Scott Witt, president of Witt Actuarial Services, a fee-only consultant that analyzes life insurance policies and annuities for financial planners and affluent individuals, New Berlin, Wisconsin. WittActuarialServices.com
Descriptions of indexed universal life insurance sound great when you sit through an insurance salesperson’s pitch. And this type of policy can be rewarding—for the salesperson. That’s because it tends to pay some of the steepest commissions in the sector, which is one reason salespeople push these policies so hard. But policyholders are likely to get a lot less than they expect.
The policies combine a death benefit with a cash-value component that policyholders can invest in an account linked to a stock market index, such as the S&P 500. Alternatively, policyholders can opt to receive a relatively low fixed interest rate rather than face stock market exposure. The cash value increases when the index climbs (though not by as much as the index itself), and it does not drop at all when the index has a down year. Insurance companies often present prospective buyers with illustrations suggesting that they would have enjoyed impressive annual growth of, say, 7% or 8% had they held this policy over the past decade or two—returns nearly as strong as those of the stock market.
Don’t believe it. The claims are hypothetical—although they’re based on actual stock market returns, they almost inevitably extend back long before the policy being sold was launched. And because of a “cap rate” hidden in the policy fine print, returns are likely to be a lot less impressive.
The cap rate is the maximum return that the cash value of a policy can earn in a year even if the index earns more. The illustrations that insurers tout often feature cap rates of 9%…10%…11%…or higher. But the insurer has a virtually unlimited right to reduce the cap rates of its in-effect policies at will—often down to 3%. Also, steep surrender charges to cancel policies mean that policyholders won’t be able to escape when they want to without a cost.
What to do: Don’t believe projections from insurance companies. Before buying, have this or any policy reviewed by an independent financial professional, such as a trusted financial planner.
If your goal is to combine a life insurance death benefit with equity upside but limited equity risk, you likely would be better off skipping indexed universal life and instead placing 90% of the assets into a carefully selected whole-life policy and the remaining 10% into a portfolio of buy-and-hold equities.