Should Your Clients Be Using Indexed Universal Life to Diversify Risk and Market Exposure?
August 3, 2010 by Marian Sole
- By Marian Sole
None of us have been immune to the global economic crisis. Whether it’s through a lost job, lost assets, or lost innocence about asset allocation, we have all been altered in some way.
The market conditions of the past two years have exposed unimagined vulnerabilities. Now, many of your clients may be newly risk-averse and seeking a wider range of options for protecting and growing their assets. These options need to address an array of issues, such as market and interest-rate volatility, the potential for rising taxes and inflation, and increased longevity.
As many have recently discovered, sole reliance on stocks for retirement and estate planning can be risky. Clients who experienced broad market losses will appreciate that diversification is not just about asset classes, but also products. The ultimate returns from investing in domestic equities, for instance, can vary significantly depending upon which investment is used — whether it’s a direct stock purchase, index fund, mutual fund, hedge fund, variable annuity, or variable life insurance. Each method protects and exposes clients to risk and upside potential in different ways.
As your clients and prospects race to recover from investment losses, they may also be running for cover against future losses. Many of them know they need to recapture the growth potential of equities, but may be wary of another severe decline in market performance. Some are staying on the sidelines, afraid to act. In this scenario, index-linked universal life insurance (IUL) can offer significant value in a well-diversified portfolio.
IUL combines the long-term protection guarantees of a universal life insurance policy with the cash accumulation potential of market index-linked options and a guaranteed floor in the event of a steep index decline — a blend of benefits vital to a long-term financial strategy. For some clients, it can offer the downside protections they need to get off the sidelines and re-engage in the growth potential of equities.
The advantages of taking an indirect route
Indexed life insurance products credit interest based on the upward movement of an equity index, whether it’s the S&P 500, the Russell 2000, or another broad stock index. These products are not securities. Purchasing an indexed life policy is not the same as investing directly in a stock market index, which is a key reason why it offers a compelling strategy for portfolio diversification. The policy cash value is based on the amount of premiums paid, the interest crediting rate, and the policy charges deducted.
Unlike investing directly in a market index fund, with an IUL, there is an upper limit or cap on the rate of return credited to the policy. The cap is usually set for each crediting segment, which is typically one year, but may also be a two, three, or five-year period. The credit cap will vary by segment period — the longer the period, the higher the cap.
Significantly, there is also a guaranteed floor on negative performance. While the floor can vary amongst products, typically if the market index of an indexed option loses value over a specified segment, the interest credit would equal 0 percent (the guaranteed floor), and the value of the indexed option would not decrease. The cap and floor work in tandem to capture a portion of the index’s upside potential while protecting policy values from the adverse effects of volatility.
Also worth considering is that indexed universal life insurance can credit higher levels of interest than a traditional universal life policy because the client can choose to base interest crediting on the movement of stock market indices rather than just receiving a fixed rate of interest.
Investing directly in an equity index fund, such as one linked to the S&P 500, can offer straightforward equity exposure with unprotected downside risk in the event of an index decline. An IUL policy, however, offers upside growth potential with a guaranteed floor to protect against a bear market. Unlike investing directly in an index fund, IUL offers these additional significant benefits:
- Immediate, affordable protection for family or business. The life insurance death benefit can help preserve a family’s quality of life or keep a business running.
- Income for retirement and other needs. Policyholders can access policy cash value through a tax-free combination of withdrawals and policy loans.
- Legacy planning/estate protection. Regardless of the performance in a portfolio’s non-life insurance investments, an IUL can serve as a way to help protect inheritances simply through the use of the death benefit paid to beneficiaries. It can also help satisfy estate tax obligations so more of an estate can be passed on to loved ones or a favorite charity.
- Ongoing flexibility. Within limits, many index-linked universal life products allow the policyholder to adapt the policy to adjust to changing needs, including changing premium payments, death benefit amounts, and indexed option allocations.
As we help our clients navigate a post-crisis world, diversification matters more than ever. But diversification is not just about asset classes. It also means offering a range of product strategies to help recapture growth and protect from risks. Some strategies will be new and require an open mind and a commitment to learning. Indexed universal life insurance may be one innovation worth paying attention to and understanding, for your clients’ sake.
Marian Sole is senior vice president of AXA Distributors LLC. She can be reached at email@example.com.