I don't know much about them, but here is my companies stance on them...
The gist of the memo is that a) the market caps are not guaranteed and almost certain to change and b) if you believe the market goes up in the long run, a VUL is a better investment.
A relatively new type of life insurance product has generated some interest in the past few years. Index Universal Life is marketed as another product that provides some of the upside potential of the market combined with assurances that the client will never lose money. Superficially, this seems very attractive. However, a closer analysis reveals serious limitations, especially compared to GVUL (guaranteed variable UL). This product is built on a general account chassis, with 90% or more of policy values invested in bonds. The upside performance is provided though derivatives. Typical Index Interest Features:
- ?Indexed Interest? paid at the end of each policy year
- This ?Index Interest? is tied to the capital appreciation of the S&P 500 Index or other market index for that year.
- The percentage of participation in the equity appreciation is usually limited by a fixed amount or a participation rate.
- The percentage is subject to a cap (usually 10% or 11%) and a floor (usually 0% or 1%)
- Payments received after the anniversary do not generate any interest until the year after they are received
- Values that have been borrowed are not eligible for Index Interest
- The most significant limitation is that the company has the right to lower the participation rate or caps at their discretion. (Financial derivatives are only priced out at 3-year time periods so the future price of the derivatives is uncertain)
- Because the equity kicker is provided by derivatives, the product does not actually own the underlying securities. Therefore, the return does not include earnings from the stocks dividends (historically close to 40% of total returns)
- Because it is a general account product, equity index products do not offer clients the protection of separate accounts in the event of company insolvency.
Thus, the product is designed to be marketed as a vehicle that offers some of the upside produced by market returns with no risk of loss in any given year. The buyer sacrifices larger annual gains as a trade- off for the protection from losses.
Additional Product Features:
- Guaranteed premiums: Many of these products offer death benefit guarantees similar to GUL products
- Surrender charge schedules can be very long ? up to 20 years
- Preferred loans at 0% cost spread
For the most part, this product will function like ordinary universal life, with the exception that the method chosen to credit growth to the account value is based upon a complex formula rather than a simple interest rate.
Concerns:
- The method of ?interest? crediting is very complex.
- The credited rate of interest is left, to a very large degree, to the discretion of the insurance company.
- Very little disclosure regarding the calculation of credited interest is disclosed. Since there is no prospectus, and since the product is not registered. It is very much a ?black box?. Under NASD notice to members 05-50, it is to be regulated as a security. There remain a number of questions on what new disclosures will be needed to adequately inform the client of the product?s drawbacks.
- The expectations of ?market gains? are very likely to lead to disappointment, since the participation rate is not always guaranteed; returns associated with dividends are not received and since the S&P 500 Index does not represent a diversified portfolio of investments. (see the attached study)
Conclusion: Compared to most GUL and GVUL, Index UL represents a poor value to the client. If the upside potential of variable is sought, this upside potential is overstated in Index UL. If the guarantees of GUL are sought, the same guarantees can usually be found at lower rates or from much stronger carriers. Until clearer standards are established by FINRA/NASD, these products also seem to provide the greatest risk of potential litigation.
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