My heretical thoughts on indexed universal life insurance

A while back, a self-proclaimed financial expert (who is also a lawyer in real life) emailed me (after I downloaded a whitepaper of his) to tell me my simple approach to financial planning was very lazy and not client focused.

He also told me the consumer is basically stoopid and needs to be told what to buy and then blocked my email from his servers. I don't understand why people don't trust these folks.

¯\_(ツ)_/¯

Anyway, this kind of thing is pretty common in the industry.

A good deal of financial planners think their clients are idiots, which is why some of them engage in deceptive marketing practices. Don't get me wrong. These advisors aren't screwing their clients over to make money. They're screwing their clients over because:

1) They're sociopaths or;

2) They're "type A" personalities who have a supercharged personality and are essentially on a massive power trip. They actually love the feeling of being in control, and even in control of other people and in my own personal (non-professional) opinion, they "get off" on it. They can't live without it. And, to feed their need to control others, they resort to dishonest and manipulative tactics.

It's not about the money for them. It seems like it should be because they tend to make oodles of money. But, money is not really they goal. Their goal is power and control.

I don't even have to provoke these people anymore. I just sign up on their email list to do a little competitive market research (see what the competition is up to) and wait...

They end up coming to my website... get their panties in a twist... and then tell me all about it.

Often, they find me because I publish a lot of articles, essays, and other stuff about life insurance. 

I'm easy to find.

By the way... this JD/financial planner is a YUGE advocate of indexed universal life and believes whole life sucks.

His problem with me was that I do not advocate indexed life for most people.

Why?

Other than being overly complex... it's an assumption-based product.

Which means... the insurer assumes it will work out one way... but they make no guarantees about it.

Many years ago, I had the good fortune of meeting and corresponding with Jason Konopik.

He be one of the leading life insurance actuaries in the industry. He has personally designed, or helped design, many of the indexed universal life products on the market today... and knows exactly what the limitations of them are... what profit targets these insurers need to hit to make those products work... and so on.

Anyway, he emailed me a bunch of his own personal spreadsheets and we chatted on the phone at great length.

Some of the information is nonpublic and I'm sworn to secrecy.

But... here's what I CAN tell you.

What he said then... and what he still says today (publicly)... is "IUL has incredible potential but it's a non-guaranteed product... Insurance companies will not lose money on a non-guaranteed product."

And... what stuck out in my mind was his warning, "buyer and agent beware."

Yeesh.

Anyway, if you are wooed by an IUL salesman, then I say best of luck to ye.

Everyone else, embrace the simplicity...

UPDATE: If you give some people a long enough rope, they will eventually hang themselves with it.

As luck would have it, this guy contacted me again after 2 years, and we had (almost) the exact same email conversation as before. Except... some of the details changed. Back when I originally wrote this blog post, the lawyer dude had criticized some life insurance companies for screwing over their clients in the past.

Anyway, back on March 3rd, 2017 @ 11.29AM, he writes:

Now, what WL cool aid drinkers will say it that there are too many variables with IUL. That the insurance company could do this or that to screw the client. That is true they could, but again, we have a substantial track record of what insurance companies selling IUL actually have done. Some did screw their clients (look at F&G).

And, then, today, he writes:

My point was that all companies (including WL) will do what they need to do to be profitable...

...I said insurance companies will always figure out a way to stay profitable.

I didn’t say that by the IUL designs at the companies I recommend are ones I think will screw the client to be profitable.

If they did, I would tell agents not to use IUL.

So... he's not going to recommend IULs or insurance companies that will screw over their clients. Presumably, this includes companies that don't have a track record of hosing their policyholders either. Then, he lays this on me:

F&G has the simplest product with a published renewal history of their SPY cap that is better than any other company.

And when I asked him about our conversation 2 years ago:

F&G as a B+ rated carrier two years ago. They were bought out and their rating went to A- so I’m ok with them now and I like the firm that bought them.

There is nothing inconsistent with my choice of companies.

Wait. Is F&G a good carrier or one that has screwed over their policyholders?

Or, does he think that now that they've been bought out, they turned over a new leaf and are completely reformed? I don't have any personal experience with F&G Life and I'm not here to talk down on the company or speculate on what they have or have not done, but rather to point out what is obviously a rationalization on the part of this JD/"advisor".

I think if you were a policyholder, you'd want to know the advisor is making a good recommendation from a company and not flip-flopping on said company over a span of 2 years. If you wouldn't recommend a company 2 years ago, but you would today, that says something about the nature of your recommendations and also the industry. Namely, that what are supposed to be solid recommendations you can rely on are rather shaky and can change very quickly.

I do realize companies change and maybe a company stops offering a good product. That's fine in most industries but... it's a real problem in the life insurance industry. People don't buy cash value life insurance policies for the short-term. They buy them for the long-term — like 30 to 50 years or longer. And, if an advisor really and truly believes a company has had a bonafide history of hosing its policyholders, it's probably not a great idea to routinely recommend them. Or, if you do, have a really good reason for doing so that doesn't involve hypothetical future rate of return projections.

Let's talk about that for a moment.

