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New Kid on the Block – Indexed Universal Life

Whole life insurance has been around for over 150 years. Universal life was introduced in the early 1980s. Universal life offered the option of increasing or decreasing the premium and death benefit and credited cash values ​​each year with a current interest rate. Variable life followed, allowing policy owners to invest their cash value in stocks. All three have their pros and cons.

Now there’s a new kid on the block: Indexed Universal Life.

Here are the main features:

1. Indexed Universal Life (IUL) is similar to Universal Life (UL); premiums and death benefits are flexible. You can increase or decrease the bonuses, or even stop them altogether. Depending on the evolution of your situation, you can reduce or increase (subject to insurability) the death benefit.

2. IUL is similar to Variable Life (VL) or Variable Universal Life (VUL) because the cash value is based on increases in one or more stock market indices. The most common are the DJIA, NASDAQ 100 and S&P 500.

Variable life contracts allow direct investment in stocks, much like a mutual fund. Index-linked universal life policies don’t invest directly in stocks, so you don’t have the same downside risk. The insurance company assumes all risk.

If your chosen index increases over a period of time (usually a year), your cash value increases. However, if the index drops, your cash value remains the same or is credited with a guaranteed minimum interest rate of 2%.

3. How cool is it? If the market goes up, you participate in the growth. However, if the market goes down, your account does not go down; it stays the same. It’s even better. All winnings are blocked. They can never be withdrawn due to future market declines. It’s like climbing stairs. If the market goes up, you go up a notch; if the market goes down, you stay where you are.

4. Indexed universal life has only been around for a few years. Only a few companies offer this contract. However, since 2000, the annual growth rate for this type of policy has been 24%.

When discussing IUL with your life insurance agent, you will need to understand a few new terms:

1. Credit Options

Credit options are the calculations behind how the insurance company determines how much to credit your cash value at the end of each credit period. The two most common are point-to-point and monthly average.

Point-to-point examines the value of the stock index you have chosen at the start of each contract year and compares it to the value at the end of the point-to-point period. This is normally one year, but can be 2 or 5 years, depending on your choice of contract.

It doesn’t matter what happens in the meantime. You could have a very high growth rate if the market and corresponding index experience a growth spurt in the last few months of the term. On the other hand, you could end up with a healthy loss if the index dips during the later part of your tenure with what for a regular investor would be a gain for the year.

The monthly average method takes one reading of the index each month. Then at the end of the year, add them up and divide them by twelve. This approach tends to smooth fluctuations.

What is the best? It depends on your risk tolerance and market performance over the life of your policy. Since a life insurance policy is a long-term proposition, in the real world the two should end up at roughly the same level over a long period of time.

2. Participation rate

The participation rate is the percentage of index increase credited to your indexed universal life policy each year. This can be, for example, 55%, 80%, 100% or 135%. One percentage is not necessarily better than another. It’s simply how the insurance company accounts for their downside risk and it’s a feature that allows you to undo a drop in cash value if the market goes down.

3. Ceiling rate

The cap rate is the maximum rate of return that the insurance company will credit your policy each year. For example, if the cap rate is 12% and the index you have chosen has increased by 10%, your policy is credited with a gain of 10%. However, if the index has increased by 15%, your policy is credited with 12%, the ceiling. Not all indexed universal life policies have a cap. Participation rates and cap rates work together.

Indexed universal life insurance is an exciting new approach. If you’re looking for a higher rate of return than whole life insurance or traditional universal life insurance, but don’t want the market risk of variable life insurance, index-linked universal life insurance might suit you. The fact that cash values ​​are based on stock market performance, coupled with the feature that prevents losses and locks in gains should be enough to warrant further exploration.

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