The sales pitch for indexed universal life (IUL) insurance is undeniably compelling. Shoppers are told that IUL policies offer access to stock market profits but no exposure to stock market losses…that they’ll be able to borrow from their accounts without any net cost—and possibly even at a profit…that the flexible premiums mean they can choose to pay less for their coverage when their budgets are tight…and that all these wonderful perks are in addition to the death benefits and tax advantages people expect from life insurance.
With all that upside, it’s no surprise that IUL is a popular type of life insurance, with hundreds of thousands of new policies sold every quarter.
But—IUL policies are nowhere near as appealing as insurance agents’ sales pitches make them seem, warns fee-only insurance consultant Glenn Daily. Bottom Line Personal asked Daily what consumers need to know about IUL…why they should steer clear of it…and what life insurance they should consider instead…
What Is IUL Insurance?
Indexed universal life insurance is, as its name implies, a form of universal life insurance. Universal life features both a death benefit and a cash-value account, much like whole life insurance—but unlike whole life, IUL lets the policyholder easily adjust the premium payments over time…within limits. The policy will stay in force as long as it has enough money to cover the monthly charges.
What separates indexed universal life insurance from fixed and variable universal life insurance is that the returns of an IUL policy’s cash-value account are linked to the performance of a stock market index—either a well-known index, such as the S&P 500, or a proprietary index created by the insurance company. That does not mean the money in this account rises and falls dollar-for-dollar with its underlying index—IUL accounts have floors, such as 0%, that limit losses if the underlying index declines…and features that restrict potential stock market gains when the index experiences especially strong years. Details vary greatly from policy to policy, and new designs are constantly being developed.
Downsides of IUL Insurance
Reasons why IUL insurance isn’t as attractive as insurance agents make it seem…
It’s virtually impossible to know if you’re getting a good deal
An experienced investor likely has some sense of what it means to invest in a well-known stock market index, such as the S&P 500. But taking out an IUL policy is very different from putting money into that policy’s underlying index—when you factor in the policy’s floors, caps and other complications, putting money into an IUL account is more akin to trading stock options, which can be far less intuitive investments. Working out whether an IUL policy is a wise investment is very difficult even for professional insurance analysts, and it’s essentially impossible when the IUL uses a proprietary index rather than a mainstream index such as the S&P 500.
High caps often hide high costs
Insurance companies have figured out that the higher the cap they set on the annual gains of an IUL policy’s cash-value account, the more attractive that policy will appear to consumers. As a result, there are policies with caps as high as 12% or even 15%, paired with floors of 0%. That sounds wonderful—policyholders have access to truly impressive stock market returns when the market rallies, but no exposure to losses when the market declines. But: The higher the cap, the greater the odds that the policy is expensive and has other fees. Insurance companies have discovered that consumers attracted by the possibility of big potential gains often overlook the toll that fees take on their accounts.
IUL policy projections, called “illustrations,” are misleading
Regulators have tried to make sales information more useful, but as soon as regulators address one shortcoming in the illustrations, companies find a new loophole to exploit. The most serious flaw in IUL illustrations is that they show only a handful of scenarios, and they usually assume the same interest rate in all years. This hides the risk that you will need to pay a higher premium in the future to keep the policy in force.
Of course, the IUL indexes—and therefore the interest rates that the company will credit—will vary over time. Better: A “stochastic” illustration in which thousands of scenarios of future index values are generated along with the corresponding credited interest rates.
IUL promotes a “free money” illusion
The sales pitches for IUL policies often include what seems like an incredible financial opportunity—the interest rate that policyholders pay to borrow money from their accounts is lower than the interest rate the account is projected to earn. Potential policyholders are told that not only will they not lose money if they borrow from their accounts, they may come out ahead.
What the insurance agent might not mention—and certainly won’t stress: This isn’t always true. The interest rate the account earns will vary from year to year based on the performance of the underlying index, so while policyholders might sometimes come out ahead when they borrow against their accounts, they also could very easily come out behind. It’s like taking out a mortgage on your house to invest in the stock market—even if the stock market’s average annual return over time is greater than the interest rate on your home loan, there’s no guarantee that this gamble will pay off.
An even more extreme strategy is called “premium financing”—you borrow money from a third-party lender to pay the premiums, using the policy’s cash value and other assets as collateral. The illustration shows that you will magically be able to repay the loan from the future cash value, leaving you with a “free” IUL policy. Lawsuits are mounting from angry policyholders who went along with these risky financing schemes and who are now facing big losses.
There may be no way to obtain lower commissions
With most whole life policies, it’s possible to negotiate the agent’s commission by combining high-commission and low-commission coverage in a package. But most IUL policies don’t provide a way to reduce the commission.
IUL Options and Alternatives
The IUL policies available now are not a prudent choice given the problems described above. Better bets for consumers who are attracted to what insurance agents claim IUL offers…
Variable universal life policies that include an indexed account among their investment options can function very much like an IUL policy—except that the policyholder has plenty of other investment options to choose among if he/she later realizes that the indexed account isn’t performing up to expectations. Example: Nationwide Advisory VUL (Nationwide.com).
Simple low-cost, term-life versions of an IUL policy can avoid the high fees and complexity in most IUL policies. Example: Everly IUL TermVest+ (EverlyLife.com).
If you already have an IUL policy: Your best option may be to hang onto it at least for a while. Most of these policies impose steep surrender charges if the policy is cancelled within the first five to 10 years. Reevaluate whether your policy is performing up to your expectations and worth keeping once you’ve had it long enough that its surrender charge has disappeared.
