Since the National Association of Insurance Commissioners adopted Actuarial Guideline 49 in 2015, the way indexed universal life is sold has changed drastically, but not necessarily for the better. The original regulations are being reexamined, so the future of IUL hangs in the balance once again.
Don’t get me wrong, I do believe that setting uniform illustration standards to curtail misleading sales practices is necessary. However, AG 49 was really born from dueling opinions between insurance companies that believed in IUL and those that were staunchly against it. The original regulations were merely an exhausted compromise after rounds of saber-rattling and laborious deliberations.
Although AG 49 clearly states that its purpose is to “aid in client understanding,” I believe that the first wave of regulations actually hurt client understanding more it than helped. As a practicing agent who takes an educational approach with clients, I can tell you first hand that explaining the true essence of how IUL works is much more difficult now than it was before. You see, during the heat of the AG 49 battle, some of the key educational reports inside older IUL illustrations ended up as casualties on the cutting-room floor.
Here are the three main mandates that AG 49 originally put forth to “provide uniform guidance for policies with index-based interest,” as well as a discussion on how they can now be modified to better “aid in client understanding” (quotes taken directly from AG 49).
1. Determining the maximum crediting rate for the illustrated scale.
This was obviously done so that clients would no longer be bamboozled by outlandish projections on IUL illustrations. For example, one carrier offered the ability to illustrate an average annual crediting rate of 11.44% by cherry-picking one particular historical period using an obscure index strategy. Being fair to the majority of advisors, most of us were setting proper expectations with clients by backing way off from the maximum possible crediting rate allowed by our illustration software.
Regardless, to curtail any future abusive illustration practices, AG 49 mandated the maximum illustrated rate be derived only from that carrier’s 1-year S&P 500 annual point-to-point strategy regardless of any better performing strategies offered. Moreover, the maximum illustration rate must be no more than the average of every possible 25-year period that can be found within the S&P 500’s last 65 years using that carrier’s current cap and floor.
Given there are more than 10,000 unique 25-year daily slices within the last 65 years, all involved agreed that this was a fair enough average crediting rate to be used on illustrations. Although this solution may seem clean and easy, there’s one big problem with it.
The AG 49 average may now be reined in, but it’s still just a smooth and steady average uncharacteristic of how the market really moves. Did you know that of the last 65 calendar years dating back from Dec. 31, 2018, the S&P 500 Index:
Had 37 years greater than 8%.
Had 23 years less than 3%.
»Had only five years between 3 and 8%.
So why in the world are we showing clients illustrations with steady averages between 3% and 8% for 65 straight years? Clients can’t possibly anticipate the seemingly binary effect that S&P 500 volatility can have on their IUL policy using this methodology.
I’m not saying we use options pricing models to determine what caps could have been during these higher interest rate environments. I’m simply saying that the client should see the effect of the fluctuating index through history using that carrier’s current day cap and floor.
2. Limiting the policy loan leverage shown in an illustration.
Again, this was so clients wouldn’t be misled by obscene amounts of ongoing positive arbitrage when using IUL’s participating loans. Before AG 49, if a carrier had a loan rate of 5% and a crediting rate of 8%, the illustration would paint the picture that they would always get 3% of positive arbitrage despite taking massive loans against their policy for retirement.
Although AG 49 now limits this effect to a more reasonable 1% of positive arbitrage on loaned money, the client still sees nothing but a steady average throughout decades of retirement.
We used to be able to compliantly show IUL’s expected ups and down by using supplemental reports showing historically back-tested illustrations. Several carriers would offer 20, 30, 40, 50 and even 60-year lookback illustrations where the client could clearly see the eroding effect of policy loans and charges on their cash value through choppy decades and even the speed bumps of multiple consecutive zero-percent years.
I used to love featuring the worst in the bunch, the 50-year lookback. Essentially five of the first 10 years have zeroes or just a few basis points higher. Then four of the following 10 years had two zeroes and two years had 1.4% or less. So nine of the first 20 years showed 1.4% or less, with mostly zeroes. After licking its wounds from this slow start, the retirement scenario on the same report featured “the lost decade” with three consecutive zeroes during the tech crash followed by another in 2008.
