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Indexed Universal Life The "Gap" Product

From its inception only about a decade ago, indexed universal life insurance has seen tremendous growth in recent years.  Much like its sister product the indexed annuity, equity indexed universal life insurance offers clients and agents the principle of upside protection with the elimination of downside risk to achieve the possibility of better long-term results than traditional universal life insurance products can deliver.  However, understanding all the ins and outs of these products can be extremely challenging to even veteran life insurance agents.  In order to break down indexed UL products, its important to go back to the basics…

Fixed Universal Life Insurance

The cornerstone of a traditional fixed UL product is that the net account value of a policy is credited at a declared rate.  This crediting method is generally tied to the issuing carrier’s General Account and their underlying investments.  A typical crediting rate in mid 2010 might be around 5%.  Because the majority of any life insurance company’s assets are long-term instruments, traditional fixed UL is relatively insensitive to short term volatility in the widespread financial markets.  Even in the late-2008 and 2009 financial crisis, very few fixed UL crediting rates saw much of a decline in their crediting rates.  The ones that did see a decline were typically only 15 to 50 basis points over a 2 yr period.  It is this relative constant crediting rate and downside protection that many agents and consumers value with Fixed UL.

Variable Universal Life Insurance

Much like Fixed UL, a Variable UL policy’s account value can earn interest.  It was created for a policyowner to participate more aggressively in upside potential within their life insurance policy.  From that perspective VUL is great, however as we saw in 2001 and 2008, the exposure to downside risk is tremendous.  Many clients that held VUL policies saw Account Values decline by 40% or more.  Early years Surrender Charges combined with the fact that most policies lapse-test off this figure caused many a policy to lapse with the policyowner investing tens of thousands of dollars only to see it all disappear.  Many of these policyholders were burned so badly they vowed never to take the risk associated with VUL as long as they live.

Indexed Universal Life – the “gap” product

The indexed life insurance policy evolved from the market appetite for a “gap” product.  Consumers saw the value in the safety of traditional Fixed UL but didn’t like the fact they were locked in to very conservative crediting rates forever and ever.  Their wish list was to participate in more of the upside like VUL could offer, but with the safety of the Fixed UL.  Enter Indexed Universal Life.  It filled the gap for the consumer that wanted upside potential of VUL with the downside protection of Fixed UL.

It is important to remember that at its core, Indexed Universal Life is still a Universal Life policy.  All of the attributes of premium paying flexibility, death benefit flexibility, potential for Cash Value accumulation, etc exist in Indexed UL just as they do in traditional UL or VUL.  Similarly, an Indexed UL policy’s net account value earns interest just like traditional UL.  Like all universal life, policy charges are deducted out of the policy and the net account value remaining earns interest at the policy’s crediting rate.  It is the way Indexed UL calculates the policy’s crediting rate that sets it apart as the “gap” product client’s were looking for.

The early forms of Indexed Universal Life insurance products involved a relatively straightforward and easy to understand crediting strategy.  The rate the net account value grew at was based on the performance of the S&P 500 index over a 1 yr period.  There was a “floor” of 0% and a “cap” of say 12%.  If the S&P earned 7% in a year, the policy’s net account value was credited at 7%.  If S&P was higher than 12% the policy was credited at the cap rate of 12%.  If the S&P went down 40% the policy’s net account value did not earn anything (0% credited).

This new life insurance chassis quickly gained momentum and now is on pace to outsell traditional forms of universal life.  In its growth, indexed UL has advanced remarkably over the years.  However, with these advances, comes complexity within the products themselves and their underlying crediting methods. Often times this complexity leads to confusion for the client and even the agents representing the products themselves.  It is very important for life insurance agents to align themselves with a dependable team to help them navigate the complex landscape of indexed UL products on the market today.  Let Bell & Associates lead your journey in the right direction.

-J.T. Bell

Chief Marketing Officer

© Bell & Associates - 2010