More random thoughts on indexed universal life insurance

by David Lewis

What’s the point of owning a life insurance policy if the insurer can legally (by contract) shift all the risk back onto you?

That is a very good question.

One I’m not answering today.

What I want to answer today is a question I’ve seen crop up over and over and over again.

Sometimes when I introduce the idea of whole life insurance, folks are instantly unsatisfied with it… and so they go searching for something better. And that something (they are told) is indexed universal life insurance.

Indexed universal life insurance is a special type of universal life insurance that uses exotic investments called “options contracts” to try to credit more interest to the policy’s cash values than you’d normally get from a fixed interest policy, like whole life.

It’s not exactly a mathematical certainty that this setup will work out well for the policyholder, and there’s a lot of pressure to show really high returns, which is why there are no explicit guarantees on cash value growth (side note: there ARE minimum guaranteed gross crediting rates, but maximum mortality and expenses charges are also guaranteed to be higher than those rates).

OK… now we’re getting deep into the weeds… so… proceed with caution…

Every one of these contracts looks great on the surface (yay marketing department!).


… There are a few ways insurers can inflate the earnings rate on the insurance policy illustration which are totally confusing for the average person to understand. And… when this confusion happens… it happens in such a way that you (the client) start to assume that you’ll get something which you may not actually get.

Ex: Insurers set aside a budget for the underlying investments that make the indexed UL policy “go.” If the budget runs out, they can’t buy any more the underlying investments… unless… they increase the internal costs of the policy… which they can do because the entire contract is non-guaranteed.

And insurers will do this to subsidize higher cap rates… which will allow them to show higher interest rates… which shows more interest being credited to policy cash values… which insurance advisors are more than happy to show clients.

Now… maybe you think Uncle Gluten is being paranoid or biased or a little too hard on the insurance companies.

Here’s what I suggest you do: go look at an insurance company’s indexed ANNUITIES. What is the cap rate on their basic indexed annuity (not one that promises a “roll up” or special systematic withdrawal privileges, called a “2-tier annuity,” but rather a basic indexed annuity)?

The reason you’re looking at annuities is these things don’t have a life insurance death benefit (cost of insurance) embedded in them.

Whatever a company’s indexed annuities are paying… THAT is your clue as to the REAL earning potential of the company’s products… partially because annuities are much less expensive to put together and manage than a universal life policy… you can see what the company is willing to pay when the cash value to death benefit ratio is 1:1 versus 1:5 or 1:10.

The “trick,” if you want to call it that, is an insurer can show a higher GROSS interest rate on an indexed UL policy’s cash value but its NET return on cash value will be what you earn after deducting all the costs of insurance… this is why you see annuity rates mirroring the NET cash value rates on life insurance… annuities cap out earnings at a lower interest rate whereas the indexed ULs show gross interest rates and fees and let you do the math yourself.

So the long-and-short of it is… the average indexed life insurance policy looks like it could produce a long-term return of between 3% and 6%, net of fees. Maybe there’s a policy out there that can average 7%, but that seems pretty high given where interest rates are and what insurers are paying for options contracts these days.

By the way, this idea is also true when it comes to whole life insurance.

That’s why I usually suggest people buy from a MUTUAL insurer so they get the low guaranteed interest rate (which mirrors fixed annuity rates) + all the profits of the insurer (the dividends, which is where most of the cash value growth comes from).

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About David

David Lewis is a licensed life insurance agent, and has worked in the life insurance industry since 2004. During that time, he has worked with some of the oldest and most respected mutual life insurance companies in the U.S. To learn more about him and his business, go here.