The Basics

SELLING IUL

Objections

There has to be a specific reason why you aren’t selling Indexed Life today. Do you have clients that are willing to give up just a little of the downside guarantees of a traditional Fixed UL product, for some more of the upside? Do you have clients that are willing to risk just a little of the downside guarantee for some more of the upside? If the answer to this question is “yes,” then you should take a look at Indexed Life. As of the close of 2007, there were 34 insurance carriers offering the product and that means plenty of choices for both you and your client.

If you are too comfortable selling the same old product over and over again, get out of that rut! Selling insurance is not a “one product fits all” approach. Different clients certainly have different needs and fall on different areas of the risk spectrum, right? The number one objection we receive to why an agent doesn’t want to sell Indexed Life? “I like selling Extended No Lapse Guarantees.” Well, guess what- Indexed Life products have ENLGs! As of the second quarter of 2008, more than 38% of the carriers in the IUL market offered Extended No Lapse Guarantees on their products. In fact, the most competitively priced ENLG product in the entire Universal Life market is an Indexed UL. Believe it! So, why aren’t you selling Indexed UL?

Indexed Life offers a variety of product options, guarantees, riders, and even Account Value bonuses. Do you prefer to offer products with preferred loans? Some Indexed UL products offer preferred loans as early as year 6. Maybe you are more interested in premium financing and looking for products with no surrender charge- we’ve got ‘em! Are you an experienced IUL agent and looking for variety in the indexed crediting options on the product you sell? Try an IUL with interest crediting based on an international index. There are riders galore, so you can customize the plan for your client: long term care riders, overloan protection riders, paid-up riders, and all sorts of waivers. It is time to explore all of the possibilities this product has to offer.

But with all of the fabulous options, comes awesome responsibility. Anyone familiar with the Indexed Annuity market is certainly aware of the scrutiny these products have faced in the past few years. Today, these products are under the threat of becoming securities products rather than being regulated as the fixed insurance products that they are. As of yet, the fixed insurance status of Indexed Life products has not been threatened. Why? Indexed Life sales are a drop in the bucket compared to Indexed Annuities. As of the close of 2007, Advantage Group Associates, Inc. estimated that Indexed Universal Life sales were only 10% of total Universal Life sales. The product’s popularity is growing due to its tremendous value proposition, but at a much slower pace than Indexed Annuities.

Indexed Life does not suffer from the market conduct issues that Indexed Annuities do. The annuity market in general has received a tremendous amount of negative attention because of unsuitable sales, particularly to seniors. The Indexed Annuity industry is specifically suffering from this negative attention. There is a regulatory conflict over who should be overseeing the sales of these products because of these market conduct issues. It is the contention of the SEC that Indexed Annuities are securities products, and these market conduct issues are their motivation for this proposal (despite the fact that they are fixed insurance products, regulated by the state insurance divisions). Let’s do everything that we can to ensure that this same situation does not occur with Indexed Life.

Setting Realistic Expectations

Realistic expectations for indexed crediting on IUL should be set when the policy is presented. That means somewhere between 0% and the cap/participation rate/spread. Promising double-digit returns on Indexed Universal Life is reckless. An agent who makes such promises is asking for replacement of his book of business, due to product misunderstanding. A client that expects double-digit returns needs to readjust their expectations, and revisit their agent. The Indexed Life market would be full of dissatisfied clients if agents presented the products in this manner, as the results will not come to fruition. Better to under-promise and over-deliver when it comes to Indexed products.

Understanding Illustrated Rates

The National Association of Insurance Commissioners (NAIC) requires that all permanent cash value life insurance products have a signed life insurance illustration at the time of policy delivery. An illustration is a projection of (hypothetical) future policy values, based on certain assumptions. These illustrations must project the policy values and death benefits assuming guaranteed charges and guaranteed minimum interest, as well as assuming current charges and current interest. With a traditional Universal Life plan these illustrations are projected at the current interest rate of X%, with X= the current credited interest rate of the UL plan. With Indexed Life, illustrations are more complex, as the insurance carrier has no way to project how the index may/may not perform. The carrier knows what the current participation rates, caps, and spreads of the Indexed Life product are. These rates are used, along with a study of the historical rates of the external index that the crediting method is based upon (such as the S&P 500®), to determine a hypothetical “Illustrated Rate.”

