Big sales,big problems with indexed universal life insurance

By John Hilton

Indexed universal life is a lot of things, depending on who you are talking to.

An indexed universal life insurance policy is a multipurpose product that helps beneficiaries accomplish a variety of financial goals, most notably due to its tax-free retirement income capabilities.

Indexed universal life insurance (IUL) combines a death benefit with the potential for cash value growth, offering flexibility that's appealing to many. For some lawyers, however, IUL insurance is a seemingly endless source of business as lawsuits proliferate.

Consumer advocates say IUL policies are confusing to almost all who buy them, a product rife with rampant fraud. Regulators find indexed universal life insurance products a persistent headache due to their complexity and inconsistent sales practices.

One thing that nobody will argue is that IUL sells — and sells big. While other types of life insurance products lag with low-single-digit growth or negative sales numbers, IUL face amount increased 11% in the first quarter and the number of policies sold increased 13%, LIMRA reported.

“Many clients appreciate that an indexed universal life insurance policy offers a zero-floor guarantee,” said Raza Begg, an executive director at Experior Financial Group in Cheektowaga, N.Y. “This guarantee means that the policy is guaranteed never to lose or incur losses based on a stock market index, providing a level of safety that attracts risk-averse investors.”

Versatility and powerful sales ensure that IUL is not going away in the near term. But is change needed to help indexed universal life insurance evolve into a more responsible life insurance product? Many insurance professionals say yes and point to illustrations, participation rates, and consumer education as areas that are lacking.

IUL critics have “some valid points,” Begg concedes, noting that an IUL policy is a fairly new product to many policyholders.

“Unfortunately, consumers usually do not understand an IUL policy,” he added. “The lack of exposure and the limited number of insurance agents with access to this type of policy are the main reasons many have not heard of this tool.”

Why IUL is so popular — and problematic

Transamerica offered the first indexed universal life insurance policy in 1997. Today, more than 40 life insurance companies are offering some type of IUL policy, with more insurers adding new IUL insurance products and features each year.

Like indexed annuity products, IUL traces its popularity to the safe, middle ground it stakes out between market growth and market downturn risks. IUL policies provide policyholders with permanent life insurance coverage along with a cash value account and a guaranteed death benefit.

The money in a policyholder’s cash value account can earn interest by tracking a stock market index selected by the insurance company, such as the Standard & Poor’s 500. That interest rate can fluctuate, but losses are limited and gains often are capped through participation rates.

Options allow the holder to buy or sell the underlying index at a specific time for a set price, which can rise or fall quickly. If an option is exercised at the right time, the yield can be significant. But if the option expires and the timing is never right, the entire investment in that option is lost, resulting in additional expense charges.

“IUL is one of the few financial products that allows you to access up to 90% of your death benefit while still alive in case of a health issue,” Begg explained. “This access gives the policy owner more control over how their savings should be utilized, as a death benefit or a source of retirement income.”

IUL is generally considered to be more volatile than fixed universal life policies but less risky than variable UL, since IUL does not invest directly in equities like mutual funds or real estate.

However, management fees, cost of insurance, and other internal insurance costs associated with the options budget make IUL a costlier option in many cases. The options aspect is one reason critics say IUL is too complex for average Americans seeking simple personal finance solutions.

How IUL balances death benefit protection, cash value growth

Internal costs, including premium expense charges and cost of insurance, can cause an IUL account’s cash value to drop substantially. That puts a life insurance policy at risk of lapsing, and policyholders are on the hook for higher premiums just to keep the permanent life insurance policy intact. Sometimes significantly higher premiums are required.

IUL is often part of complex premium financing deals involving large premium payments and significant cash value growth projections. Several of these deals have gone bad and led to lawsuits.

In one Oklahoma case, Tom D. Le and Trang H. Nguyen purchased a $15 million indexed universal life insurance policy with an initial premium payment of $2 million. The plan called for the first 10 years of premium payments to be covered by a drawdown on a bank loan.

Plaintiffs claimed they were told there would be no more premiums due under the life insurance policy after year 10. They would still make yearly interest payments only on the bank loan until year 15. The Nguyens would end up with a fully paid-up $15 million death benefit for only the payment of the yearly interest on the bank loan, court documents say.

A PacLife illustration was used to show plaintiffs that the cash value of the policy would be $2.8 million in year 15, while the Arvest loan balance used to pay the premiums would be $2.25 million.

The Nguyens claimed they later learned that premium payments would be required for the life of the policy, or 84 years, court documents say. Their case was settled in June with no terms disclosed.

Speaking generally, Begg concedes that fees are high in the initial years of an indexed universal life insurance policy. But those expenses should be compared to a 401(k) plan, he added.

“You will know up front what the total expense will be in an IUL, unlike in a 401(k) where there are no fixed expenses,” he said.

But seasoned financial advisors generally agree that IUL is a complicated product for the average American to fully grasp, especially when comparing it to simpler insurance products like term life insurance or a whole life insurance policy.

IUL can be “a very complicated product,” said Steve Azoury, owner of Azoury Financial in Troy, Mich. “Consumers may not understand the costs of the death benefit. They may also be unaware of the different crediting rate strategies on the potential gains. Finally, consumers could be confused by the potential of policy lapse if expectations are not met.”

Why IUL illustrations create confusion for policyholders, regulators

Attorney Robert Rikard, half of the Rikard & Protopapas law firm in Columbia, S.C., has three IUL cases in South Carolina state court. He is hopeful that all will go to trial by the end of the year, providing some resolution for clients who regret signing up for a big-dollar IUL insurance policy.

Rikard, who has other cases involving different types of life insurance, said indexed universal life insurance is too often being sold as the foundation of a retirement planning strategy.

Most of the questionable strategies involve policy loans and/or inflated illustrations, often both. Rikard has experts who testify to the recklessness of these financial plans.

“Experts that have worked for me, who have either sold these insurance products or evaluated them, say it really is just a small sliver of the public that should be sold an IUL policy,” he said. “Life insurance agents need to be educated better on the fact that if you’re going to recommend an IUL, it has to be a small slice of a much-larger, well-allocated asset portfolio. The IUL cannot be 100% of a client’s life savings.”

IUL sales are often sealed with sales illustrations, and efforts continue to clean up the practice. The combination of life insurance agents who often don’t fully understand the product, coupled with unrealistic illustrations, is frustrating regulators and consumer advocates alike.

Actuarial Guideline 49 was adopted in 2015 to address indexed universal life insurance products created after the original 1997 illustration model was adopted. Life insurance companies quickly got around it by offering IUL products with multipliers and bonuses.

That led to AG 49-A in 2020 and eventually AG 49-B. Regulators referred to the latter update as “a quick fix” when it was adopted in 2023. Regulators have repeatedly shied away from an overall illustrations rule rewrite that could provide more clarity.

“These financial products are just incredibly complex,” Rikard said. “When you get into the weeds with these insurance agents, they really don’t understand how these products work. They’re simply relying on the illustration to sell the product, and the illustration is the best-case scenario if every single thing in that illustration works correctly.”

InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. John may be reached at john.hilton@innfeedback.com. Follow him on Twitter @INNJohnH.