Indexed universal life insurance has become one of the most commonly sold products in our industry over the past 10 or 12 years.
There are many reasons for IUL’s popularity: the base product is flexible, it has many distribution options available, it can be built to focus on protection or on accumulation, and may have many riders that make it adaptable to different needs. And for many years, regulations did not directly address how the product could be illustrated, leaving the industry without firm guidelines regarding the projections being made.
That changed in 2015 with the passage of Actuarial Guideline 49, an attempt to bring some level of standardization to the illustrations being used at the time. In general, AG 49 reduced illustrated rates in the industry, producing customer expectations that are more likely to be met. However, IUL is still relatively new and, because the industry is innovative, new IUL designs were introduced that had not been contemplated when AG 49 was passed. These new designs rely on annual asset fees to drive higher interest crediting during positive market returns, and as a result, these designs once again created the concern that customer performance expectations may not be met in reality.
Why did IUL product designs raise concerns? Much of it has to do with how the product was illustrated. When illustrating an IUL policy, every year is an up year, even though it is known that the indexes that drive the interest crediting historically have down years. During any of those down years, charges would be deducted, but no positive performance is credited. Similarly, when an illustration shows a loan where the asset remains in the index, a situation is created where it pays for a policy owner to take a loan. The illustration shows that every year they make money on that loaned asset. In reality, there will be down years in the index that will result in a loan cost for those assets. In the eyes of the regulators, this has led to illustrations that are overly optimistic.
Where we find ourselves is not a new place. Universal life illustrations from the 1980s and early 1990s relied too heavily on the continuance of the high interest rates at that time. As rates fell, many policies came apart, leading to disgruntled policyholders and a wave of lawsuits. By the second half of the 1990s, variable universal life had become the new darling as the S&P 500 delivered stunning returns.
The dot-com crash changed the minds of many customers and financial professionals. Many consumers who stuck with VUL fled after the Great Recession. It was during this time that many producers that preferred the UL chassis shifted rapidly to IUL. Since that time, interest rates continued on a downward trajectory and pulled down both caps and participation rates over time. It’s possible we could again be over promising.
A New Guideline. New Possibilities
All of this brings us to AG 49A, the supplement to the original guideline intended to increase the level of standardization and potentially reduce the chances of significant over-promising through illustrating an IUL.
While a main emphasis of the guideline was the incorporation of additional regulation around product multipliers, it has a broader impact. It also reduced the allowable illustrated spread on index loans from 100 basis points to 50. Additionally, there are changes in how a carrier calculates the allowable maximum illustrated rate. The impact of the regulation will be to reduce the attractiveness of an IUL illustration, particularly when it is built for accumulation and distribution of assets.
This is good for the industry and good for the consumer. Although it may make it more challenging to sell an illustration, the end result should be greater satisfaction with the product. We work with complicated products that are challenging to explain to most of our clients. An IUL policy is one of the most complex, and as an industry we have added features and benefits that increase the likelihood of a client misunderstanding. When regulations attempt to provide more clarity and a level playing field, they are a benefit to all of us.
Meeting Expectations With A Low-Cost Approach
As a product manufacturer, we have long held the belief that the lower the product expenses, the better the likely long-term performance for the policy owner. Paying increased expenses for potentially improving performance may turn out well, but it also could turn out poorly.
The fee-for-performance model doesn’t guarantee a good outcome, or even increase the likelihood of a good outcome. It simply improves performance where it was already good, and reduces it where it was already bad. It could be suitable for a client who understands the additional risk that they are assuming, but the tools available to show the full extent of that risk are few, and frequently unused.
A lower-cost IUL product may not illustrate better under current regulations, and it may or may not perform better – that is not the promise. But reducing the range of outcomes increases the likelihood of meeting client expectations. An IUL that does not charge significant asset fees means a zero percent investment return is not as painful. A policy that only uses guaranteed bonuses insures that those bonuses will be credited. And even when you minimize downside risk, you can still take advantage of upside potential. That is the promise of a lower-cost IUL.
AG 49A has been developed in response to product development and illustration activity occurring after the original AG 49. It may not be the last word on IUL illustrations. As noted above, we are an inventive industry and it is impossible for regulators to anticipate every new design that may come about. However, the AG 49A should narrow the range of outcomes for the policy owner, thereby increasing the chance of meeting client expectations going forward. That should be viewed as a good outcome by everyone: product manufacturers, agents and, most importantly, policyholders.
Karl Kreunen, is vice president, product marketing, at Ohio National Financial Services. He can be reached at [email protected].