Since its inception, agents, marketing organizations, and even some general consumers have possessed the "average" interest rate credit adopted when projection indexed universal life insurance values. At one point, insurers used different periods of "looking back" – usually the one who showed their products in the best light – and regulators allowed these insurers to use whatever the average index-linked interest rate from that back. This created a scenario where many insurance companies assumed that their static interest rate for cash value was slightly in the range of 7.75 to 8.5%. This seemed high, but due to other functional aspects of the IUF, it also seemed to grossly overestimate how values can work.
We had a situation on our hands that confused how the "average" or arithmetic mean differed from the geometric mean. For several years, investment sales and marketing organizations used this difference to attract the less educated on the subject. The funny thing is that many in the insurance industry cried badly while Wall Street played dumb about the differences and their significance. But unfortunately, it seemed that with indexed universal life insurance, insurance marketers were just as willing to confuse the subject ̵
Attempt to govern in IUF assumptions
In the mid-twenties, regulators – on behalf of mostly entire life insurance-focused insurers – took up the issue of limiting IUF illustration creativity. We saw the widespread adoption of AG49 in 2015, and this began a long process of tempering indexed universal life insurance forecasts.
AG49 later introduced even greater restrictions that further dampened what one might assume in an IUF projection. And on occasion, economic conditions forced ceiling interest rates – and other indexing functions that affect the total accumulation of interest on the cash value – down.
Today we have IUC policies that can meet constraints on projected values that unrealistically dampen what the policy can actually achieve. Although I personally have no problem selling the results of a life insurance cash accumulation. I am concerned that this may lead people to make erroneous assumptions about indexed universal life insurance and its relative position in the market, among other savings options. Since the IUF has a slightly higher degree of "risk" – perhaps more appropriately labeled as variation – than a life insurance product as a whole life insurance, it is understandable to conclude that the IUU is only worth buying if its return is higher than the whole life insurance. Of course, the degree to which it must be higher is subjective. However, if illustration limitations are too aggressive to limit the expected return for an indexed universal life insurance policy, we may have a situation that allows "safer" adopted products such as lifetime to unfairly gain benefit.
Evaluation of Restrive Current Limitation on Indexed Universal Life Insurance Illustrations
We decided to look at a 50-year historical overlay of different indexing options within an indexed universal life insurance and compare what these results look like in the current illustration. . This is not the first time we have carried out such an analysis. But last time, our concern was exactly the opposite – that current methods may allow an overly optimistic assumption. Therefore, we used three indexing options available from a specific indexed universal life insurance product that is currently available for purchase. Using these different options was important because:
- It gives us greater insight into how different index functions work.
- They all have different maximum allowable index credit assumptions, and this allows us to look for a trend and test how well regulation governs these variations.
- It gives us a chance to evaluate our own practice of assuming that – for the most part – all indexing functions will give approximately equal results.
The three indexing options used were as follows:
- Standard one-year point-to-point S & P500 indexing account. This account used an 8% rate and a 1% floor rate.
- One-year point-to-point S & P500 indexing account with improved ceiling interest. This account used a rate of 10% with a floor of 1% but also had an extra cost charged to the cash value of the insurance.
- An unused S&P 500 index account with a spread of 9% and a floor of 1%. This means that the index credit was the change in the S & P500 value index minus 9%. If this adjustment brought the credited interest rate below 1%, the floor was used.
We also checked these results against a static interest payment of 5.5% per year.
Here are the results:
What I find most interesting about these results is how the index accounts differ from their maximum allowable indexing credit. They are as follows:
- Standard one year point to point: 5.46%
- Enhance (High) Cap one year point-to-point: 6.18%
- Unlimited with 9% spread: 5.53%
Given these results, the unlimited indexing account should have the highest allowable interest rate, but it does not. This is probably due to the "back-testing" method in the current regulation which focuses too much on the simple "average" index credit results. But for those interested, this is how simple averages come out during this time period:
- Standard one year point to point: 5.4%
- Enhance (High) Cap one year point-to-point: 6.5%
- Unlimited with 9% spread: 6.9%
So obviously even more adjustments are made, otherwise the maximum allowed on the unlimited option is simply lower than it needs to be. Note, I am aware that further adjustments play a role based on the insurer's average overall account return.
How we use geometric averages to choose assumptions about average interest rates
When insurance marketers assumed index credits around 8%, we were convinced that 6% was a much more realistic assumption. This was not based on any form of backtesting for an average index credit, but instead derived a number that accurately tracked a target annual growth rate of cash value – in fact the same as the internal rate of return (IRR) we discuss it with insurance. This, we argued, was a much more accurate way of projecting IUF cash values. we still strongly believe in this.
Note from the table above that the static assumption of 5.5% IUF has an internal return that is lower than all indexing functions. This happened even though the current regulation – which is interpreted by this specific insurance company – does not allow an assumption that is so high for standard S & P500 point-to-point account. This is because the timing of index credits and the fact that the cash value in some years will grow at a rate higher than 5.5% is important.
To arrive at the same IRR from the standard point-to-point indexing option during the same time period, we must use a static interest rate accumulation of about 6.3%.
Although we strongly believe that it is wise to dampen expectations with indexed universal life insurance, we also believe that it is possible to go too far with this product and any other strategy one may have for the future. The above analysis shows us that the IUF has good chances of producing higher returns than what is currently allowed for illustrations of life insurance. Although there are some reasonable arguments that this is a net positive. We think it is wise to strongly warn that this may be an over-correction from a time when assumptions were too optimistic.