Equity Indexed Products


The fastest growing new form of life insurance today is Equity Indexed Universal Life. Mark Orr, CFP explains why:

EIUL offers the benefits of traditional permanent Life Insurance with some additional performance enhancing features. The benefits include:

  • Safety
  • Liquidity
  • Death Benefit
  • Flexible Premium Payments
  • Potential Return on Principle
  • Tax Deferral
  • Liquidity
  • Protection against market downside risk
  • Transparency and simplicity

A Brief Background

  • EIUL has been around for 12 years – the first policies were issued in 1997 – following the introduction of Equity Indexed Annuities.
  • Sales remained low with premium starting around $65 million until 2004.
  • In 2004, major insurers entered the market and premiums rose to $539 million in 2008.
  • In addition to the S&P500, Indexes now include The Dow Jones Eurostoxx 50, The small cap Russel 2000, the NASDAQ 100 and others – for different investment styles.

How Your Equity is Invested

  • Equity is Tied to A Market Index: The equity in your policy is tied to a market index – most commonly, the S&P500 Index, which represents the largest US based publically traded companies.
  • Principle Invested In The Insurer’s General Account: Your money is never actually invested in the market, but in the company’s general account, which is largely bonds.
  • Call Options Purchased: Part of the interest that these bonds pay is used to buy 1-year call options on the S&P500 index.
  • If the S&P declines (as when the S&P declined by 37% in 2008):
    • The call option expires unexercised, and the principle in your policy does not decline since it was not invested.
  • If the Index appreciates:
  • The option is sold for a profit, and a percentage of that gain is credited to your account.
  • Interest Rate Floor: Your interest rate will not decline below a minimum from 0 – 2%, depending on the policy. Your account value cannot decrease based on what happens on the stock market.
  • Interest Rate Ceiling: Your interest crediting rate is capped at between 11% – 15% a year, depending on the policy.
  • Reset mechanism: This provision locks in the gains in up years upon which your policy’s account value is based on the crediting Mutual Fund investors want to get back to where they were before the market declined.

Potential Results

EIUL has been called “the Ultimate Roth Strategy” because it combines tax deferral with protection against downside market risk. Your principle is never at risk, but you can benefit from market appreciation up to a maximum participation rate. According to Dalbar Associates’ “Law of Averages 2003” these were the returns investors realized from 1984 – 2002:

  • Over 12% a year:  What the S&P 500 Index returned.
  • Under 10%: What the average mutual fund returned.
  • 2.7%: What the individual mutual fund investor earned due to switching to “hot funds.”

Downside Protection

During periods when the market is down, you trade a negative return for preservation of principle.

When the market advances, there is no lost ground to make up, and your values build from exactly where they left off before the market declined.

Reduced Volatility

This shows how EIUL’s cap and floor would have reduced volatility extremes over the last 10 years, compared to the performance of the S&P 500®(red line.)* Assuming a growth cap of 12% and guaranteed floor of 0%, actual S&P 500® returns would have translated into a smoother EIUL crediting rate (blue line) for the last 10 years.

Who Buys EIUL?

Risk Averse Clients: EIUL doesn’t offer the true market participation of Variable Life Insurance that more aggressive investors favor, or the guaranteed (but modest) rates and lower premiums of Universal Life. However, EIUL offers an attractive third option – a middle ground for risk averse buyers who saw the market downturn of 2001-2002 and are looking for some guarantees. These products can offer some peace of mind to buyers looking for a mix of guarantees and some potential for cash accumulation.

But the Moving Parts Vary: However, there can be disadvantages to having an equity indexed product. While the concept is simple, Steven Weisbart, economist for the Insurance Information Institute, cautions that “the crediting rate system in these products is probably not familiar to would-be buyers and agents.” Since there are so many “moving parts” to one of these products, it is sometimes difficult to figure out what the product actually does at first.

