Commentary: Why Zero Is Not My Hero

By Ron Sussman

The current pandemic and resulting stock market volatility seem to have encouraged insurance companies to promote indexed universal life with even more bravado than usual. If I hear, “zero is my hero” one more time I am going to beat to a pulp the speaker of this banal nonsense with my college macroeconomics textbook.

As a salesperson, I realize that condensing complicated financial data into easy-to-digest sound bites can be a useful tool for helping clients understand difficult concepts. But distilling what is truly a very byzantine product with significant risks into a pithy slogan such as “zero is my hero” obfuscates the reality that those products may not even live up to their most hyped and arguably most significant feature, a 0% floor on interest earnings.

The more I hear this from insurance companies, the more I wonder why we don’t hear the mutual companies crowing about their guarantees. My first thought was, “If I owned whole life, 3%-4% would be my hero.” Or, “If I owned universal life, 2% would be my hero.” Either would be a significant improvement over zero when markets turn negative.

And is zero really zero, nada, nothing, no loss? Doesn’t a zero percent rate of interest become a negative number when you factor in the costs of the policy such as mortality, expenses, options costs, etc.? But more important, when you consider the real returns of indexed products over a long period of time, including those magic zeros, how much has the purchaser really gained or lost relative to other options such as whole life?

Without getting into a seriously complicated discussion of options pricing, product pricing, insurance carrier behavior towards in-force blocks of business, etc., can we all agree that the reason the National Association of Insurance Commissioners is so intent on regulating IUL and the way interest is illustrated is that the product is so complicated and poorly disclosed? And don’t forget that low interest rates and high market volatility result in lower caps and participation rates. Something we are seeing in real time right now from virtually every carrier.

Just think of the practical aspects of managing customer expectations. I, like most of you, regularly discuss policy performance with my clients. Especially when markets are volatile. So, it’s of vital importance to me that I can explain the annual (or quarterly) statements clients receive. With traditional UL, WL or variable life, the statements are very easy to explain. Everything is timely, easily disclosed and explained. And while dividends are somewhat of a black box, it’s relatively easy to explain how the companies pay them and why.

This is not the case for IUL policies. I recently had a conversation with a friend who is also a sales vice president with a major seller of indexed products. Once again, he reminded me that “zero is my hero.” Since we’re friends, I suppressed my desire to make barfing sounds when he said that.

My actual response was twofold: First, 2%-4% sounds two to four times better than zero; second, and less sarcastically, I asked him if he ever had to explain the annual statements his clients receive for their IUL products. His answer was very telling. He said, “Hell no!” There is no way to make sense of the annual statements.” In fact, he said, “The statements are usually printed before the index segment interest rate is declared, rendering all of the data in the statement worthless.”

By comparison, my conversations with clients who own variable life are very rational, informed and complemented by the quarterly statements they receive. The market allocation they choose is easy to follow and is virtually identical to what they see in the news every day. Furthermore, changes easily can be made on-line.

For me however, there is one overriding concern about which products are offered to which clients, and that is the long-term performance of the products relative to the client’s risk tolerance and level of financial sophistication.

IUL exists because insurance carriers needed a way to juice up their illustrations with returns that were at once greater than their bond portfolio yields (which have been trending lower for 30-plus years) and attractive to purchasers who may see the stock market as a fair proxy of relative returns. This foisted all of the risk of options trades, sequence of returns, etc., onto the client, without the client’s having the ability to make changes in real time. Parse the contract language and options costs, and it becomes obvious that the implied real returns are slightly greater than the average yield on high-quality debt instruments.

Speaking of which, have you noticed the very low single-digit returns on debt instruments lately? If so, then you most likely took note of the slow march towards reducing caps and participation rates of in-force IUL products. This is because IUL really isn’t a proxy for the equity markets, it’s a proxy for bond yields.

If you were to conduct a Monte Carlo analysis of the return probabilities, you would be hard pressed to find an IUL product whose average implied returns are even close to the average returns of the S&P 500 over a 50-year period. And that illustrated gross return hinges on all manner of sophisticated options trades, speculative policy pricing, and other hidden features and costs that diminish the net return.

All things being equal, what is the value of all this financial wizardry? Did having a zero percent floor really add value, or would my end result have been the same or better in a less complicated policy construction? How will clients be rewarded for accepting the very real risks inherent in these contracts relative to the alternatives? From my perspective they won’t. I don’t see this working out well in the future.

So is zero still your hero?

Ron Sussman is founder and chief executive officer of CPI Companies. Ron may be contacted at [email protected].