Indexed Universal Life Takes the Insurance Market by Fire

Posted: 3 January 2020 4:20 pm
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A new universal life insurance policy is growing in popularity, despite its not-so-apparent risks.

With the stock market hitting new heights daily, many are looking for a way to cash in. In the insurance world, a new way to milk this unprecedented gravy train has emerged and caught wind, to the dismay of regulators.

Indexed universal life has emerged as one of the most in-demand insurance products in the United States. Per the Wall Street Journal — citing data from the research firm Limra — a quarter of all insurance sales in the first nine months of 2019 were for indexed universal life. This is a 205 increase from 2014 and a five-fold increase from 2008.

Indexed universal life is a derivative of variable permanent or whole life insurance. Like all permanent life insurance plans, indexed universal life stays in effect for the life of the insured — as long as the premiums are paid. All universal life policies have a death benefit that is set by the policy and is paid upon the death of the insured and a savings component known as the cash value, which grows with time. While this cash value typically grows either at a set rate or as a function of the equity accounts it is invested in, indexed universal life policies’ cash values are indexed to a specific index, like the S&P 500 or the NASDAQ 100.

As — unlike a variable permanent life policy — the money is not actually invested in the equity accounts, and as variable permanent life policies typically have a minimum growth rate in case of declines in the market, indexed universal life insurance plans are typically sold as safe bets. This, unfortunately, is not true, and the complexity of the product may be belying the policy’s risks.

Understanding Universal Life

Part of the problem with indexed universal life is the “universal life” part. Essentially an automatically renewable one-year term insurance policy with a tax-deferred savings account attached, universal life policies were created in the 1980s to take advantage of the sustained run of high interest rates. The savings account — which is meant to pay part of the cost of renewing the policy annually — was meant to gain significant value against the skyrocketing interest rates, turning insurance into an investment vehicle.

When interest rates dropped in the 2000s, premiums shot up, as the savings account could no longer defray the cost of the policies. This is compounded by the fact that the longer one holds onto an insurance policy, the more the insured will have to pay in premiums due to advancing age.

With some insurers offering enticements such as “multipliers,” which offers higher interest rates at a higher premium, there is a danger that consumers may buy into a product that they do not fully understand. In a down market, for example, despite the minimum promised rate, some indexed universal life customers may find themselves looking at a policy that has grown unaffordable, but is also losing its cash value.

Different insurers use different methodologies in determining rates, making these policies harder to judge. It is not uncommon, for example, for indexed universal life policies to have a maximum interest rate, which prevents policyholders from fully taking advantage of a bull run. Others use a “participation rate,” where the policy pays a set share of the designated index’s gain. The insurers, however, typically retain the rights to change rates, within industry-approved limits.

It is advised that a prospective investor take the time to carefully consider the risks involved in signing up for any universal life policy. It may be that it is a better bet, for example, to choose a whole life policy and just set up a high-yield savings account.

“We joke that it takes an actuary, an attorney and sometimes an engineer to understand the calculations,” Billie Resnick, co-author of an American Bar Association book on life insurance, said to the Wall Street Journal.

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