By Todd Langford, www.truthconcepts.com Mt. Enterprise,Texas
The Whole Truth about Indexed Universal Life, Part 2
Why not sell (or buy) IUL/EIUL? How is it different from Whole Life?
Insurance companies have put numerous pages on the front of Equity Indexed Universal Life (EIUL) illustrations that describe the issues below, but most people (by design) will not take the time to read and understand what these pages are saying. I would encourage you to read those pages thoroughly before depending on an EIUL policy to increase your assets or protect your family.
Similarly, Universal Life (UL) and its cousin Variable Universal Life (VUL) have some of the same problems so I’ve spelled out the issues below and placed an * next to the ones that are specific only to EIUL. As stated earlier, all Universal Life policies are a side fund (money market for regular 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.
Now that we’ve addressed the arguments agents have for EIUL policies, and offered rebuttals, let’s look at the truth:
#10 Internal costs are not guaranteed
#9 Mortality charges are not guaranteed
#8 Market drops cause double pain
#7 Late premiums kill any guarantees
#6 Dividends from the index don’t get credited*
#5 Participation ratios are often less than 100%*
#4 Returns are usually capped at various interest rates*
#3 Guarantees are not calculated annually*
#2 All of the above can be changed by the company
#1 The risk is shifted back to the insured
Now, let’s look at each of these individually and tell the whole truth about the matter.
10. Internal costs are not guaranteed. Internal administration fees charged against cash value on any type of Universal Life policy and shown on illustrations are run under current expense levels but those can change at the discretion of the company. Since the insurance company uses this money to run its operations, as prices of office supplies and real estate go up, they may choose to adjust these internal costs after you have bought the policy.
9. Mortality charges are not guaranteed. Mortality changes, what the insurance company charges for the death benefit are removed from the cash value or paid by premiums. In UL, these pay for annually increasing term insurance costs. This is true for any type of UL, no matter what the side fund is invested in. The cost for this one year term insurance can be changed at any time.
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 so 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 any guarantees. Late premiums can remove any guarantees in the policy. In most UL policies, even if the premium is finally paid, 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, the insured may not even know that a premium was late and that the guarantees have been forfeited. Thinking about the time frame of a 50 year policy paid monthly (600 payments) ask yourself what the likelihood is 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 provide the policy holder no credit for any dividends from the stocks making up the index. The side fund of an EIUL isn’t actually invested in the index; instead the index is used to determine the gross crediting rate for the side fund. If money were actually invested in the index, the investor would get both the change in Net Asset Value (whether up or down) AND the dividend income. However, in the case of EIUL, only the change in value of the index is the determining factor and 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 and many insurance companies only credit a certain percentage of the increase in the market. Known as the participation ratio, this is often reported at 80% or less meaning you are getting only 80% of the increase in the market.
4. * Returns are usually capped at various interest rates. Capping returns in order to keep high returns in the market from crediting too much to the side fund is a strategy many insurance companies use. The maximum return they’ll give credit for may be at a certain percentage rate even though the index may have generated a higher percentage rate.
3. * Guaranteed minimum returns are not always calculated annually. 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, with some policies this guarantee is not applied annually but instead over an “indexing period” which could be 5-10 years. So you could have negative years in the index (below the guaranteed minimum rate) which would be applied to the side fund. This would cause a further reduction of value in excess of the guaranteed minimum rate in one particular year and as long as the overall average rate for the entire indexing period is not less than the guaranteed minimum rate, this would still count as meeting the minimum.
For example, if the minimum guaranteed rate is 2% inside a 5 year indexing period, you could have crediting 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, but 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. All of the above can be changed by the company. At the discretion of the company any of the above factors can be changed at any time for the benefit of the company even after the policy has started. This is really one of the scariest aspects of all types of UL. 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.
1. The risk is shifted back to the insured. Whereas typically the point of all insurance purchased is to shift the risk from the insured to the company, all types of UL shift the risk backwards or from the insurance company to the insured.
