The Basics
Introduction |
Regulation |
NTM 05-50 |
IUL Rates |
Selling IUL |
Crediting Methods |
History |
Glossary
INTRODUCTION
You’re probably starting here, at The Basics because you’re
looking for more information on what Indexed Life is—you may not even be sure
what life insurance is at all. Well, you came to the right place. The Basics
is an educational resource on our site which will teach you about the fundamentals
of Indexed Life. When you’re done reading this, you should have the foundation
for a solid understanding of Indexed Life.
Let’s assume that you don’t know what life insurance is.
Life insurance is an insurance product that protects
individuals against the risk of death. If the insured person(s) die, the insurance
company pays out a sum of money.
There are many different types of life insurance to choose from.
There are the two broad categories that all life insurance can be placed into: temporary
and permanent protection. The first decision one needs to make before deciding which
type of insurance is right for them is whether they want temporary or permanent
coverage.
Term Life insurance is a type of temporary protection.
It provides a benefit that is payable only in the event that the insured dies during
the policy term and the policy is also active. In general, Term Life does not accumulate
cash values, and the policy will terminate if the policyowner quits paying their
premiums. There are numerous types of Term Life plans available today including
Level Term, Decreasing Term, Increasing Term, and Annual Renewable Term. One important
aspect to take into consideration is that Term Life generally does not last the
insured’s entire lifetime, which is why it is considered temporary protection.
However, this type of insurance is relatively inexpensive as compared to other types
of life insurance coverage.
There are numerous types of permanent protection available today.
Each product has its own advantages and disadvantages, and an agent and client must
decide together which plan is best for the given circumstances. It is important
to understand that the synopses below are just an abbreviated, high–level
summary of each type of plan, and are not intended to be complete. Please consult
your agent for complete details if interested in a particular type of life insurance,
or read more about it each type by researching it on
Google.
Whole Life insurance is a type of permanent protection that provides
strong guaranteed cash values. As long as the premiums are paid on a
Whole Life plan, or there are sufficient cash values, the death benefit will be
paid out. Many Whole Life plans are participating, which means that dividends may
be payable on the policy. Once the policy has been active for some time, it is possible
for the policy premiums to be paid through the accumulated cash values. In addition,
policyowners have the option of taking loans against the cash values as well as
withdrawals against the dividends of participating plans. It generally has a higher
cost relative to other types of permanent insurance plans because of the strong
guarantees. Another disadvantage is that Whole Life is inflexible in nature when
it comes to the premiums and death benefits – you must pay the full premium
amount either out-of-pocket or through cash values, and you cannot reduce or increase
the death benefit amount if necessary.
Interest–Sensitive Whole Life insurance is a type of permanent
protection that provides guaranteed cash values, but earns interest based on a stated
interest rate. This type of Whole Life plan, also known as ISWL, is like
whole life but has a minimum guaranteed interest rate in addition to a current rate
of interest that is credited, which is based on the insurance company’s investment
portfolio. The advantages and disadvantages of this type of insurance are similar
to traditional Whole Life with the exception that the cash values are intended to
keep up with inflation.
Indexed Whole Life is a type of permanent protection much like
ISWL that provides guaranteed cash values, but earns potential interest that is
based on an external index such as the S&P 500®. There are not many
companies offering Indexed Whole Life today. It is inflexible like other Whole Life
plans, and generally has a higher cost because of the stronger cash values. There
are carriers that offer single premium Indexed Whole Life plans, as well as full-pay
and short–pay IWL plans. Sales of this type of Indexed Life plan are nominal
in comparison to Indexed Universal Life.
Variable Life is another type of Whole Life plan, but is registered
as a security. As long as the premiums are paid on a Variable Life plan,
or there are sufficient cash values, the death benefit will be paid out. This type
of insurance is regulated by the Securities and Exchange Commission (SEC), as the
cash values and death benefit fluctuate based on the performance of stocks, bonds,
mutual funds, and other investments. Very few insurance carriers offer this type
of insurance today, but those who do must offer it via a prospectus. Note that this
product is a securities product rather than a fixed insurance product like the other
types of insurance that we have discussed thus far. A policyowner controls the fund
allocation on a Variable Life product, but they also assume the risk on this plan.
Variable Life has unlimited upside potential, but unlimited downside protection.
A consumer can lose their principal due to fluctuations in the market with this
type of product. A minimum death benefit is provided regardless of policy fund performance,
but there is no guarantee on the cash value.
