Indexed universal life insurance is the twist on permanent life insurance that is driving the sales of most major insurance carriers.
Once a client decides to purchase a permanent insurance product, the next decision they must make inevitably becomes — whole life or IUL?
Make no mistake — the upstart has not yet overtaken the tried and true. Whole life continues to be the top-selling life insurance product by premium, as it has been for many years. However, IUL has experienced explosive sales growth since the 2008 financial crisis. IUL now stands as the next most popular life insurance product after whole life, according to LIMRA sales data.
Both IUL and whole life generally are sold for death benefit protection today with potential for cash value accumulation and retirement income down the road. Whole life touts its robust death benefit, premium and cash value guarantees along with steady dividend performance, while IUL promotes its index-linked upside performance combined with some level of downside protection.
Whole life is the traditional fixed-rate stable performer that most people associate with permanent life insurance. Universal life is an “unbundled” version of permanent life insurance in which premiums are flexible and generally are estimated based on current charges and credits. But this also means that the carrier can raise or lower those charges and credits if so desired.
“Indexed” universal life means that the policyholder can allocate their cash value account to the traditional fixed-rate or an equity-style index (typically, the Standard & Poor’s 500). The downside risk is mitigated by inherent performance guarantees, but the upside potential of the gain is limited or capped as well. Also – because it is an index – dividend payments are not factored into the equation.
As the sales numbers demonstrate, both products resonate with a broad cross section of insurance consumers. However, despite the overwhelming popularity of both products, it is a rare breed of agent who sells both product types. Not quite as stark as opinions of the designated hitter rules— nonetheless, agents generally live in one camp or the other. Most present only whole life or only IUL to the vast majority of their clients. But why do agents, and ultimately clients, need to settle for one? Isn’t there a way for carriers to offer agents and clients a better solution, combining the best of both worlds?
Interestingly, carriers have been experimenting with this notion for some time, going back to the 1990s. Generally, the concept has been to create a new variation of whole life paid-up additions (PUAs).
PUAs are purchases of additional insurance (death benefit) that have a cash value. These purchases are made with dividends and/or a rider that allows the policyholder to pay an additional premium over and above the base premium. This creates the growth of death benefit and cash values in a participating whole life policy.
Adding large amounts of paid-up additions may create a modified endowment contract (MEC). A MEC is a type of life insurance contract that is subject to last-in-first-out (LIFO) ordinary income tax treatment, similar to distributions from an annuity. The distribution may also be subject to a 10 percent federal tax penalty on the gain portion of the policy if the owner is under age 59½. The death benefit is generally income tax-free.
The dividend performance of traditional PUAs would be replaced by the performance of the S&P 500 or another popular equity market index. At least one carrier developed a “variable paid-up addition” for their whole life contract in the late 1990s, tying the cash value performance of the variable PUA to the movement of the S&P 500 equity index. Unfortunately, sales of this product were hampered by the “dot-com bust” and the unlimited downside risk inherent in this design.
In a twist on the King Solomon story in the Old Testament, the insurance carrier has managed to successfully “split the baby” — satisfying both camps and keeping the baby alive. Oftentimes, an innovation fails or succeeds not based on the idea itself, but based on its entering the marketplace at the appropriate time. As consumers, agents and carriers emerge from the 2008 crisis and have become familiar with the concept of indexed insurance products, we believe that now may be the perfect time to reimagine a new type of whole life PUA — an “indexed PUA.” This innovation works as follows:
Indexed PUAs would receive a positive or negative adjustment of the traditional dividend based on the performance of the S&P 500 index, subject to a cap and floor.
This adjustment would be available only on PUAs, thus ensuring that the base whole life policy guarantees are not impacted by equity market volatility.
Clients would have the ability to adjust their allocation between traditional and indexed PUAs over time as their needs change.
To be fair, this solution may not necessarily work for all clients. There will be many clients who will still prefer a traditional whole life product or a traditional IUL.
However, given the significant size of the whole life and IUL marketplaces, we believe the time is ripe for carriers and agents to begin offering a “best of both worlds” indexed PUA solution to their clients. This concept could be attractive to many of today's insurance buyers, providing attractive whole life guarantees along with the opportunity for index- linked upside potential.
What Are Paid-up Additions, and How Do They Work?
Paid-up additions (PUAs) are additional life insurance that a policyholder purchases with the policy’s dividends. PUAs also can be a type of rider on a whole life insurance policy. PUAs also can earn dividends.
The policyholder can surrender PUAs for their cash value or take a loan against them; however, that may reduce the policy’s cash value and death benefit.
PUAs’ cash value can increase over time. These increases are tax-deferred.
The policyholder can use PUAs to increase their coverage without having to go through medical underwriting again.
Frank Chechel is second vice president, product management, individual life, with Guardian Life. He may be contacted at [email protected].
Anthony Domino is managing principal with Associated Benefit Consultants, Rye Brook, N.Y. He may be contacted at [email protected].