In 2013, many independent producers struggled in selling life insurance products designed to accumulate cash value and produce income.
Career agents have a huge advantage based on their heritage, the training programs in place at career agencies and a fairly massive financial incentive to sell cash accumulation focused products.
Many independent producers don’t completely understand one of the more advertised and emphasized products in our cash accumulation arsenal: Indexed Universal Life.
In 2014, to compete for the cash accumulation sale, independent producers need to figure it out.
A telling example is the confusion on the part of many around guaranteed crediting rates and the resulting sales practices.
It’s an important topic, as guarantees are one of the foundational elements of the IUL value proposition: You, policy owner, are guaranteed a minimum rate of return each year.
The reality, however, is much more complicated and warrants further discussion.
The floor in an IUL contract is the real guarantee. Period.
It’s rather simple: The floor rate is the minimum interest rate that the policy owner will be credited for each point-to-point segment. As straightforward as that should be, it’s still misunderstood.
The crux of that discussion is that the floor is a gross return versus net, and the reality is that policy owners may experience years with a net negative return after policy charges.
That ugly reality is not discussed by most producers and will be an unwelcome surprise when the inevitable negative year occurs.
the minimum account value guarantee
Separate from the floor, the Minimum Account Value guarantee is a rate that the carrier will guarantee under certain conditions, such as death, surrender, exchange or even if enough years go by.
This is very different than an annual return guarantee like the floor rate mentioned above, but is often presented, and even illustrated, as a year-by-year guarantee.
But the issue with Minimum Account Value guarantees is that they will almost never come into play.
Regardless of the type of triggering event, these all come down to one common element: Looking back over a long period of time and guaranteeing a minimum level of performance over that time period.
Here’s some sample language from one policy illustration:
- This policy has a Minimum Account Value that is calculated monthly using a 3.00% guaranteed average annual interest rate and assumes that all premiums are allocated to the Fixed Account. If the Account Value is being calculated due to any termination of the policy, including lapse, death, surrender or maturity, the amount in your policy’s Account Value will be at least as large as the Minimum Account Value.
- At the end of policy year eight and every eight years thereafter on the policy anniversary, the Account Value will be compared to the Minimum Account Value. If the Minimum Account Value is larger than the Account Value at those times, the Account Value will be increased to equal the Minimum Account Value. If the Minimum Account Value is not larger than the Account Value, neither one will be adjusted.
incidence of return
A Minimum Account Value guarantee sounds great at first, particularly to the client who may not think too critically about what it really means. Where these fall apart and become essentially meaningless is when we look at the incidence of return in a typical IUL structure.
Remember that there’s already a floor that insulates the contracts from gross negative index returns. One of the results of this is that a hugely negative return that the policy needs to recover from is highly unlikely once the first few heavily loaded policy years are behind us.
So the only way to trigger this Minimum Account Value provision is to have the index return less than 3% on average over the eight-year period mentioned above.
Take a look at the historical returns for an IUL with a 0% Floor and 13% Cap below and you will see the problem: This rarely, if ever, happens.
what minimum account value guarantees really do
In reality, Minimum Account Value guarantees don’t do much beyond create a false sense of security.
In practice, however, they create a problem on illustrations.
If you review an illustration from a carrier with one of these true-up provisions, the guaranteed side of the ledger shows a level return at the true-up rate and guaranteed charges. That, unfortunately, is not how the contract actually works.
The accurate illustration would show the floor rate and guaranteed charges until the true-up provision is triggered, and then show the net result of the true-up provision in that year.
This pattern would then play out over the life of the contract, or until the policy would lapse under the guaranteed assumptions.
That would certainly tell a different story than the current practice, and perhaps do away with the completely inaccurate notion that the policy would credit this Minimum Account Value rate on an annual basis.
Clearly, both the floor and the additional rate guarantees have a place in these contracts. The issue, as with many things over the course of the life insurance industry’s long history, comes down to sales practices.
The story producers are telling regarding what these products will and won’t do is not always grounded in the truth, and that’s a big problem.
In most cases, it’s simply a lack of understanding. In others, it’s a blatant, knowing disregard for the facts in an attempt to make the sale.
In either case, it’s unsustainable.
To that end, we’ve compiled a resource that summarizes the key elements of the guarantee provisions in a wide selection of IUL contracts currently available for sale, including some comments on the potential traps in the way they are illustrated.
In most cases, these traps don’t mean the product in question is a “bad” one. Rather, it means there is an element to the illustration or underlying structure that could be misrepresented or misunderstood.