UPDATED

by Bill Boersma

Expanded Commentary

This is a follow up to an earlier post. Thanks to everyone for their comments. I’d like to expand on my thoughts and invite more commentary.

I ended up asking people to think of this two different ways. First, if the IUL (Indexed Universal Life) is showing a crediting of 7% allowed by AG49 (AG49 is an insurance regulation that sets standards for how insurer are allowed to illustrate IUL policies), let’s assume the VUL (Variable Universal Life) is in a diversified portfolio that has historically returned 7%, meaning it’s roughly 50% securities. Second, assume the VUL is invested how it needs to be invested to equate to what the IUL assumes the S&P 500 will do to credit 7%.

Two VUL Portfolios

To be clear, this assumes two very different portfolios for the VUL policy.

In the 7% VUL portfolio we know that past results aren’t indicative of future performance, but for planning and analysis purposes I think most people will go along and agree that if it’s in a portfolio that has over the long run averaged 7%, moving forward over the long run it’s not unreasonable to assume it will continue to average 7%. For this conversation, we’ll assume this, and with no other meaningful changes, the policy should pan out.

Changing the assumptions and assuming both the IUL and the VUL invested in their respective S&P 500 options, the story changes dramatically.

One point is that the VUL sub-account is actually invested in the S&P 500 while the IUL sub-account is fully in the insurance carrier’s general account with the policy’s cash value yield buying options to credit market upside in up years. Importantly, the IUL is tagged to the S&P 500 Index, not the S&P 500… a huge difference. The S&P 500 Index does not include dividends which are generally a couple hundred basis points of the return.

IUL

In the IUL policy assuming a 7% crediting, I believe Scott Witt got it correct when he said, “If history is any guide, the initial cap rate and illustrated credited rate are likely stretched to the limit.” By this I believe he means that it’s the maximum allowable rate under AG49, assumes no reduction in caps and requires a stock market that continues to perform at historical equities returns. AG49 is built on an arithmetic average of geometric means so it can be argued it’s a 50/50 proposition. I believe it can also be argued that if the VUL portfolio was built on a long term 7% return assumption, it too can be considered a 50/50 proposition. The difference is, the IUL is based on much more aggressive assumptions and the VUL much more conservative. I’m not talking about volatility, but about the nature of the underlying drivers of return.

If we assume the portfolios, whether more aggressive or conservative, will perform moving forward like they did in the past, with no other moving parts, then the policies should both pan out.

Both policies have to deal with sequencing of returns.

Both policies have their respective fees and mortality charges.

Both policies are assuming the S&P 500 continues to perform at a double-digit return.

However, if the market does continue at historical returns, the VUL is getting double digit crediting while the IUL is getting much lower. The VUL will obviously have higher highs and lower lows. Assuming max funded contracts, both will likely be able to endure down markets and all available analysis I’ve reviewed shows the VUL to outperform significantly over time.

Monte Carlo Analysis

Next, I input the data into some third-party Monte Carlo analysis software called LISA (Life Insurance Sustainability Analysis) to see how this stacked up. A Monte Carlo analysis is a statistical modeling tool. It provides a range of potential outcomes based on different model assumptions. For the IUL policy, the model shows a 30% probability of success, defined as the policy persisting through age 100. This particular IUL ledger has a current cap rate of 11.50%. If that cap is reduced to 11% the success rate decreases to 14% and at a 10% cap it’s 1%. When I change the loan option from the more aggressive indexed loan to the fixed loan, the success rates go down to 16%, 6% and 0% at 11.50%, 11% and 10% cap rates respectively.

With the VUL, assuming a 50% equities exposure resulting in close to the 7% crediting rate, the model shows the success rate is 42%, lower than the 50/50 outcome discussed above, but not out of the ballpark. Assuming a 100% equities exposure the probability of success is 97%.

Does that all make sense?

Takeaway

My take away is that an IUL and a VUL built as similarly as possible and with the same crediting rate with the IUL in an S&P 500 one year point to point index and the VUL in diversified sub-account with 50% equities exposure are going to illustrate similarly, but the model gives a higher probability of success with the VUL policy because of the dividends and the more conservative portfolio.

An IUL in an S&P 500 one-year point to point index and a VUL in the S&P 500 sub-account will performance very differently, with the VUL coming out on top regarding the model’s probability of success and cash value and death benefit values. This is the cumulative result of including dividends, a much higher crediting rate and the lack of an upside throttle. Over time, the upside cap can be more meaningful in reducing returns than a floor crediting rate is in increasing returns.

The VUL can certainly suffer a larger loss in any given year, but the caps may suppress growth more than most people realize.

I look forward to more comments. Enjoy your day.

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.

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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.

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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.

This material is for informational purposes only and is not intended to provide specific advice or recommendations for any individual nor does it take into account the particular investment objectives, financial situation, or needs of individual investors.

The LISA (Life Insurance Sustainability Analytics) software uses Monte Carlo simulations to illustrate potential policy outcomes based on assumed cap rates, crediting methods, and hypothetical investment returns. Results generated by LISA are hypothetical in nature, do not guarantee future performance, and should not be relied upon as a guarantee of any specific policy result. These assumptions may not reflect actual future performance.

Policy values will fluctuate based on actual index performance, charges, cap rates, and other factors. Actual client experience will differ from these illustrations. Investment subaccounts are subject to market risk, including the potential loss of principal.