Sounding the alarm on indexed universal life insurance – Forbes Advisor

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For more than a decade, indexed universal life (IUL) has been one of the most profitable businesses in the life insurance industry. New IUL premiums rose 29% in the fourth quarter of 2021 alone, according to LIMRA, an industry-funded financial research firm.

There are now at least 52 insurers selling indexed universal life insurance, says Barry Flagg, president of Veralytic, a life insurance product rating service. Pacific Life is the largest, with about 19% of the market.

But critics say indexed universal life insurance is sold dishonestly. “These are complex products sold with false promises and deceptive marketing,” says Birny Birnbaum, executive director of the nonprofit Center for Economic Justice. “Keep away from them.”

Mount an Index

The cash value of an IUL policy is linked to an index. This could include vanilla indices such as the S&P 500 and Russell 500 indices. But the money could go into more esoteric markets like the Hang Seng, gold and emerging markets.

Options allow the holder to buy or sell the underlying index at a certain price at a certain time, which can rise or fall quickly. If an option is exercised “in the money”, the gain can be significant. But if the option expires “out of the money”, the entire investment in that option is lost. And that’s why IUL is a riskier investment than traditional insurance. Critics say the risk is not properly disclosed and is borne by the insured.

“Consumers should avoid IUL because the insurers and agents selling the product have no obligation to work in the best interest of the consumer. Mix massively complex products designed to extract artwork with opaque, inexplicable characteristics and you have a recipe for future financial disaster,” Birnbaum said in a July 2020 statement that warned consumers against buying IUL.

The American Council of Life Insurers (ACLI), which represents 280 companies in the insurance industry, admits that IUL is not for everyone. “But indexed universal life wouldn’t gain popularity if millions of long-term planners and families didn’t find the cost of owning the product a good value,” said ACLI spokesperson Jack Dolan.

Related: Best Life Insurance Companies of 2022

Try to play it safe

Indexed universal life insurance belongs to the same category as other permanent life insurance policies, such as whole life insurance. This means that it will not expire, unlike term life insurance, as long as the premiums you pay and the account values ​​of the policy are sufficient to keep the policy in force.

Life insurance companies that sell traditional policies like whole life insurance invest primarily in corporate bonds and government-backed mortgages where the money will be safe and earn a low annual return each year. but reliable.

An indexed universal life policy is different. As the name suggests, it takes the annual interest income from the bonds and mortgages underlying the policy and invests that interest in options on one or more indices. These policies are sold by insurance agents as an indirect means of playing the options market. The insurance company administers and purchases the options, rather than the policyholder, who expects to see additional value gains while maintaining the basic investment security in the policy.

It’s a way for life insurance policyholders to get their cash value to participate in the market.

Fees can exhaust the policy

If it’s true that an indexed universal life insurance provides a greater benefit than a traditional life insurance policy in a good year – like 2021 when the S&P index rose 26.9% – and although it can protect against investment loss, the costs associated with an IUL can deplete the policy of its value.

To allow for the money management budget involved in options trading and to compensate the insurer and its agent, IUL policies can include many more fees and costs than an average life insurance policy. An insurer charges more than 8% of premiums and policy cash value in the first year alone, according to Steven Roth, president of Wealth Management International, insurance analyst and litigation consultant. That’s more than most hedge funds.

These charges threaten to deplete the cash value of your policy during adverse times when the market, or any other index to which the policy is linked, plunges. If internal costs cause the account value of the policy to drop too far, your policy may be terminated and you will have to pay higher premiums just to keep the policy intact.

“When the S&P lost 500 points in March [2020] due to the COVID-19 crisis, the loss in policy placement was nil, if measured from the previous year. But the monthly policy fee may have caused losses of several per cent of the policy’s value – and if it dropped too much – then policyholders received a ‘premium call’ forcing them to invest more money,” explains Roth.

Pay or lose

If you don’t continue to pay the higher premiums to keep the policy in force, you risk losing all premiums previously paid, as well as the death benefit in the future.

In an example cited by Veralytic, a person could pay $367,000 over six years on an IUL policy and get nothing back if the policy is cancelled. When a policyholder tries to surrender the policy, the insurer can keep the entire first year’s premium since they have already paid the commission fee to the agent who sold the policy.