With a mutual life insurance company, a whole life 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 potentially having to credit any portion of high market returns in the index that exceeded their general portfolio rate to policy holder cash values. 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 is going to under perform 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. I believe this may be the next major blight on the industry since under funded Universal Life (UL) so heavily promoted in the 1980’s. The unfortunate outcome 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 negative press is that is causes panic and the people will think the entire life insurance industry is bad and many perfectly structured whole life policies could get cancelled to the detriment of the policy holder and their family, just like what happened in the 1980’s.
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 portion of my assets and the protection of my family and expose it to risk? Doesn’t that defeat the whole 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 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 numerous moving parts for this product, many of the people selling it that I’ve spoken with don’t even understand it themselves. For me, I prefer a number of 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.
Greetings!
I read your article on the EIUL…. it is good info because people should be educated; however, the presentation is biased. Do you sell whole life insurance? Also, it would be outstanding if you could share with people that it all really comes down to how the product is structured and the company they use as the information you gave is very general. Finally, the IUL gives an option of level term death benefit that creates a decrease in the cost of insurance overtime as cash value increases. YEs… I am an insurance agent and yes I am bias towards the IUL. I do however educate people on the good and possibly bad things on all the products I offer.
Thank you! Be well!
Thanks Daniel,
We agree that education and advice are both important! No, we don’t sell any products, just software. (Though my wife does sell life insurance through her own separate company. She has the ability to – and has – sold both, but for reasons such as those listed above, she is a much bigger fan of WL, generally speaking.) And generally speaking, we are not in the business of endorsing products, certainly not companies, but there was enough misunderstanding and misrepresentation on this topic that we felt it was important to do some education. We are thrilled to hear that you are presenting both sides of the story!
I agree with most of the points above. However this is just a list of the downside of EIUL without mentioning the benefits. How is that considered the “whole truth”. The whole truth would include both the upside and the downside.
I think we can all agree that EIUL’s are riskier than Whole life. However with more risks come more reward. And many of these risks apply to Whole life as well.
1st the cap + par rates argument .. the most popular allocation is the S&P 500 annual point to point at 100% par rate. you mentioned that participation rates are often less than 100% but you failed to mention that the low participation rates allocation are often uncapped. You also failed to mention that the majority of companies (if not all) offer a 100% par rate taht’s capped at a certain percentage. This is not telling “the whole truth” . The beauty of EIUL is that you have a floor of 0% when the market is down, the trade off is that you don’t get the full upside of the market. The reason why it’s been so popular is that people are willing to make that tradeoff for a peace of mind.
2nd You mentioned that the company pays no dividends which again is true. How is that the whole truth when you decide to compare it to Whole life and failing to mention that you don’t get market returns with whole life. Whole life pays dividends, EIUL pays interest rates bases on the movement of a certain market index. When the market is doing really well and blowing by the cap rate and EIUL policy will have much better performance than WL, while when the market is down EIUL is returning 0% + the costs of insurance .. then the WL policy will perform better. That’s “the whole truth”
For the sake of making these posts too long I won’t nitpick at every single bullet point but I wanted to make it clear that this article is about the “downside of EIUL” .. it’s really not the “whole truth” about EIUL ..
There are various people out their who have different risks tolerance.. if you’re a wild cowboy, invest in the market or even a VUL. However, if you want to be more conservative then that, EIUL is a great choice. IF EIUL is still too risky for you, go with a blended participating whole life policy.
That’s the whole truth.
Thanks for your response and your interest in “the whole truth” that I’m sure we are all interested in. And we apologize, this comment sort of “fell through the cracks” for awhile. Including some feedback from Kim (my wife and advisor Kim Butler)… We are not sure you have read the other part (link is in article) as we do address cap rates. The “0% floor” is extremely misleading as that is before costs, so yes, if the floor of a policy is 0% subtract costs, policyholders can have down years. We have also seen policies with large (2% – 4%) “participation costs” too. In general, we feel there is a lot of smoke and mirrors designed to get people focusing on the gross and not the net gains. And there have been companies that have had to re-do their illustrations, as there have been admitted issues with illustrations being overly optimistic and inaccurate.
