31 May 2013 0 Comments

Understanding Indexed Universal Life (IUL)

income schoolThis is my fourth consecutive entry on IUL.  That’s a lot of information on one policy type, but since IUL is receiving so much push from insurance companies and agents—and—since it has so much potential as well as so much room for misunderstanding, a potential buyer should be aware of what to look for.

The best way to learn about IUL is to obtain an illustration of how the policy might work for you.  With an illustration you select a premium and face amount and using your age and underwriting class you will likely be able to see how the policy performs based on three scenarios:

  • Guaranteed interest and charges
  • Current charges and historical interest
  • Mid-point charges and interest.

But, there’s much more than that to the illustration which typically includes 20-30 pages of small print.  There are so many moving parts to IUL that it becomes very difficult to analyze.   Reading the illustration in its entirety is something you are not apt to do.  Most agents have probably not read it from cover to end.  What you do need to be aware of is that, although the IUL cash value is tied to the performance of outside indexes such as the S & P 500, Dow Jones Industrial Average  or NASDAQ 100, it will never match these indexes exactly.

The policy’s contractual provisions that will affect how closely you track an index are:

  • The Cap Rate
  • The Floor Rate
  • The Participation Rate.

The Cap Rate limits the maximum that will be credited to your policy in any given measurement period.  If the index being tracked is the S & P 500 and it gained 17% in a given year, if your policy has a cap rate of 12% that is the maximum you will earn.  The cap rate may have a current cap of 12%, but the guaranteed cap rate will probably be much lower, possibly around 2-3%.

The Floor Rate is typically 0%.  This means that if the index shows a loss of 8% in a given year, the policy’s cash value will remain unchanged from the prior year (subject to reduction for other policy charges).

The Participation Rate indicates what percentage of the index is credited.  If it is 100%, then an index with a 9% growth will be credited with 9%.  With a participation rate of 80% the amount credited would be 7.2%.  If the participation rate is 140%, then the amount credited is 12.6% (or 12% if that is the cap rate).  Once again, the current participation rate may be guaranteed, or there may be a lower guarantee.

Yet another consideration is that IUL’s will have a fixed interest account that might have a guaranteed minimum crediting of 2% and a current crediting of 3-4%. Because so many policy factors are changeable and could affect the amount credited, it’s probably safest to assume the illustration’s Mid-point cash values for planning purposes.

I’ll wrap up my IUL treatise on the next entry.

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