“Policy values ​​in IULs are depressed for many years due to high initial fees and high surrender charges,” says Roth, adding that “These usually last more than 10 years after the policy is purchased.” . Roth was recently part of a class action lawsuit against Prudential Insurance Co. involving overbilling and improperly expired universal life policies. He is working on another against Pacific Life over deceptive sales practices regarding the earning potential of indexed universal life policies.

ACLI’s Dolan says the size of the premium depends on the policy’s option returns. “The fact is, in a different (and better) economic environment, less bonuses would be paid more than originally planned,” he notes. “Owners of this product need to know exactly how it works because, unlike some other types of life insurance, IULs have a fluctuating component.”

If you don’t have the stomach for investment losses or don’t have the patience to invest for the long term, IULs are probably not for you.

The problem with IUL sales

A little-known rule passed by Congress in 2010 as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act exempts indexed universal life insurance from federal regulation. Thus, IULs are not regulated by the United States Securities and Exchange Commission, unlike stocks and options.

Insurance agents are generally not required to undergo the same training as stockbrokers to sell “derivatives”, such as options based on an underlying index like the S&P 500. Their only requirement is to be licensed by the state as an insurance agent. .

“Keep in mind that a wide range of consumer protections are in place for all life insurance customers, including a 10-day ‘free search’ period after purchase,” Dolan says.

But Birnbaum, of the Center for Economic Justice, says insurance agents often use optimistic projections, or “illustrations,” to show the gains these policies can yield over the years. This gives the impression that the policy will be “free” in certain years, or that you will not have to contribute as much as other types of life insurance.

The problem is that these projections are not guaranteed and may not materialize. People will buy IUL policies based on a fictional future and come up against a harsh reality when they have to pay far more than expected to keep the policies in force.

Facing the unexpected

Remember that a life insurance policy can be in effect for 40 years or more and a lot can happen during that time. For one thing, after a few years, the insurer can lower the “credit cap,” which is the maximum amount it allows the policyholder to earn on the policy when options are doing well, Roth says of WealthManagement.

Insurers often use low-cost loans to sell IULs and have lenders lined up to offer loans to potential IUL buyers, he says. This practice is called “arbitration”. In fact, many index-linked universal life insurance buyers have been encouraged to buy up to five times the amount of insurance they actually need with these low-cost loans, Roth says. They are led to believe that the policy will earn 6% or more every year, and since they can borrow money to pay the premiums at 3% or less, they think they will earn at least 3%, much better than what a bank can offer. – and on borrowed money.

But the contract holder will likely need to requalify as a borrower every three to five years, during which time the interest rate may rise while the cash value of the contract may fall.

No wonder, then, that LUIs are complicated. Birnbaum’s Center for Economic Justice obtained a Pacific Life policy that includes 72 pages of legalese and many different profit projections – called “illustrations” – which makes it difficult for the buyer, or even the agent, to understand. insurance. Pacific Life did not respond to repeated calls and emails.

What’s wrong with this picture

A committee of the National Association of Insurance Commissioners (NAIC), which sets the standards for state regulators who oversee insurance, has struggled for years to produce guidelines that states can adopt to ensure that the illustrations used by insurance agents to sell LUIs reflect the risks taken by buyers. Their last effort in July 2020 came from a life insurance and annuity committee of the NAIC.

“The NAIC has been very active on the regulation of IULs, which continues to this day,” says ACLI’s Dolan.

But not successfully, according to Birnbaum. “We challenge any member of the Committee to understand and explain, so that a purchaser of this product can understand how this product works,” he said in a letter to the NAIC. “Regulators are doing nothing to stop unfair practices,” he warns.

Opinions on indexed universal life insurance vary, but critics warn that it’s not the risk-free investment it can be sold for and you could lose it all. Veralytic’s Flagg advises you to check with an accountant before buying, as they operate under a stricter set of rules than most insurance agents.

Be careful if agents try to paint a pretty picture with illustrations that aren’t guaranteed, or that suggest you’ll get a big deal by taking out a loan to pay your IUL.

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