It is definitely true that on some years, an IUL policy will out-perform whole life, net to net. So this is perhaps a matter of a difference in philosophy. In our preferred investment philosophy, whole life provides the best vehicle for permanent insurance and safe, guaranteed, reliable savings. It was never intended to be an investment that would get you “market returns,” yet if you do look at all the numbers (and consider tax savings and the fact that it is net of fees), it often can and does approximate market returns, yet without the volatility. So Kim recommends to clients that they use WL to store cash and for income protection, and she recommends other things for investments that typically do outperform IUL without roller coaster riding like the stock market (or like an IUL, to a lesser extent). Plus they can be used for qualified retirement plan monies, which can prove very useful.
In short, we don’t believe that trying to mix “savings” and “investments” and “insurance” in one product necessarily provides the best of all worlds. (We especially see philosophy from people who only sell insurance… because “if all you have is hammer, everything looks like a nail.”) So we believe that WL is the best guaranteed savings vehicle (with permanent protection and the capability of leveraging) and that it should be used along with actual investments that will provide higher returns (without the insurance component also without the volatility of the stock market) for asset growth and cash flow. However, if you want to earn, say, 10% every year on a bridge loan or fractional real estate investment fund, it won’t be liquid or available as collateral! So our philosophy takes into account things that a financial calculator can’t necessarily demonstrate well… the value of liquidity, collateral and guarantees vs. a higher ROI. Hopefully this gives an even larger context for “the whole truth.” And we understand that you may have a different philosophy, so thanks for being willing to engage with ours.
I thoroughly enjoyed your article of the inherent problems of Indexed Universal Life plans. Long Long time ago.. truly the only type of insurance out there was whole life. And whole life is exactly what it is meant to do “cover a person for their whole life”! As many insurance companies demutualized in the 80’s and the stock market performed better in the 80’s and 90’s than any other period of time (which we may not see again for a while) company and consumer greed took over. Went away were the safe pensions and whole life insurance …which were replaced by 401(k) plans and a philosophy of “buy term and invest the difference”. So now where are we today? The investors of the 80’s & 90’s are retiring and are surly not prepared. Some don’t even have enough money for their eventual burial. Too bad they didnt purchase a whole life plan back in the 80’s & 90’s. Those that purchased Universal Life plans are forced to either “throw” more money at the contract or let it lapse. Those that purchased Variable Life plans have lost their shirts (and their life plans) with the 2001 and 2009 market downturns.
Insurance Companies like to have several types of life products on their books…term life, universal life, variable life, etc.. as it takes the “risk” off of the company and puts it on the consumer. With Variable life ..the risk is totally retained by the consumer. In contrast, a consumer that has a whole life policy has guarantees and holds no risk as the risk is transfered to the company. Hence the true reason for purchasing insurance in the first place. I’m always amazed that we all have home insurance, car insurance and health insurance….but how many people have “permanent” whole life insurance? And the odds of having a death claim are 100%! Why wouldnt you get something that you have a 100% chance of needing?
Personally, I feel investments should stay investments and insurance should stay insurance. Insurance should be guaranteed and safe. Investments for risk. To build true wealth one should be properly balanced between safety and risk. Unfortunately most people are not balanced and are either too conservative (and will loose the time value of $) or too aggressive.
Going back to the specific product on topic….Not only are their lots of “smoke and mirrors” with these Variable life and Indexed Universal Life illustrations …as “annual returns” that these illustrations show are NEVER linear. These illustrations are very misleading. These types of Life insurance plans are very complex that even many insurance agents don’t understand..let alone an investment broker. Every product should solve a particular need. If a person’s need is for growth and can afford the risk then they should get a ROTH IRA or invest in their companies 401(k) plan. If a person’s need is for safe returns and insurance protection then get a whole life plan.
Purchasing a life insurance plan within an investment doesnt make sense for most of the consumers out there. The costs and fees are too high and so are the risks. Building wealth is part asset accumulation and part asset protection…build your wealth and then protect it and have insurance that you absolutely know will be there when you need it the most. Keep is simple…not complex!
We appreciate your comments, Dr. Decker! Thanks for weighing in.
Team TC