“If the world were perfect, it wouldn’t be.” Yogi Berra
As another exciting World Series finishes up, seems fitting to open an overview of indexed universal life insurance with a classic quote from the late New York Yankees legend. Because Yogi nailed it. Even when things are going super well, the universe may have other, potentially painful events for us.
Certainly, we need to protect against the unexpected. But we also should plan for things we can anticipate or all-out expect, such as funding a retirement or healthcare expenses in our old age.
Moreover, a lot of us who came up during the Great Recession of 2008-9 still worry about market volatility too. We like the greater return potential market exposure provides to help grow a financial strategy, but we’re also aware of the risk of loss of principal that comes with direct exposure to the market. Burned once, we’re twice cautious.
Wouldn’t it be nice if we could protect our families against the unexpected, while still having the potential to accumulate cash without the risk of market losses?
Indexed universal life insurance (IUL) can help meet all these goals.
What is IUL
Foremost, it’s life insurance. The premiums pay for a permanent tax-free death benefit1 as well as other features found in most universal life products, such as:
- Flexibility in coverage and premiums, so policy owners can adjust them, up or down, as situations change.2
- Access to the death benefit through “living benefits,“ which can provide a resource in the event of a serious, qualifying illness.3
- Opportunities to take loans or withdrawals from the policy’s cash value that, if sufficiently funded, can also pay for emergencies or even help reduce premiums.4
- Potential to generate a retirement income stream to last a lifetime using a life insurance income rider.5
To help back-up many of these features, IUL insurance accumulates cash value. How it does this, however, makes it very different compared to other types of policies like whole life or traditional universal life.
What “Indexed” Means
IUL offers different options to allocate policy premiums. Known as an indexed strategy, each is designed to credit interest based, in part, on changes in a market index, such as the S&P 500 benchmark. If the index goes up, an index credit may be earned, but if it goes down, values are protected from loss due to the index’s decline.
Protection from Loss
This is the cool part of IUL ─ no downside. Most IUL products guarantee that if the market drops, the index strategy will never earn less than a 0% credit.6 This “0% Floor Guarantee” is usually a built-in feature at no additional charge. In exchange for some upside, some policies include a 1% Floor Guarantee option if clients want even more downside protection.
Earning 0% may sound like not gaining anything. But by not losing, this has historically provided an advantage compared to investing directly in the market. With interest being credited when the index is up, but not losing money due to a decline in the index, it doesn’t take many down periods for the indexed strategy to compare favorably even though the upside potential of the indexed strategy is limited.
Giving Credit Where Due
Without getting too far in the weeds, index credits don’t go to the policy’s entire cash value. Rather, they are applied to individual indexed segments, which are created every time premiums are swept into the index. This happens after 12 months of policy expenses are held separately in a fixed account. The net premiums are then moved into the index strategy or strategies chosen by the policy owner. A common time period for a segment is about 12 months, at which point the insurer compares the value of the index at the beginning to the ending date of the segment (typically called a point-to-point strategy).
In theory, a policy can have a lot of segments, each receiving its own credit amount. This could be a plus too, because it spreads out the interest crediting over different cycles that an index might experience.7
Participation Rates & Caps
Strung together, these sound like the preamble to a Harry Potter spell, but they’re not at all mystical. They’re just parameters to determine how much of an index return ends up as interest credited to the policy.
Here’s what you need to know about them:
- A participation rate tells us the maximum percentage that an indexed strategy will share in the positive changes of its index. So, if the S&P rises 10%, a 60% participation rate for an S&P indexed option would limit the credit to 6%.
- A cap is just the maximum interest that may be credited. For example, a 10% cap means that 10% is the most the chosen indexed strategy will ever be credited, no matter how high the market goes.
Generally, these guidelines are put there to help insurance companies efficiently price and manage their policy’s index options in a sustainable way. Issuers often provide additional incentives, such as no cap limits or participation rates greater than 100%, on certain indexed strategies as well.
Planning for life’s uncertainties is a lot like baseball, which is the only sport where the team controlling the ball is actually on defense. We may think we have everything under control, but we have to be ready to field anything that can alter our world in a heartbeat.
To determine if indexed universal life insurance is right for you, it’s
important to weigh your options. Most importantly, speak with a financial
professional to make an informed decision.
Yogi said it best: “you can observe a lot by just watching.”
Indexed universal life policies do not directly participate in any stock or equity investments.
“Standard & Poor’s®”, “S&P®”, “S&P 500®”, and “Standard & Poor’s 500™” are trademarks of Standard & Poor’s and have been licensed for use by National Life Insurance Company and Life Insurance Company of the Southwest. This Product is not sponsored, endorsed, sold or promoted by Standard & Poor’s and Standard & Poor’s makes no representations regarding the advisability of investing in the Product. The S&P Composite Index of 500 stocks (S&P 500®) is a group of unmanaged securities widely regarded by investors to be representative of large company stocks in general. An investment cannot be made directly into an index.
TC110771(1019)P
[1] Internal Revenue Code § 101(a)(1). There are some exceptions to this rule. Please consult a qualified tax professional for advice concerning your individual situation.
[2] It is possible that coverage will expire when either no premiums are paid following the initial premium, or subsequent premiums are insufficient to continue coverage. Increasing coverage requires additional underwriting approval.
[3] Living benefits are provided by no-additional premium accelerated benefit riders. Payment of Accelerated Benefits will reduce the Cash Value and Death Benefit otherwise payable under the policy. Receipt of Accelerated Benefits may be a taxable event, may affect your eligibility for public assistance programs, and may reduce or eliminate other policy and rider benefits. Please consult your personal tax advisor to determine the tax status of any benefits paid under this rider and with social service agencies concerning how receipt of such a payment will affect you. Riders are supplemental benefits that can be added to a life insurance policy and are not suitable unless you also have a need for life insurance. Riders are optional, may require additional premium and may not be available in all states or on all products. This is not a solicitation of any specific insurance policy.
[4] The ability of a life insurance contract to accumulate sufficient cash value to help pay expenses or meet accumulation goals will be dependent upon the amount of extra premium paid into the policy, and the performance of the policy, and is not guaranteed. Policy loans and withdrawals reduce the policy’s cash value and death benefit and may result in a taxable event. If remaining policy values and scheduled premiums are insufficient, additional out-of-pocket payments may be needed to keep the policy in force. Surrender charges may reduce the policy’s cash value in early years.
[5] Life Insurance income riders typically have limitations and restrictions to exercising them, including but not limited to, minimum and maximum age requirements, years policy has been in force and minimum policy values. Receipt of other policy benefits that reduce policy values may also reduce the ability to exercise the income rider. Receipt of income benefits will reduce the policy’s cash value and death benefit, and may reduce or eliminate the availability of other policy and rider benefits.
[6] Monthly deductions continue to be taken from the account value, including a monthly policy fee, monthly expense charge, cost of insurance charge, and applicable rider charges, regardless of interest crediting.
[7] This helps reduce interest rate risk associated with one annual crediting anniversary, but it does not, however, guarantee an advantage over an annual crediting method.
