Indexed Universal Life – Will it live up to the hype?

Is Indexed Universal Life Too Good to be True?

HOW IS INDEXED UNIVERSAL LIFE PROMOTED?

Tax-efficient investment

• Indexed Universal Life is being promoted by insurance companies, Insurance Marketing Organizations, and agents more as an investment than as insurance. The marketing material leads one to believe that this is an investment, even though the illustrations are required to point out that this is primarily an insurance product. I have seen terms such as ‘asset class’, ‘tax-advantaged cash growth’, and ‘protected from negative earnings’. Additionally, agents are taught to run illustrations are based on depositing the maximum Non-MEC premium so as to maximize the ‘tax advantaged’ savings component.

• Tax-free withdrawals

  How are many illustrations run? Large Non-MEC premiums, maximum legally allowed illustrated returns, and current charges for COI and admin charges. And at retirement, a policyholder can start withdrawing large amounts of money to supplement their retirement income. And these withdrawals are ‘tax-free’.

• Downside protection

  The marketing material essentially says that a policyholder can ‘enjoy a portion of the market upside but get protected from negative returns’. Almost sounds too good to be true.

• Summary about the promotion of Indexed Universal Life

  Who wouldn’t want:

  • tax deferred growth
  • tax efficient income
  • downside protection
  • tax free death benefit

Are IUL contractual provisions being obscured in the marketing material and on illustrations?

• Costs – COI, Admin fees

Cost of Insurance (COI) are illustrated at the current level and insurance companies remind us that mortality rates are improving. However, several insurance companies have increased the COI on older blocks of business. Administration fees can also be increased as the company sees fit.

• Participation rates and caps

Illustrations use the current rates and caps throughout the entire illustration, when in fact these can be changed anytime by the insurance company for pretty much any reason. Here is a quote from page 16 of 86 of an illustration package: “…Life can change the growth cap for any reason, including changes in the market and the impact it may have on our profit margins”.

• Overloan Protection Rider (OPR)

Remember the claim that you can make tax-free withdraws to supplement your retirement? It only works if you don’t lapse the policy. The Overloan Protection Rider is designed to prevent the policy from lapsing due to excessive loans. If a policy lapses with a loan that is greater than the premiums paid the the ‘gain’ will be treated as ordinary income for tax purposes.

There are technical requirements to put these riders in effect. Here is a sampling:

• you must contact the company in writing
• you are at least age 75
• your policy has been in force a minimum of 15 years
• it must not cause the policy to become a MEC or cause the policy to fail to qualify as life insurance
• the ratio of debt to policy value must between 95% an 99%

IRS non-rulings on Overloan Protection

Although the companies have presented the OPR as a way to prevent a lapse and hence prevent the creation of a taxable event; they are forced to admit that “exercising the OPR has not been ruled on by the Internal Revenue Service (IRS) or the courts. Therefore, exercising the OPR may be subject to challenge by the IRS because it is possible that the loans in excess of the cash value may be treated as taxable distributions.”

Real world issues with regards to cash value life insurance

The flowery illustrations only work out if the company keeps costs at current levels for an extremely long period of time (20-40 years); the company doesn’t lower caps or participation rates for an extremely long period; and the policyholder keep the policies for this long period. Is this likely?

Consider the following:

• Lapse rates on cash value life insurance are high according to LIMRA and The Society of Actuaries. The ten year persistency is:
  • universal life 61%
  • whole life 63%
  • indexed universal life too early to tell
• Low 10 year persistency combined with surrender charges during the early year means almost guarantees that  approximately 40% of policyholders will experience actual rates of returns from (-100%) to 0%.
• Multiple companies have increased the COI on certain blocks of business
  • The marketing departments of life insurers remind us that mortality rates are improving. So why would COI rates increase? And yet several companies have recently raised COI rates. Here is a partial list of companies that have raised COIs lately:
    • Lincoln Financial on Jefferson Pilot and Aetna plans
    • Axa on US Financial plans
    • Voya (formerly ING)
    • Transamerica
    • Prudential PLC on Jackson National plans
• Caps and/or participation rates are changed
  • Here is a real life example on a indexed universal life I purchased five years ago: The first opportunity (fifth year) to change the cap it was lowered from 11.25% to 9.75%. I wonder what that does to the projected values from the original illustration. I am still waiting for the illustration as of today (4.12.2017)
• Industry-wide abuses

Consider the Vanishing Premium lawsuits from the 1990’s. In the 1980’s many whole life plans were paying substantial dividends. The dividend scale was so good that if this trend continued forever (the time period life insurers like to illustrate) policyholders may be able to use the dividends to “pay up” the policy early. It could even be ‘paid up’as early as seven or eight years, according to the illustration books the insurance companies provided agents. Of course the trend didn’t keep on going. So many policyholders had to pay premiums longer than they were told/sold. This lead to a rash of litigation and settlements against some of America’s most ‘respected’ life insurers such as New York Life, MetLife, Prudential, John Hancock, Transamerica, Great West, and Jackson National.

Conclusion?

Is it reasonable to expect this insurance product to perform as promoted in the marketing material and sales illustrations?