Universal Life provides permanent lifetime coverage that is unbundled
and flexibleUniversal Life (UL) was developed in the 1970’s, and
provided a revolutionary new way to provide insurance to consumers, so that they
could customize their insurance plans. This type of insurance provides for minimum
guaranteed cash values and death benefits. It also provides current cash values
and death benefits based on a current rate of interest that is credited, based on
the insurance company’s investment portfolio. Universal Life is a permanent
type of insurance that provides for lifetime coverage, if performance warrants.
The policyowner has no control over the potential interest crediting on this type
of product, but the insurance company assumes any risk in the event of a downturn
in interest rates. The funds that back this type of product are held in the insurance
carrier's general account. Therefore, the Universal Life policyholder is always
protected by the guaranteed minimum interest rate, regardless of interest rate performance.
Insurance carriers who sell UL offer it via a life insurance policy, as it is a
fixed insurance product. Traditional UL is generally used for clients who are more
risk averse and value stronger guarantees. Universal Life has limited upside potential,
stronger guarantees, and downside protection. A consumer cannot lose their principal
due to fluctuations in the market with this type of product.
Universal Life plans allow for clients to reduce their face amount (amount of life
insurance applied for), or increase the amount of coverage, subject to risk assessment/underwriting.
Policyowners are given the availability of changing between death benefit options
(subject to policy provisions and underwriting). Additional flexibility is provided
through the ability to stop, restart, or change premium amounts. It is possible
for the insurance charges to be paid through the accumulated cash values and policyowners
also have the option of taking loans and withdrawals against the cash values. It
is very important to monitor Universal Life plans because they are interest-sensitive
contracts. If a client purchased a UL contract when interest rates were favorable,
and the premium level was established based on current rates, then interest rates
declined in subsequent years- it is possible that premiums may need to be adjusted
down the road. It is very important to ensure that interest-sensitive contracts
are funded appropriately and monitored annually. Doing an annual review with a life
insurance agent is always a good idea! In addition, a popular feature on many types
of UL contracts (whether fixed, indexed, or variable) is an Extended No-Lapse Guarantee
(ENLG) which guarantees that coverage will remain active, regardless of interest
rate performance, as long as a specified premium level is paid. These features can
ensure that a UL will not become underfunded as long as the ENLG premiums are paid.
Indexed Universal Life provides lifetime coverage that is unbundled
and flexible, yet earns potential interest that is based on an external index, such
as the S&P 500®. Universal Life (IUL) was developed in 1997,
and was a solution for people who wanted the safety and guarantees of Universal
Life, but also wanted a potential for greater interest crediting. This permanent
type of insurance provides lifetime coverage if performance warrants, as well as
minimum guaranteed cash values and death benefits (like traditional Universal Life).
Minimum guarantees may be slightly lower than traditional UL, in order to compensate
for the greater upside crediting potential. Upside potential is limited, however.
The cash values of an IUL are based in-part on one or more indexed crediting method(s)
that the client selects. In this manner, IUL's resemble VUL because the client has
some control over the policy through the premium allocation (although not all policies
give a choice of multiple crediting methods). However, like traditional UL, the
insurance company assumes any risk in the event of a downturn in interest rates.
The funds that back this type of product are also held in the insurance carrier's
general account. Therefore, the Indexed Universal Life policyholder is always protected
by the minimum guarantee, regardless of interest rate performance. Insurance carriers
who sell this type of product offer it via a life insurance policy, as it is a fixed
insurance product. This type of product is typically positioned for clients who
are risk averse, but want greater potential for indexed gains. Indexed UL has greater
upside potential (although limited), minimum guarantees, and downside protection.
A consumer cannot lose their principal due to fluctuations in the market with this
type of product.
Note that this type of insurance is just like traditional Universal Life in all
ways except for the interest crediting and the minimum guarantees. For more information
on those topics, please see the IUL Rates page
page. Regardless of the minimum guarantee, a client can never receive less than
0% interest crediting on an Indexed Universal Life plan. Like Universal Life, it
is very important to ensure that this interest-sensitive plan is funded appropriately
and monitored annually.
Indexed UL is a type of fixed insurance product, and regulated by the state insurance
departments for each individual state. It does not require the presentation of a
prospectus because it is not a securities product.
Variable Universal Life provides lifetime coverage that is unbundled
and flexible, and earns potential interest that is based on the performance of stocks,
bonds, mutual funds, and other investments. Variable Universal Life (VUL)
is much like traditional Universal Life, but it has no minimum guaranteed cash values
(except on monies a client allocates to a fixed allocation) and unlimited upside
potential. This permanent type of insurance provides lifetime coverage if performance
warrants. As long as a VUL has sufficient cash values, the death benefit will be
paid out. This type of insurance is regulated by the SEC, as the cash values and
death benefit fluctuate based on the underlying funds that they client selects.
