Illustrating Equity Index Universal Life Policies

In my last entry, What You (as Trustee) Need to Know About Equity Indexed Universal Life, I spoke about one of today’s hot insurance products.

The EIUL policy is designed to capture a portion of the upside of the equity market, while limiting the downside.  The policy is credited with returns from an index without dividends, with both a cap on the upside and a guaranteed minimum return to cushion the downside.

Please refer to my prior entry for a recap of the mechanics, caveats, advantages and disadvantages of this type of policy. Today I want to focus on the illustrated rate of return that is used in the policy illustration.

As I stated previously…The policy promoters tout the fact that EIUL “limits your risk” because of the investment floor feature. However, the risk that you, as trustee, take on is the risk that the policy will not perform as illustrated.  So, how do you as the policy owner decide on a reasonable hypothetical return to be used in an EIUL policy?

Some carriers have used “back tested” models, but recently a top EIUL carrier came out with an “Indexed UL Rate Translator” that “represents one approach to translating an assumption of long-term performance of the selected index into a hypothetical assumed rate for the purposes of the policy illustration.” The support material from the carrier states that the mechanism for translating the index return to an EIUL policy return “applies an algorithm that takes into account your stated expectation for long-term equity return, the current costs of supporting the index strategy, and the general theory that investments with similar levels of risk should be expected to yield similar levels of return.”

They have created a website  where you can input expected index returns along with the cap, floor and participation rate of a policy and it will kick out the corresponding hypothetical crediting rate of an EIUL policy based on the specific inputted information.

Recently, I went to the site and entered various hypothetical returns for the S&P 500 Index to calculate the “translated returns” for an EIUL policy utilizing that index.  I assumed a 100% participation rate, 10% cap and 0% floor.  The translated returns are listed below.

S&P 500 Hypothetical Returns

4%

6%

8%

10%

12%

Translated EIUL Policy Interest Credited

4.82%

5.25%

5.67%

6.10%

6.52%

Some may disagree with the output of this “calculator”, but I for one can see its value.  In a bull market, the actual index will outperform the EIUL policy because of the cap which cuts off all gains above a certain return.  For example, in 2013 the S&P 500 Index return without dividends was just over 29%, but the EIUL policy listed above will be credited with a return of only 10%. The result is that a 12% hypothetical rate in the S&P 500 Index translates to only a credited rate of 6.52% in the policy.

The EIUL policy limits losses in bad years and this is another reason this Translator makes sense to me. In a bad market where the S&P Index over time may return only 4-5% and suffer years of negative returns, the EIUL policy will most likely equal or outperform the Index itself.

Many EIUL policy illustrations I have seen assume policy funding based on a credited rate of 7% or so. If you are taking in a policy with a crediting assumption that high I would suggest a second illustration with an outcome at 5% as the basis of policy funding. If by chance the policy is actually credited with a 7% return over time, your client can possibly lower the premiums in later years.

It is your decision as trustee, but it is always better to under promise and outperform.  It makes for happier clients.