Indexed universal life insurance (IUL) has been one of the most successful companies in the life insurance sector for more than a decade. According to LIMRA, an industry-funded financial research firm, new IUL premiums climbed by 29% in the fourth quarter of 2021 alone.
According to Barry Flagg, president of Veralytic, a life insurance products rating service, there are now at least 52 insurers supplying indexed universal life insurance. Pacific Life is the largest, accounting for roughly 19% of the market.
However, some claim that indexed universal life insurance is being sold in an unethical manner. “They’re complicated products with deceptive marketing and false promises,” says Birney Birnbaum, executive director of the organization Center for Economic Justice. “Keep your distance from them.”
Taking the Index
An IUL policy’s cash value is linked to an index. This might include standard indices like the S & P 500 and the Russell 500. However, money may be flowing into more obscure markets such as the Hang Seng, gold, and emerging markets.
The holder of options can purchase or sell the underlying index at a specific price and time, which can rise or fall dramatically. The reward from exercising an option “in the money” can be substantial. If the option expires “out of the money,” however, the entire investment is forfeited. As a result, IUL is a more risky investment than typical insurance. Critics say that risks aren’t made clear enough and that the policyholder has to take the risk.
“Consumers should avoid IUL since the insurers and agents who sell it have no obligation to act in the best interests of the customer,” Birnbaum advised buyers against purchasing IUL in a July 2020 statement.
IUL is not for everyone, according to the American Council of Life Insurers (ACLI), which represents 280 insurance firms. However, indexed universal life would not be growing in popularity unless millions of long-term planners and families found the cost of ownership to be a reasonable bargain, says ACLI spokesperson Jack Dolan.
Attempting to be safe
Indexed universal life insurance is similar to whole life insurance and other permanent life insurance products. This means that, unlike term life insurance, it will not end if your premiums and policy account values are enough to keep the policy in effect.
Traditional life insurance companies, like those that offer whole life insurance, put most of their money into corporate bonds and government-backed mortgages, which are safe and give a small but steady return every year.
A difference is an indexed universal life insurance policy. As the name implies, it invests yearly interest revenue from the bonds and mortgages that underpin the policy in options on one or more indices. Insurance brokers sell these plans as an indirect way to participate in the options market.
Instead of the policyholder expecting to see further improvements in value while keeping the core policy investment safe, the insurance company manages and purchases the options.
It’s a means for life insurance policyholders to participate in the market with their cash value.
Fees may deplete the policy.
IUL policies can have much higher fees and charges than standard life insurance policies to cover the costs of money management and compensation for the insurer and its agent. According to Steven Roth, president of Wealth Management International, an insurance analyst, and litigation consultant, one insurer charges upwards of 8% of the premiums and cash value in the first year alone. That is more than the majority of hedge funds.
During downturns in the market—or whatever index your insurance is linked to—these fees threaten to deplete the cash value of your policy. If internal costs lead the account value of your policy to drop too low, your coverage may lapse, and you’ll have to pay higher premiums just to keep it alive.
The monthly policy expenses may have caused losses of several percent in the policy’s value—and if it went down too much, policyholders received a ‘premium call,’ compelling them to pay in more money, Roth explains.
Pay up or face the consequences
You risk losing all previously paid premiums as well as the death benefit if you don’t continue to pay the higher premiums to keep the policy in force.
According to Veralytic, an individual could pay $367,000 for an IUL policy over six years and receive nothing if the policy is terminated.
When a policyholder wants to surrender it, the insurer may keep the entire first year’s payment because the commission fees to the agent who sold it have already been paid.
“Large up-front payments and high surrender fees lower policy values in IULs for many years,” Roth argues, adding that “these often endure for more than 10 years after the policy was taken out.” Prudential Insurance Co. was recently included in a class-action lawsuit alleging overbilling and improperly lapsing universal life insurance policies by Prudential Insurance Co.
He is now preparing a lawsuit against Pacific Life for misleading sales tactics about how much money indexed universal life insurance products could make.
According to Dolan of the ACLI, the size of the premium is determined by the returns on the policy’s options. he observes. Because, unlike certain other types of life insurance, IULs have a variable component, owners of this policy must understand exactly how it works.
IULs are generally not for you if you don’t have the stomach for investment losses or the patience for long-term investing.
The Issue with IUL Sales
Indexed universal life insurance is free from federal regulation under a little-known law approved by Congress in 2010 as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. IULs are not regulated by the US Securities and Exchange Commission like stocks and options are.
Their only condition is that they be licensed as an insurance agent by the state.
However, according to Birnbaum of the Center for Economic Justice, insurance salesmen frequently employ optimistic estimates, or “illustrations,” to demonstrate the advantages these products can provide over time. This gives the impression that the policy would be “free” in certain years or that you wouldn’t have to spend as much as you would for other types of life insurance.
The difficulty is that these predictions are not guaranteed to come true, and they may not. People will purchase IUL policies based on a hypothetical future, only to discover that they must pay significantly more than they anticipated to keep the policies in force.
Managing the Unexpected
Keep in mind that life insurance coverage might last up to 40 years, and a lot can happen in that period. For one thing, if options perform well, the insurer may lower the “crediting ceiling,” or the maximum amount a policyholder can earn on the insurance, after a few years, according to Roth of Wealth Management.
According to him, insurers frequently employ low-cost loans to sell IULs and have lenders lined up to offer loans to potential IUL purchasers. This is referred to as “arbitrage.” In fact, Roth claims that these low-cost loans have pushed many indexed universal life insurance purchasers to buy up to five times the amount of insurance they truly need.
They are encouraged to believe that the policy will earn 6% or more per year and that because they can borrow the money to pay the premiums at 3% or less, they will earn at least 3%, which is significantly better than a bank can offer—and on borrowed money.
However, every three to five years, the policy owner will be required to requalify as a borrower, at which point the interest rate may rise while the cash value inside the policy may decrease.
It’s no surprise that IULs are difficult to understand. The Pacific Life policy received by Birnbaum’s Center for Economic Justice contains 72 pages of legal language and numerous profit projections—referred to as “illustrations”—making it difficult for the buyer or even the insurance agent, to comprehend. Pacific Life did not return multiple phone calls or emails.
What’s the Deal With This Image?
For years, a committee of the National Association of Insurance Commissioners (NAIC), which sets the standards for state insurance regulators, has struggled to come up with guidelines that states can use to ensure that the illustrations used by insurance agents to sell IULs accurately reflect the risk that buyers assume. The NAIC Life Insurance and Annuities Committee made its most recent effort in July 2020.
“The NAIC has been very active in the regulation of IULs, and that activity continues to this day,” adds Dolan of the ACLI.
Critics warn that indexed universal life insurance is not the risk-free investment that it is advertised to be, and that you could lose your entire investment. Before you buy, verify with a certified public accountant, according to Veralytic’s Flagg, because they follow a stricter set of rules than most insurance brokers.
Agents that try to create a rosy picture with unguaranteed graphics or who say you’ll make a lot of money by taking out a loan to pay for your IUL should be avoided.