Milo Minutes: Is IUL Too Good to Be True?

With recent innovations in the Indexed Universal Life (IUL) space and increasing requests from producers to run the same illustration scenarios, I felt it was time to write about IUL. I was reading an insurance magazine and noticed that while IUL sales are increasing, sales of other types of products have remained flat. Let’s dive into a common IUL illustration scenario and break down the policy.

Typical IUL illustrations show the policy being overfunded with income tax free retirement distributions beginning at age 65 or some show premium financed illustrations with the bank loan being paid off from policy proceeds in the 15th year. At first glance, these illustrations look appealing, but what advisors and clients often forget is that an illustration only proves one thing—that ink can stick to paper. The real issue is that most illustrations are run at the maximum allowed interest rate, often around 6.25% - 6.75%, which most actuaries would say is aggressive.

I’ve listened to Bobby Samuelson, an independent actuary, and he suggests running IUL illustrations at a more conservative rate of 4-5%. The worst thing you can do is promise a client income tax-free retirement distributions based on that higher, hypothetical rate, because they will remember that marginal number. But what happens if the policy doesn’t perform as expected at 6.75%? Most people also overlook the importance of the sequence of returns, which significantly impacts the total distribution. The market doesn’t move in a straight line—it goes up and down, affecting the policy’s performance. If you run the same illustration at 5%, you’ll likely see the distribution amount significantly reduced by as much as 60%, making the point clear.

A few points:

• - There is a surrender charge for the first 10-15 years depending on the policy.
• - Cap rates and participation rates are typically not guaranteed, so future reductions can reduce future returns.
• - The underlying index may have only existed for 2-5 years, but the illustration shows long term performance data starting from 2008.
• - Policy charges and the cost of insurance are not guaranteed. The cost of insurance increases with age.
• - Bonus assumptions factored into the illustration can inflate the numbers, but they come with additional costs. In negative market years, these bonuses can lead to a negative rate of return on the policy.
• - The illustration assumes index loan rates, which are not guaranteed. Higher loan rates could dramatically reduce distribution amounts.
• - The products are extremely complex that very few people actually understand.

While Indexed UL can offer attractive illustrations, they are highly dependent on optimistic assumptions that may not hold over time. The index itself, the bonus rates, and the loan structure are all variables that can change, potentially reducing the expected benefits significantly. Indexed products can be a useful tool, but only when they are well-monitored and fully understood. Always remember, no product is perfect for every situation, and with aggressive IUL illustrations, it really can seem too good to be true.

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An Indexed Universal Life (IUL) is not considered a security. Premium and death benefit types are flexible. It’s crediting rate is based on the performance of a stock index with a cap rate (i.e.10%), a floor (i.e.0%) and a participation rate (i.e., 100%). This type of universal life policy may lapse due to low or negative performance of the stock index, inadequate funding, and increasing cost of insurance rates. Tracking Number 7005012.1