Insurance carriers who sell it offer it via a prospectus, as it is a securities
product like Variable Life. A policyowner controls the fund allocation on a VUL,
and they also assume the risk on this plan. This type of product is typically positioned
for clients who are willing to accept more risk, and less concerned about guarantees.
Variable Universal Life has unlimited upside potential, no guarantees, and unlimited
downside protection (unless an ENLG is attached to the policy). A consumer can lose
their principal due to fluctuations in the market with this type of product.
So, now you should have a basic understanding of each of the primary types of
life insurance. Now, let’s narrow that discussion down to the
three main types of Universal Life insurance for an exercise to educate you on Indexed
Universal Life and the likenesses and differences between the primary product lines.
In our discussion, we’ll focus on:
- Universal Life (traditional fixed)
- Indexed Universal Life
- Variable Universal Life
Life Insurance Risk Spectrum
|
|
Guaranteed Interest
|
Upside Potential
|
Indexed Participation
|
Client’s Risk Tolerance
|
Fixed
(Traditional)
|
Typically 2% |
Very Limited: typically less than 6.00% |
None |
Low |
|
Indexed |
Typically 0% annually with a cumulative guarantee of 1 – 3% |
Limited: typically capped at less than 17.00% |
Gains based on performance of external index |
Moderate |
|
Variable |
Fixed account only |
Unlimited |
Gains based directly on fund performance |
High |
What is Universal Life (UL)?
A life insurance policy issued by an insurance carrier that guarantees a minimum
interest rate with a stated rate of excess interest credited, which is determined
by the performance of the insurer’s general account. A Universal Life policy
is considered a low risk/low return insurance product.
What is Indexed Universal Life (IUL)?
A life insurance policy issued by an insurance carrier that has a minimum guarantee
where crediting of any excess interest is determined by the performance of an external
index, such as the Standard and Poor’s 500® index. An Indexed Universal
Life policy is considered a moderate risk/moderate return insurance product.
What is Variable Universal Life (VUL)?
A life insurance policy issued by an insurance carrier that has no minimum guarantees,
and where crediting of any interest is determined by the performance of underlying
investment choices that the policyowner selects. A Variable Universal Life policy
is considered a high risk/high return insurance product.
So, we have established that there are several different types of life insurance,
the primary categories being Fixed and Variable. These products are all very different,
despite the fact that they both may be used for the same purpose. Now that we have
seen some of the likenesses in these products above, let’s discuss some of
the differences.
Who carries the risk with this product?
Universal Life
The insurance company must pay out a minimum guaranteed rate of interest, regardless
of what they earn on their investments. A client may purchase a Universal Life policy
with a minimum guarantee of 3.00%, and a current credited rate of 4.50%. However,
if the market “tanks” and the insurance carrier can only earn 2.00%
on their money, the consumer is still protected by the minimum guarantee of 3.00%.
For this reason, the insurance carrier holds the risk with a Universal Life policy.
Indexed Universal Life
The insurance company must pay out a minimum guarantee, regardless of what they
earn on their investments. The minimum guarantee on Indexed Life products is lower
than those of a traditional Universal Life, but their potential interest crediting
is greater. A client may purchase an Indexed Universal Life product with a minimum
guarantee of 1.00%. The maximum credited interest may not exceed a cap of 8.00%.
However, if the market “tanks” and the insurance carrier does not earn
anything on their money, the consumer is still protected by the minimum guarantee
of 1.00%. For this reason, the insurance carrier holds the risk with an Indexed
Universal Life policy.
Variable Universal Life
The client invests directly in the underlying funds, and any gain or loss is passed
directly to them in whole (less fees and charges). There is a potential for loss
of principal with a Variable Universal Life, due to poor market performance. The
variable sub-accounts have no minimum guaranteed interest, but the upside potential
is greater than that of traditional Universal Life and Indexed Universal Life products.
A client may purchase a Variable Universal Life with a minimum guarantee of 1.00%
only on the fixed subaccount, and no minimum guarantee on the variable subaccounts.
Assuming 100% of the premiums are allocated to variable sub-accounts, if the market
“tanks,” the insurance carrier bears no risk, but passes it directly
to the client. For this reason, the client holds the risk with a Variable Universal
Life policy.
[ TOP ]