The rate of return on an indexed universal life policy is intimately tied to how much money an insurance company can devote to the underlying investments that power the policy. In this case, it's options contracts. Stock options are how life insurers promise "the upside potential of the stock market" and the insurer's general account (which is comprised of a very specific mix of bonds and other income-producing assets and businesses) with downside protection.

But, in order to provide this sort of promise, insurance companies have to trade in options contracts. Those options cost money — a lot of money. To give you an idea of the kind of money... if an insurance company has an options budget of about 3%, then it can afford to give policyholders a 5.8% cap or a 52% participation rate. A 10% cap rate on an IUL would cost about 4.5%.

The cost for these cap rates is constantly changing due to a variety of factors. Bobby Samuelson keeps tabs on these changes monthly, and publishes an IUL benchmark index. If you look on the chart, you can see what sort of cap rate, participation rate, and budget the insurance company can offer given current market rates for bonds and derivatives. In the long-run, the market cap and par rates is where everything is headed. Don't let an agent tell you otherwise. Nothing can defy market pricing——not even smooth talking life insurance agents.

Most insurers today are desperately trying to offer cap rates higher than 10%. A cap rate simply refers to the amount of upside the insurer can afford to give policyholders. So, on a cap rate of 10%, if the stock market does 8%, the policyholder gets 8% credited to his policy, less cost of insurance and other policy charges. If the stock market does 12%, the cap kicks in and the policyholder caps out at 10% crediting to the policy, less cost of insurance and other policy charges.

In today's economic environment, insurance companies can only really afford a 5.8% cap, but many of them are offering caps in excess of 10%. How do they do this?

Magic.

No, no... no magic. They are doing it because they are subsidizing those cap rates through various means. Some companies assess higher policy charges to policyholders to make up the difference and some are using older blocks of business to subsidize newer business and some are using a somewhat dubious practice called "mean reversion pricing" — they are hoping that options prices and interest rates improve so that current losses on their indexed universal life business are erased in the future.

Yes, some insurers really do that.

By subsidizing the caps, insurers can delay reducing the cap rates. But, make no mistake, it's only a delay. Eventually, cap rates must come down. And, when they come down, it may not be without some pain. See... if an insurance company is "coasting" on a cap rate (or participation rate) that they cannot really afford, then... they're going to probably have to "overcorrect" for previous financial gluttony. Of course, maybe rates will rise before the hammer falls, and maybe options pricing will revert. But... that's an awfully big risk to take with your policyholder's money and in a contract which is supposed to mitigate risk, not increase it.

So, anyway... a reasonable way to illustrate an indexed universal life policy over the long-term is to illustrate it at maybe 0.50% to 1% over long-term bond rates or fixed interest UL products. At today's rates, that puts you between 4% and 5%.

Public companies, like F&G, get bought out for a variety of reasons. When a B+ rated insurance carrier gets bought out and then their ratings increase as a result, that obviously looks good, but it also obscures the fact that they were B+ rated for a reason.

As a policyholder, you have to be able to buy a cash value life insurance product and hold onto it for 50+ years. If you can't do that because you can't trust the insurance carrier or because you don't have the gumption to stick with it, then don't buy the policy. And, if the policy goes sour on you 3 years into it, switching can be expensive... which is why, regardless of which carrier you choose, you should choose one you don't mind being married to for (literally) the rest of your life, depending on the company (there are some whole life contracts that are competitive with IUL, and some that can blow it away).

And here's where IUL becomes a thorny long-term proposition.

It is often pitched as a "sexy" life insurance product (by both insurance companies and life insurance agents)... a product you can goose with lots of premium, ride the stock market upswing, and then dump (or exchange for another policy) if things start to go south. But, in my mind, this is crazy. It turns life insurance into a game of speculation instead of it being a safety net and protection against the unexpected and unpredictable. And, that's why I remain very skeptical of indexed universal life.

A few closing thoughts:

The JD summed up his opinion on the future of IUL:

If you talked to most actuaries that design IUL they will tell you they are designed to return around 6% over time.

Could be 5% could be close to 7%.

I think that’s where the numbers would be 6.5-7% but for this crazy 11 year bull run.

The next ten years might not be that great which could bring a 5.5% return.

At that, they will still compare well to other ways to grow wealth.

A 5.5% return is good, but the same type of return is also possible in whole life insurance, with much less risk. That's not to say whole life insurance will return that much, but historically it has done that so we know it's absolutely possible.

In fact, some whole life policies historically have returned more than 6% net if designed specifically for high cash value accumulation (a true IRR of 6% for you finance geeks). A lot of it depends on the future of bond interest rates, bond prices, the insurance company's alternative investment portfolio, and the future business operations of the mutual life insurance companies (including savings from underwriting and operations).

Again, the future is uncertain, which is exactly why whole life insurance makes so much sense. You could speculate on indexed universal life insurance being better than whole life. That's up to you. It might work out. It might not.

Me? I like the certainty of whole life.

David Lewis

This post brought to you by //The Rogue Agent//. David has been a life insurance agent, and worked with some of the oldest and most respected mutual life insurance companies in the U.S., since 2004. Learn more about him and his business, here.

This post brought to you by //The Rogue Agent//. David has been a life insurance agent, and worked with some of the oldest and most respected mutual life insurance companies in the U.S., since 2004. Learn more about him and his business, here.