It is important to understand that each carrier has their own methodology for performing their historical study of the index to determine their Illustrated Rate. This methodology, known as an “Illustrated Rate Lookback Method,” is often closely evaluated by agents. Today, there are 11 different Illustrated Rate Lookback Methods in the Indexed Life market (including not using a lookback at all). This poses a challenge to compare two Indexed Life products on an apples-to-apples basis. Furthermore, two carriers could use the same methodology, but use different dates during the same period to determine their Illustrated Rate. For example, Carrier A and Carrier B may both use a 20-Year Lookback. However, Carrier A might perform their lookback period on the 28th of each month, and Carrier B might perform their lookback on the 15th. This will result in different illustrated rates, and therefore different illustrated values.

Ultimately, the method will assist the insurance carrier in determining a hypothetical Illustrated Rate, which the carrier believes to be a realistic expectation of future performance based on current Indexed Life participation rates, caps, and spreads. This Illustrated Rate is used to project the non-guaranteed policy values, and may range from anywhere from around 4.00% to upwards of 10.00%. The important thing to understand is that this rate does not represent the actual rate that will be credited to the policy. With a Fixed UL, a policyholder can have a reasonable expectation that the rate illustrated at the time of sale is somewhere close to what they may receive in future years (although it still needs monitoring annually, as every interest-sensitive plan does). With Indexed UL, it is unknown what will be credited to the policy in future years. Some years, the client will receive zero interest credits. Some years, they may receive double-digits returns. More often than not, they will receive something in between the two. An Illustrated Rate is the best solution for Indexed Life insurance carriers to be able to project future policy values in a policy illustration, which is required at the point-of-sale.

It is important to note that past performance of an index may not be indicative of future Indexed Life policy performance. Why? Although the Illustrated Rate may have been determined by performing a historical study of an index, past performance is NOT necessarily representative of future results. In other words, if I knew what the S&P 500® was going to be at a year from now, I’d already be rich and not training on Indexed Life!

The day ANY policy is sold, whether it be Fixed UL, Indexed UL, Variable UL, or any other cash value life insurance, the illustration will never come to fruition. It is good practice to explain this during the training and sales process. Agents learn to set reasonable expectations for their clients, and policyholders learn to monitor their interest-sensitive life insurance. If a policyholder forgets to pay a premium, a loan gets taken, or the interest rate drops- this changes all of the values that were projected on the life insurance illustration at issue. There are a variety of factors that can change the illustrated values in these projections. For that reason, it is important to understand that the illustration is merely a representation of possible values, not a promise of future values.

Anyone familiar with the block of now-underfunded UL contracts that were sold during the high interest rates in the 1980’s should have a deep appreciation for selling Indexed Life responsibly. When Universal Life policies were at the height of their prime, they were being sold with credited rates in excess of 12%. When the policies were projected assuming the then-current interest rates and premium funding levels, they looked like they would provide cash values and life insurance coverage for the lifetime of the insured. However interest rates crashed, and many policyholders did not alter their premium levels to adjust for the interest rate decline. In turn, their cash values declined and many policyholders lost their coverage. For those that did not, they received notification that their policy was near lapse and they needed to increase their premiums (sometimes dramatically), in order to keep the coverage active. This is a risk with any interest-sensitive life insurance plan if the coverage is not monitored regularly by the policyholder and agent. Careful monitoring of annual statements can ensure that the premiums are sufficient to cover the insurance charges and contribute to cash values. It can also ensure that underfunded policies are avoided.

