In part one of this discussion, we discussed 10 myths about IUL. Now that we’ve dissected those myths, we can get to the truth of why you shouldn’t buy (or sell) indexed universal life insurance.
Insurance companies have put many pages in the front of Equity Indexed Universal Life (EIUL) illustrations that describe the issues we’re going to discuss, yet most people (by design) will not take the time to read and understand what these pages are saying. Unfortunately, this is where much of the misinformation stems from. People insist that IUL products don’t work as I explain, yet it’s spelled out in the fine print if you take the time.
I encourage you to read those pages thoroughly before depending on an EIUL policy to increase your assets or protect your family. (Or before selling them to clients.)
10 Facts About Indexed Universal Life Insurance
We’ve talked about myths, now let’s get to the facts. Note that all “types” of universal life insurance (like VUL) can experience some of the problems listed below. However, a few apply only to EIUL policies and have been marked with an asterisk.
All universal life policies are a side fund (money market for UL, mutual fund-like separate accounts for VUL, and index fund-like accounts for EIUL) plus annually renewable, or one-year increasing premium term insurance for the death benefit.
10. Internal Costs Are Not Guaranteed
The internal administration fees you see on a UL policy illustration are run using current expense levels. So while they may appear solid, the company can change those fees at their discretion. And they do.
Insurance companies use fees to run operations, and as inflation rises, the company can simply choose to increase costs, too. Those “flexible premiums” may sound good in this case, however if you pay a premium that doesn’t cover those new costs, you could lose your policy.
Whole life insurance is designed in such a way that internal costs are guaranteed. You won’t ever have to worry about them changing, and your premium or policy being affected.
9. Mortality Charges Are Not Guaranteed
Mortality charges are another “cost” of insurance. When you pay premiums, some of that is earmarked for the risk of insuring you. Insurance companies have actuaries who calculate the cost of insurance based on highly accurate life expectancy formulas.
With universal life insurance, however, these costs go toward annually increasing term insurance. The cost for a single year of insurance can be changed at any time.
On the other hand, whole life insurance bakes those costs into the policy. They’re charged up front, while the risk to the company is highest, and decline year by year as your life expectancy increases. (The longer you live, the longer you can expect to live.) This is reflected in the cash value growth, which is slow in the early years do to internal and mortality costs.
8. Market Drops Cause Double Pain
Market drops affect the side fund negatively no matter what the side fund is invested in. Since the death benefit is comprised of the one year (or annually increasing) term insurance plus the side fund, any market drop causes double pain.
Markets can drop regardless of whether they are supported by stocks or money markets. When the side fund is reduced by a drop in the market or current interest rates, it now has less value. This means more term insurance must be bought to make up the difference, which further reduces the side fund. Consequently, you have double pain; less cash value, and higher costs.
7. Late Premiums Kill Guarantees
Late premiums can remove any guarantees in the policy.
In most UL policies, even if you pay your premium, once it is late, the insurance company is off the hook for supporting any guaranteed premiums, cash value amounts, or death benefits. In many cases, you may not even know that a premium was late and that the guarantees have been forfeited.
Think about the time frame of a 50-year policy paid monthly (600 payments). What is the likelihood of a mistake being made by the premium payer, their bank, the post office, the insurance company clerks, or anyone else along the way?
6. Dividends From The Index Don’t Get Credited*
Equity indexed universal life policies do not provide you with any dividends from the stocks making up the index. The side fund of an EIUL doesn’t actually invest in the index. If that were true, you would get both the change in Net Asset Value (whether up or down) AND the dividend income.
However, in the case of the EIUL, you only feel the impact of the change in the index’s value. The dividend is left out of the calculation entirely.
5. Participation Ratios Are Often Less Than 100%*
As mentioned directly above, the side fund is not invested directly in the index. Additionally, many insurance companies only credit a certain percentage of the increase in the market. This is called the Participation Ratio, and it is often reported at 80% or less.
In other words, you are only participating in 80% of the market increase, rather than 100%. And while many people sign up with a 100% participation rate, this is something the company can change at will, without your knowledge.
4. Returns Are Usually Capped*
It’s a common strategy for insurance companies to set a cap to the returns you get. This ceiling prevents the side fund from earning too much. So even if the index turns a 14% return, if you’re capped at 10%, you won’t be seeing the full impact.
This being said, there is often a floor, too. However, even if that floor is zero and you don’t have any market losses, the costs of your insurance can still change and reduce your cash value.
