The hidden risks of indexed universal life and what advisors should know

By Anna Baluch

Indexed universal life insurance now represents about 25% of life insurance sales and the product is rapidly increasing in popularity.

“As a result of the growth, there are advisors, attorneys, and other institutions that are being critical of a product that’s so ubiquitous or threatening to their particular business model,” said Michael J. Rothman, chief distribution officer at Succession Capital Alliance.

High-profile legal disputes and public commentary about policy expectations and cost assumptions have also amplified the scrutiny.

In addition, most educational content and articles focused on IUL use very case-specific situations, which are simply not applicable to many people, or generalize facts or conclusions. This has contributed to how IUL products are both marketed, understood, and interpreted in the financial services world.

For advisors, the goal should be to look beyond the noise and understand each client’s unique situation to determine whether IUL makes sense. The same applies to any other life insurance product.

Disconnect between IUL performance and reality

Most clients understand the basic benefits and limitations of IUL products.

They’re aware that an IUL policy participates in index performance, subject to caps, floors, and participation rates. They also recognize the tradeoff: limited upside protection in exchange for downside protection.

The greatest misconception clients tend to have about IUL products, however, is related to the regulations that govern anticipated rates of return and market exposure. They believe they’re similar to those of other financial solutions.

The reality is that IUL illustrations operate under a different regulatory framework. They depend on assumptions about long-term index performance, crediting strategies, and policy costs.

Unfortunately, those assumptions don’t always reflect real-world variability, often leading to unrealistic expectations about policy returns.

“Also, since the last five years have had mostly positive returns, many clients haven’t experienced the benefits of downside protection. However, of course, that protection absolutely has value,” Rothman added.

Determining whether an IUL policy makes sense

As with every financial solution, IUL coverage is only right for some clients. To zero in on whether it’s a good option, start with the client’s unique needs rather than the product itself.

An individual may benefit from an IUL policy if they have a long-term need for a death benefit or any other life insurance use case, such as estate tax exposure, business succession, or legacy transfer.

The caveat is that they must also have the financial profile to sustain permanent coverage over decades.

Once you decide IUL is worth exploring, it’s your responsibility as an advisor to evaluate performance expectations in the context of comparable asset-class benchmarks and historical crediting performance.

As you do so, keep lines of communication open and address any questions or concerns a client may have. Together, you can make an informed decision that aligns with the client’s long-term goals and personal preferences.

If the client chooses to move forward with IUL, your job isn’t over. Rothman recommends an annual or bi-annual review process. This can keep you engaged while giving the client the confidence that someone is monitoring their policy and suggesting adjustments as needed.

“These are products that will likely be owned for many years, and ultimately, their success depends on annual reviews,” Rothman explained.