Understanding Indexed Life Illustrations
May 15, 2019 by Sheryl J. Moore
At what rate do we illustrate the cash value growth of indexed life insurance products?
This is a question that has plagued the life insurance industry since indexed universal life (IUL) was developed in January 1997. The National Association for Insurance Commissioners (NAIC) adopted the life insurance illustration model regulation two years before the development of IUL; it did not address how one should illustrate these unique products promising downside protection and upside potential. So, how should one illustrate indexed life?
Insurance companies did their best to interpret their responsibilities, as it relates to the illustration regulations. As a result of the gap in guidance with the existing NAIC’s life insurance illustration model regulation, insurance companies developed a method for determining illustrated rates on indexed life themselves. They used their own discretion for illustrating “reasonable” expectations for non-guaranteed current values on indexed products for nearly 19 years. The most obvious problem was that there was no uniformity in companies being given their own discretion to determine illustrated rate lookback periods. At one time, there were ten different methods that insurance companies used in determining the rate at which IUL illustrations should be run! The more important matter, however, was that there were IULs being illustrated at rates in excess of 10.00%. Given that Variable UL was being illustrated at a rate of 8.00% or less, the industry called for reforms.
Eventually, the American Council of Life Insurers (ACLI) stepped-in, and attempted to obtain consensus in the life insurance industry on the matter of indexed life illustrated rates. The work done with the ACLI was the basis for the NAIC’s Actuarial Guideline 49 (AG49) regulation, which provides guidance on indexed life illustrated rates. There were initially two phases of AG49: the first leg addressed maximum illustrated rates in September of 2015, and the second addressed loan rates in March 2016.
To simplify matters- under AG49, the maximum illustrated rate for any indexed life indexed crediting strategy cannot exceed a historical lookback rate of the product’s S&P 500 annual point-to-point strategy, assuming 100% participation rate, with a cap but no spread rate, and a floor of 0.00%. The lookback rate is determined by averaging the annualized rates from all of the 25-year rolling periods over the past 65 years of S&P 500 index returns. It is important to note here that two insurance companies with different S&P 500 annual point-to-point caps will calculate different maximum illustrated rates. More on that later…
Ultimately, AG49 reduced the maximum rate at which indexed life was illustrating a mere 0.95%.
An Oversight in the Regulation
There were loopholes with the standards set by AG49. In May 2015 the indexed life market was marked by the addition of the very first “buy-up caps” in the industry. Simply stated, “buy-up caps” gave indexed product purchasers the ability to have higher caps, in exchange for an annual account value charge. Effectively, this gave the insurance company the opportunity to subsidize their options budget. So, where an IUL purchaser may normally have a 12.00% cap, a buy-up cap may provide the option for a 15.00% cap, in exchange for an annual fee of 1.00%. Would the client receive 15.00%? Maybe. Maybe not. Would they experience an additional charge of 1.00% each year? Absolutely. This innovation gave insurance companies the opportunity to increase their illustrated rates under AG49. It also resulted in insurance companies charging the policyholder as much as 6.00% annually, just for higher caps (and therefore illustrated values).
Product Development is Ahead of Regulation
Yet again, product development was ahead of regulation with AG49. The month before the first phase of AG49 was instituted, an insurance company introduced a “multiplier” on their IUL, which multiplied any indexed interest earned by [10.00%]. While this was not reflected in the “illustrated rate,” of the illustration, the non-guaranteed/current values of the illustration took the multiplier into effect. So, although the illustrated rate may be [6.00%], the cash values may be reflecting a rate of [9.30%] if there is a [50.00%] multiplier on the policy (6.00% x 150% = 9.00%). Most salespeople don’t understand this, but more worrisome is that most distributors don’t either. Many multipliers now have an annual account value charge for the feature. This has resulted in insurance companies charging the policyholder as much as 7.50% annually, just for the multiplier alone.
And this is all in addition to the charges for the life insurance. Typically, indexed life charges are 10.00% – 20.00% of the premiums paid on a maximum non-MEC (Modified Endowment Contract) cash accumulation solve. Take those charges, and add-in any buy-up cap charges and multiplier charges, and what do you get?
Today, the charges on IUL are as much as 121% of the premiums paid, depending on the company and product.
It is important to remember that we are discussing non-guaranteed/current values on an illustration (or what I call “best case scenario”). It behooves us all to remember that some insurance companies have actually increased their insurance charges on inforce blocks of universal life policies. It is also relevant that insurance companies have not been afraid to reduce their caps/participation rates, or increase their spread rates, on inforce indexed life business. Could the annual fees for buy-up caps increase? You bet. Could the caps afforded through the buy-up options go down in years 2+. Yep. Could multipliers be reduced, once the policy is inforce? Without a doubt. Could those inforce charges increase? You betcha.
Indexed life is a fabulous product. It provides an invaluable ability for the purchaser to earn more than the paltry 3.56% average rate being credited on traditional UL today, while still protecting them from market risk. However, it has never been more important that the advisor/agent selling indexed life understand what they are putting in front of their client. What you see is not what you get! Prepare your agents, so that they can be educated on what they are presenting to their clients.
Sheryl Moore is President and CEO of Moore Market Intelligence, an indexed product resource in Des Moines, Iowa, as well as the life and annuity market research firm of Wink, Inc. Her companies provide competitive intelligence, market research, product development, consulting services and insight to select financial services companies. She may be reached at email@example.com.