3. Guaranteed Minimum Returns Aren’t Always Calculated Annually*
As mentioned above, most EIUL policies have a guaranteed minimum return so that if the index drops below this rate, the insurance company will still credit at the guaranteed minimum rate. However, the insurance company does not always apply this annually. Sometimes, they apply this over an “indexing period,” which could be 5-10 years.
This means that over the indexing period, you could still see the impact of negative years below the guaranteed minimum rate. As long as the overall average rate for the entire indexing period of 5-10 years is not below the minimum rate, the company considers this meeting the minimum. Unfortunately, with this method, you could still see a significant reduction in your side fund.
For example, if the minimum guaranteed rate is 2% inside a 5-year indexing period, you could have credited rates of +13, -10, +10, -8, and +9% which would validate the promised guarantee because it would average more than 2% per year over the 5 years.
The implication is that you cannot have a negative return, yet as shown in the example below, you can have a negative return as long the guarantee is not calculated annually.
You’ll notice another example below of the same interest rates, but with $100,000 of existing value instead of $10,000 per year of cash flow into the account.
2. Everything Can Be Changed By The Company
At the discretion of the company, they can change any of the above factors at any time for their own benefit. They can do this even after the policy has started. This means that even if a certain participation ratio, min/cap, or other variable is in your contract, it is not set in stone.
This is really one of the scariest aspects of universal life insurance. There is no way to calculate what the outcome might be. Even if you analyzed the policy under the current structure and found it to be a viable tool, future changes could cause future problems. (And a quick google of UL lawsuits shows that lots of people have run into problems.)
1. The Risk Is All On You
Usually, the point of insurance (of ANY kind) is to shift some of the risk off of yourself. You buy car insurance so that you don’t shoulder all the costs of a car accident. You buy home insurance so if something happens to your home, you’re not starting from ground zero. And you buy life insurance so that if something happens to you and your income, there’s something left for your family.
Universal life insurance has it all backwards, and puts all the risk of insurance right back on you. You believe your policy is permanent, despite not being backed by any guarantees. So you fund it with the hopes you’ll get good insurance and good returns, while possibly getting neither if something goes wrong. And it takes very little for something to go wrong, because the stock market is unreliable.
Why Whole Life Insurance Does It Better
With a mutual life insurance company, a whole life insurance policy gives you a share of the entire profits of the company via dividends. The carrot being sold with EIUL is that it might exceed the return of a whole life policy.
Yet this begs the question: How could the insurance company pay out more than the profits of the company and still be in business?
It has been explained to me that the insurance company buys options in the market to cover the risk of crediting high market returns to their policyholders’ cash value, in the index that exceeded their general portfolio rate. If this was a sound investment strategy, why wouldn’t the insurance company use this strategy on their overall portfolio? I think the insurance company knows that the stock market will underperform against their portfolio rate over time. This could reduce EIUL profits and increase the profits of the company, which then get distributed as dividends to whole life policy owners.
As a whole life policy owner, I should be pleased that EIUL could contribute additional profits to the company which might increase dividends to Whole Life. My concern is that EIUL policies are going to create a detrimental effect on the life insurance industry as a whole.
The Problem with “Live and Let Live”
We can “agree to disagree” on IUL and EIUL all we want. However, the problem is that this product is so new, with so little positive evidence of success, that it is giving the whole industry a bad name. I believe this may be the next major blight on the industry since under-funded Universal Life (UL) was so heavily promoted in the 1980s.
The unfortunate problem is that any negative media affects the entire industry because the media doesn’t differentiate between the new faulty products and the old tried and true whole life products that have been around for close to 200 years.
As we know, the biggest danger with the negative press is that it causes panic. And lies are certainly easier to spread than the truth can be explained. Many perfectly structured whole life policies get cancelled to the detriment of the policyholder and their family, just like what happened in the 1980s.
Remember #2 above, since the insurance company has the ability to change #10- 3, they can always keep the Universal Life policies from outperforming their portfolio. Why would I want to take the safe and certain portion of my assets and expose it to risk? Doesn’t that defeat the entire purpose of insurance? In my mind, I buy insurance and shift the risk to the insurance company, because they are experts at mitigating that risk and storing the cash to support it. If I really want to invest, I do that elsewhere.
If you are seriously considering purchasing an EIUL product, please make sure you read and understand all the risks you and your family are assuming. Because of the complexity and many moving parts of this product, many of the people selling it I’ve spoken with don’t even understand it themselves. For me, I prefer several simple, guaranteed, tried, and true whole life policies. These protect my Human Life Value and store my cash in the most efficient manner I know.
Don’t just take our word for it—you can do the calculations for yourself by downloading Truth Concepts today. You can get 30 days FREE, with full access to the entire suite of calculators.