If the client deserves to see the effect of negative arbitrage from loans during consecutive zero-percent years, shouldn’t they also witness the bounce-back years that up the average and either confirm or deny that their policy can survive?
Highlighting this horrible period truly helped clients understand how IUL can operate during different market conditions. Not only that, but these supplemental reports better prepared client expectations for the zero-percent goose eggs laid in 2011, 2015 and 2018.
3. Requiring additional consumer information (side-by-side illustration and additional disclosures) that will aid in consumer understanding.
Again, I believe that additional reports to aid in client understanding are exactly what are needed. However, the original AG 49 version of these missed the mark. The “increased transparency” mandated by AG 49 that found its way into illustrations is really just more of the same.
These “alternate scenario” illustrations simply show a lower version of another smooth ongoing average. None of the new additional side-by-side illustrations make IUL easier to understand, nor do they even hint at the variation of returns that a client should expect.
Bring Back Compliant Historical IUL Illustrations
Since IUL carriers already possess software programmed to extract 65 years of S&P 500 returns into 25-year slices, why not just spit out the worst 25-year period, the best 25-year period and one historical period that most closely matches the AG 49 average?
Similar to how whole life illustration software offers the ability to back down the current dividend rate, there could also be a feature that allows you to override a lower S&P 500 cap rate for an alternate scenario.
Even fixed indexed annuities that were anticipating stringent Department of Labor oversight allowed compliant historical lookbacks so clients could grasp the broad range of likely possibilities to contrast against one another.
If an IUL carrier offered a 9.25% cap today and looked back 65 years, then the client would see the worst possible 25-year sequence averaging 3.81%, the best 25-year sequence averaging 7.26%, and one that averages 5.76%. More important, the client would see the volatile index movements each year that made up those distinct averages.
Couldn’t it be mandated that the clients sign off on seeing the worst 25-year period to ensure expectations have been properly set forth upon delivery of the policy? This type of report may even spark a conversation between client and advisor about what types of adjustments could be made to the policy if a horrible 25-year run were to happen again. At the very least, it will make clear that an IUL policy should be monitored and revisited regularly, unlike illustrations projecting a complacent average.
Don’t we want clients to understand the wide variation of swings involved with IUL before they make what should be a lifetime commitment to an insurance company?
Perhaps some clients will choose a more conservative IUL policy with streamlined costs or stronger guarantees. Perhaps some clients will simply back away from IUL altogether and choose whole life. Perhaps some clients will be truly OK with the aggressive risk/reward tradeoffs offered by some of the most exotic IUL policies on the market today.
Unfortunately for my younger clients, 25-year lookbacks won’t be enough. They need to see how their policy operates in good and bad years once retirement loans commence.
If I could show a historical illustration today looking back 50 years from Dec. 31, 2018, it just so happens that the average of this period is right in line with the AG 49 maximum (some slightly higher but mostly lower depending on the exact cap offered).
Unlike a smooth average, the 50-year lookback illustration would show a rocky start plus a very bumpy road right in the heart of retirement. For safe measure, you could even invert or randomize the sequence of returns of the worst 50-year lookback.
What a great way for agents to test their concoctions. A properly designed policy would hold up under this kind of duress, whereas an underfunded or poorly designed policy would not. Seeing these prolonged negative periods would allow the client to witness the year-by-year risk/reward tradeoff within any type of IUL growth and income strategy. Clients could better understand if what was being proposed was the right product for them through the different phases of their financial life.
I always tell my clients that my job is to educate them about their options, and their job is to sell themselves on what is best for their family.
IUL’s increasing sales numbers make it clear that the product is here to stay. I hope the focus with AG 49 this time around will be less about policing IUL, and more about furthering client understanding of how the product really works and the different set of outcomes that are possible.
Bringing back a fair and balanced set of historical illustrations would allow advisors to have these next-level conversations with clients and keep egg off the face of our industry as these policies mature well into the future.