When positioning life insurance from a perspective of potential cash value build-up, there are various product types to consider, each with its own straightforward, distinguishing features. For aggressive risk profiles, variable life products—which may be fully exposed to the ups and downs of the market—may be appropriate. On the other end of the spectrum, fixed universal or whole life contracts with guarantees may be more suitable for a risk-averse client.
In between those extremes are index universal life products, where the lines between similar products can become distorted with very different features. Guarantees and safeguards are available with many, but not all contracts and accumulation strategies vary from simple and conservative to complex and aggressive.
On its face, traditional index universal life (IUL) is simple and straightforward. The policy owner trades some upside potential in the form of a cap in return for downside protection in the form of a floor. But the reality of the current IUL marketplace is far more complex and nuanced than that.
The array of index account options available today is vast. They range from the simple and straightforward cap- and floor-tied; to the Standard & Poor’s 500 Index (S&P 500); to those with multiple underlying indexes; to some that may include global exposure and a variety of caps, participation rates, bonuses, and index credit multipliers; or any combination thereof.
Where does one start?
What is the best strategy for your client? Well, it depends. Along with aligning crediting strategies to your client’s risk profile, you should consider the purpose of the planning, time horizon, and objective.
For instance, 35-year-old Christina, a client overfunding coverage for future income planning needs, and 50-year-old James, who is entering into a commercial premium financing arrangement, have different risk tolerances and planning time horizons. Where Christina may not intend to access policy cash values for 30-plus years, James will be relying on the policy’s performance each year when reviewing and rebalancing his collateral position with the lender and potentially projecting an exit from the financing arrangement via policy distributions.
How much cash accumulation might the policy generate, and with how much variability?
Historically, this question has best been answered by running illustrations at an assumed interest crediting rate and comparing the results. Given the prevalence of bonuses, multipliers, and proprietary index funds that muddle an analysis via insurance illustrations, index products today require an approach that goes beyond a cursory review of the illustration.
So, what is the best index crediting strategy?
The best strategy is the one that best suits the client’s risk profile, planning objectives, and time horizon.
At Highland Capital Brokerage, we believe in the adage, “plan for the worst, hope for the best.” We understand that stress-testing policy designs within the intended planning structure is not just prudent, but the right thing to do. With that in mind, it is informative to apply various strategy mechanics to both the worst and best 20-year periods in the history of the S&P 500. While any comparison of index crediting strategies has limitations, applying what we know today about these commonly used strategies in the best and worst periods in the market is enlightening.
Click the link below to download the full two-page comparison report. We hope you’ll find the analysis helpful and informative when making product and allocation recommendations to your clients.
Investment 1: S&P 500 Total Return — As a baseline, assume $1,000 is invested in the S&P 500, and its performance—both positive and negative—is directly tied to the performance of that market segment. These returns take into account dividends, whereas, the other three investment options exclude dividends.
Investment 2: Simple Cap & Floor — This hypothetical investment vehicle provides risk-averse investors the opportunity to participate in market gains without the risk of losing principal. In exchange for a 0% floor that guarantees their account value will never go down when the markets fall, investors are provided with a 10% cap that limits their upside potential.
Investment 3: Cap & Floor with Multiplier — Similar to Investment 2, but this vehicle introduces a bit more risk in exchange for greater upside. Though the upside is still capped at 9.25%, investors allocate 7.5% of their account value each year in exchange for a 2.7x multiplier which raises their potential return up to nearly 25%. However, the 7.5% charge is deducted regardless of market return, so the investor risks losing 7.5% of his/her account value in down years.
Investment 4: Uncapped Index with Floor — This strategy allocates the investors’ money into an uncapped index tied directly to S&P 500 returns over a two-year period, with an allocation and participation rate of 105%. The upside potential is uncapped, with an annual threshold of 1.95%. This allows the investor to participate in all the indexes gains, while still enjoying a floor of 0%. Because this strategy uses a two-year period, the projection assumes that payments of $500 are made years one and two.