Is There Really a Perfect Life Insurance Contract?
by By Tim Fussell
Published May 02, 2012
Is there a life insurance policy that can solve everyone’s needs, whether it is low-cost death benefit protection, premium flexibility and/or solid cash value accumulation potential with very good contract guarantees? Is there one that fits everyone’s investment horizon and risk profile? Is there one that can satisfy a customer in a low-interest-rate environment when commodities such as oil are at record levels and the stock market remains extremely volatile?
No. There isn’t one contract that can do everything. There are trade-offs with each.
But an emerging and fast-growing contract design–the indexed universal life (IUL) policy–may come very close to being the ideal contract for most consumers in today’s interest and overall market environment.
The IUL has been around for about seventeen years now, starting out with only a few companies offering it. But now this marketplace is becoming very crowded with many more companies seeing the opportunity here. It is more important than ever that you find a trusted advisor who is familiar with all the various contracts offered by all the top producers. These contracts vary in many ways, and it is important to make sure the contract you are considering, with the company you have chosen, is the one that best fits with your intended purpose or purposes for the contract. This means choosing an independent agent who represents several different companies, not an agent that represents one company with several different policies.
What is indexed universal life? It is a traditional universal life insurance policy that credits interest to the customer’s contract based on the movement (if any) of an index (such as the S&P 500 Index) over a given period of time. The contract is not registered, which means no prospectus or equity licensing is required, and the customer never buys the index directly. The insurance company uses most of the premium to buy triple A rated bonds to cover the policy guarantees and a small part of the premium to buy call options on the index chosen.
This type of life insurance is certainly different than traditional UL, in which interest credited is based on performance of the insurance company’s general account bond portfolio.
It’s easy to see why, in today’s low-interest-rate environment, IUL has appeal for many customers. It allows the possibility of providing a greater upside potential to the customer than offered by relying on regular fixed interest rates.
Why not just sell variable life to provide the customer upside potential? Market research has revealed that most customers today really do want some contract guarantees in their life insurance policy—and an IUL contract does contain guarantees. Admittedly, these guarantees are at lower levels than those of traditional UL policies, but given that the IUL contracts offer greater upside potential than traditional UL, this is not a deterrent to the purchase of these policies.
Who are the perfect customers for the IUL? These are people who:
- Are somewhat moderate with their risk profile;
- Want to share some of the risk of policy performance with the issuing insurance company and are willing to give up some guarantees for the potential of additional performance;
- Focus both on cash value accumulation and death benefit protection
- Want the ability to access policy cash values in several different ways during the life of the policy, as well as the ability to have a tax-free way of supplementing retirement;
- Are willing to accept limited upside interest-crediting potential in exchange for downside risk protection;
- Generally shy away from the pure equity markets.
Proper selling of this contract not only requires the advisor to have an understanding of the terms such as cap, participation rate and floor (much like the selling of indexed annuities). But the advisor also needs to know the proper positioning of this product, so the customer has realistic expectations.
IUL contracts should be compared to straight universal life contracts. The goal for the customer (as with the index annuity sale) is hopefully to “beat” fixed interest rates by 2-4% long-term.
This contract should “not” be compared to a variable life insurance contract. If the customer is enamored with unlimited upside potential, then variable life is the appropriate choice–as long as the customer understands the lack of guarantees in a variable life. For example, a big market downturn could cause not only a loss of cash, but the policy could lapse and the life insurance would be lost as well).
IUL can be the perfect alternative for customers really wanting the upside potential with downside protection. These products were at one time riding on the success of the indexed annuities, which have enjoyed a tremendous sales run over the past 20 years during the generally low interest rate environment. Now the IUL has a great success record of its own to ride on. Certainly, the IUL guarantees aren’t as strong as those in indexed annuities. This is because of the IUL’s insurance charges and other contract fees deducted from the account values, but the tradeoff is the tax advantages of the IUL cash account—a result of its status as life insurance. Also, IUL offers much stronger security for customers than variable life. And, for the customer who really wants to maximize the amount payable to heirs, the IUL is better. Consider this: How many annuities ever get annuitized? Very few. There are probably some index annuity sales that should be IUL.
Up until recent times, the life insurance industry has really had four mainstream insurance contracts: term life, whole life, universal life and variable life. For the reasons mentioned above, indexed universal life has become another mainstream contract, and the fastest-growing segment of the life insurance market.
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