stock market because… expenses. Can you imagine what the gross expenses need to be to tank a policy that illustrates 10% to 17%in credits ?
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.
The examples given are for illustrative purposes only and not meant to be representative of all policies.
Securities offered through Valmark Securities, Inc. Member FINRA, SIPC. Investment Advisory Services offered through Valmark Advisers, Inc. a SEC Registered InvestmentAdvisor.
OC Consulting Group and its affiliates are separate entities from Valmark Securities, Inc. and Valmark Advisers, Inc.
