Avoid The Black Box: Understanding FIUL And Accumulation Bonuses

By Jason Wellmann

We’re now more than a full year past Phase 2 of Actuarial Guideline 49 (AG 49) going into effect. As a result, insurers have settled into a new reality with more moving pieces and room for interpretation when it comes to product design.

While the death benefit is still the primary reason for owning a life insurance policy, newer product categories, such as fixed index universal life (FIUL) insurance, also offer clients the ability to accumulate cash value that can be accessed via policy loans and withdrawals. These loans and withdrawals can be used for a number of reasons, including supplemental retirement income, a college funding strategy or emergencies.

Although AG 49 has leveled the playing field in terms of illustrated rates and loan amounts, it is important for financial professionals to understand other features and competitive advantages of the products they are selling. Accumulation bonuses are becoming a crucial part of this conversation. Why? Because bonus amounts are not calculated as part of the maximum illustrated rate, carriers can get creative when it comes to bonus designs. Thus, as accumulation bonuses become more common in FIUL policies, it’s important for financial professionals – and their clients – to understand that not all bonuses work the same.

More about Accumulation Bonuses

So what exactly is an accumulation bonus? An accumulation bonus is a credit to the cash value of an FIUL policy that is designed to help boost the policy’s accumulation potential. An accumulation bonus is applied in addition to any fixed or indexed interest that may be credited to the policy. Bonuses are usually an annual rate applied to all or some of the cash value of the policy. However, most bonuses are applied after cap, floors and participation rates are applied. This which means the policy’s annual interest credit potentially can be greater than the cap for the index. Some bonuses require allocation to a specified account or index. Some are only applied to the values allocated to the fixed account or to an index with a bonus built into it.

Not all bonuses are applied to the entire accumulation value of the policy, however. Some are applied only to unloaned policy values. Others are only applied to the amounts allocated to a specified account or index. As such, there are benefits and trade-offs with accumulation bonuses. Here are four factors that financial professionals should consider when analyzing accumulation bonuses.

Guarantees – Not all bonuses are guaranteed, which means the insurance company has the right to change the amount of the bonus or remove it entirely in the future. Some bonuses have a lower guaranteed rate than what is currently being offered. The guarantee could apply for the life of the policy or be limited to a certain period. In bonuses that are linked to index credits, a factor or rate may be guaranteed, but that does not guarantee an actual bonus amount. If the index performs poorly, there may be no bonus for that period. Guaranteed rates also may be adjusted for new business.

Caps, participation rates and allocation options – Products with a bonus also may have caps and participation rates adjusted to take the bonus into account. These products tend to have lower caps, floors, and participation rates compared to a similar product without a bonus.

Loans – Taking loans or partial surrenders may have an impact on the bonus, depending on the base to which the bonus is applied. Some bonuses are applied only to the unloaned value of the policy. This means that taking a loan will reduce the amount of future bonus credits. Other bonuses are applied to both the loaned and unloaned values.

Cost – Bonuses provide a benefit to the policyholders, but they are not free. Many companies apply additional fees or charges to help cover the cost of the bonus and associated guarantees. These can be explicit bonus charges – or other policy charges may be increased, such as premium load, per-unit charges or per-policy charges. Some insurance companies also may pay for accumulation bonuses by taking riskier investments in an effort to earn a higher yield.

Black Box Bonuses – what you and your clients should be aware of

Understanding the issue of whether bonuses are guaranteed or nonguaranteed is essential when recommending an FIUL policy to clients. Products with nonguaranteed bonuses may be more risky for the customer because an illustration may show a high bonus that can change. A company could change the bonus amount if actual experience is not what they expected (for example, poor investment experience or incorrect pricing assumptions). Even if the experience is what an insurer expected, if a company determines that they cannot support the current bonus amount, they can reduce it at any time.

When advising your client, it’s important that all elements of the accumulation bonus – how it is determined/calculated, how any multipliers or performance factors work, etc. - are fully disclosed so that you may discuss your client’s options based upon their needs. Unfortunately, some FIUL products include “black box bonuses,” where the illustrations are based off of undisclosed, non-guaranteed assumptions, the specifics of which are only available to the carrier. These “behind closed doors” calculations can be problematic because they make vital information about the policy – including how benefits can change and what the impact of those changes might be – a complete mystery to the client.

The “black box” element of product features is not limited to just accumulation bonuses. You may also see “black box” designs when carriers lower the cost of insurance or offer index credits in return for a spread death benefit. With a spread death benefit, the death benefit is paid out over a period of time (usually 10 to 30 years) instead of in a lump sum payment to the beneficiary. Illustrations may look favorable because of the lower cost of insurance or additional index credits, but these benefits are not guaranteed. It is important that the policy owner and beneficiaries fully understand the impact of the lower cost of insurance charges or index credits in exchange for a death benefit spread out for a certain number of years as their decision is irrevocable.

Clearly, the new landscape within FIUL dictates that financial professionals gain a solid understanding of the features and competitive benefits of these products. Although there has never been a better time for financial professionals to consider FIUL, it’s also important for them to understand the nuances of each product and the fact that some policies may not be able to deliver the type of performance shown in an illustration.

Bottom line, before recommending an FIUL product to your client, make sure you know exactly what that product offers and help your clients understand the specifics behind any guaranteed bonuses or features within the policy.

Jason Wellmann is senior vice president of life insurance sales for Allianz Life. Jason may be contacted at [email protected].

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