Variable Rate Loans

One feature that has made IUL very popular is the use of Variable Loan Interest (VLI) on policyholder loans. (Note that this feature is not available on all products.) Variable Loan Interest can be a very useful tool when used appropriately and explained properly on any policy, indexed or not. This type of loan interest is usually calculated using a formula that is based on an external index, such as the Moody’s Corporate Bond Yield Average. The rate can fluctuate based on market conditions. If you purchase an Indexed UL and your policy illustration assumes you take out loans using Variable Loan Interest, pay careful attention. It is important to understand that the rate in effect at the time you sign your policy illustration at point-of-sale will likely be different than the rate in effect at the time you initiate the actual policy loan. This can make a significant difference between what your point-of-sale illustration projects your policy values to be, and what you actually receive. Let me explain.

It is possible to have years when your policy may get 0% credited, but you may need to pay loan interest. Your life insurance illustration does not show this, however. The life insurance illustration will assume credited interest at a rate of X% (with X= Illustrated Rate), and Variable Loan Interest at a rate of Y% (with Y= a specified standard illustrated Variable Loan Rate or the current month’s VLI rate). There are many IUL contracts that illustrate an Illustrated Rate that is greater than the Variable Loan Interest rate. So, in these instances, X% is greater than Y%. Do not mistake this for “making money off of a loan,” as you need to be fully informed on the risks and benefits of your Indexed Universal Life policy, including the maximum loan rate. Just as with an Illustrated Rate, it is important to consider what rate the Variable Rate Loans are illustrated at. Is it current, historic, or somewhere in between, and is it reasonable based on minimums and maximums that could be charged? Make certain that you thoroughly understand the loan provisions of your policy before initiating a policy loan.

Hyperfunded Indexed UL

The following adage applies to many things, including Indexed Life:

“If it sounds too good to be true, it probably is.”

Because many contracts have a Variable Loan provision, and Variable Loan Interest rates are generally much lower than the Illustrated Rate, a concept called “hyperfunding” is emerging in the IUL market. In this scenario, the policyholder pays the premium for a couple of years and then begins taking out loans as well. Why? With a projected Illustrated Rate that is higher than the Variable Loan Interest Rate, the policyholder stands to make a positive spread on loaned money. (i.e. Illustrated Rate of 7.9% - Variable Loan Interest rate of 5.9% = positive net cost of 2.0% to the client) In most instances, there are no taxable consequences to the policyholder. Once projected in the illustration, it may look like it will make the policyholder rich. The problem is that quote up above: If it looks too good to be true, it probably is. In almost all instances, it is. The credited interest rate may end up being lower than the Variable Loan Interest rate- then the client is paying interest, but not receiving any indexed gains on the policy. This results in a negative loan spread, hardly what was illustrated when the hyperfunded scenario was first concocted. Ultimately, the policyholder must ask themselves if they are willing to take such a risk for a hyperfunded strategy.

Equity Harvesting

Equity Harvesting has become a very popular advanced sales concept in the Indexed Life market. In this scenario, policyholders take the equity from their homes and use the money to purchase life insurance. The premise of this sale is that home values always increase, so one should borrow against their home to purchase life insurance. Ultimately, the goal is that both the house and the life insurance policy values will increase over time, resulting in a double gain. Once the policy values have become sufficient, they will be used to make the payments on the home equity loan.

There can be problems with the Equity Harvesting strategy. First, home values have been plummeting since mid-2007. Second, interest rates on home equity loans and mortgages have risen to uncompetitive rates. Third, Indexed Life products are limited in their crediting potential, unlike their Variable UL brethren. The end result can be tragic for a policyholder/homeowner who does not understand the potential consequences. This is not to say that the strategy cannot be successful. However, it does require full and accurate disclosure.

In Closing

Selling Indexed Universal Life might be the best thing that ever happened to you. It can open-up doors to an entirely new client-base, or provide downside guarantees for existing clients who have previously been burned on securities products. However, it is important to understand the products completely before presenting them to a client. For many of the scenarios which were explained above, a misinformed agent or client can certainly have the potential for bringing complexity into the Indexed UL sales process. This is something that could be potentially disastrous for the entire Indexed Life market if it takes on a snowball effect.

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