Is It Right For Me? Equity indexed universal life insurance may be right for you if you fit the following criteria:

  • The potential cash accumulation of variable life insurance is enticing but seems too risky.
  •  and the guarantees of universal life are comforting to you but the potential for cash value accumulation seems too low.

Advantages: EIUL policies have favorable tax treatment, no restrictions on what the cash value can be used for, and provide a tax-free cash death benefit for the policy beneficiary in the event of the death of the insured.

Additionally, the cash value in an EIUL policy generally receives some creditor protection, depending on the state, and does not count against the family for the purposes of determining need-based financial aid for college.

EIUL policies provide some safety of capital, because of the guaranteed minimum crediting rating. They also provide premium flexibility, so you can increase, lower or skip premiums when needed.

Disadvantages: EIUL policies can have a relatively high fee structure compared with pure savings vehicles, such as CDs, making them more suitable for long term holding periods, and because commissions are front-loaded, it can take a few years before the cash surrender value of the policy catches up with the accumulated premiums paid into the policy.

Policy premiums are frequently higher than the guaranteed rate, especially on low-balance cash values. You must fund them sufficiently to keep the policy in force later in life.

The crediting methods used to calculate the policy owner’s share of  market returns vary, and caps on returns may be lower than the historic performance of the stock market.

Before deciding on a particular product, be sure to research the stability and track record of insurance company behind it. The amount of interest you are credited is in the hands of the company and whatever guarantees the product offers are only as solid as the insurer itself. Always check into the insurer’s ratings (A.M. Best, Moody’s, Standard & Poor’s, etc.) to get a better picture of how strong the company is financially.

Footnotes:

The chart shows the average annual historical index interest rate for four different time periods, all ending 12/31/11. For each month in the specified time period, the point-to-point Index Growth Rate for the one-year period ending on the last day of that month was calculated using the actual historical S&P 500® performance excluding dividends.  Index growth,excluding dividends, for that period assumes a hypothetical Index Cap of 12% with a 0% floor. The average of these values was then calculated over all the months in the given time period.

Life insurance policies contain fees and expenses, including cost of insurance, administrative fees, premium loads, surrender charges and other charges or fees that will impact policy values.

“Standard & Poor’s®“, “S&P®“, “Standard & Poor’s 500™” and “S&P 500®” are trademarks of Standard & Poor’s Financial Services LLC (“Standard & Poor’s”) EIUL is not sponsored, endorsed, sold or promoted by Standard & Poor’s and Standard & Poor’s does not make any representation regarding the advisability of investing in Equity Indexed UL.

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Indexed Annuities – A Tortoise and Hare Analogy

This  sales piece by the annuity marketing group Wealthvest featured on Annuity Think Tank likens investment to the story of the tortoise and the hare:

  • The S&P Index is the volatile hare, given to fast sprints but sudden naps.
  • An Indexed Annuity, like the reliable tortoise, keeps on going.

The chart shows that if your money is on the hare (blue line), you are clearly taking a risk. But if your money is on the tortoise (red and green lines) you’ll have consistent returns without any losses. That’s because a Fixed Indexed Annuity, locks in returns each reset period to eliminate the possibility of negative returns.

A Brief Explanation of Indexed Annuities: While most fixed annuities only credit interest calculated at a rate set in the contract, equity-indexed annuities credit interest using a formula based on changes in the index to which the annuity is linked, such as the S&P500. The formula decides how the additional interest, if any, is calculated and credited. How much additional interest you get and when you get it depends on the features of the particular annuity.

Your equity-indexed annuity, like other fixed annuities, also promises to pay a minimum interest rate. The rate that will be applied will not be less than this minimum guaranteed rate even if the index-linked interest rate is lower. The value of your annuity also will not drop below a guaranteed minimum.

For example, many single premium annuity contracts guarantee the minimum value will never be less than 90% (100% in some contracts) of the premium paid, plus at least 3% in annual interest (less any partial withdrawals). The value of the annuity is adjusted at the end of each term to reflect any index increases.

More of the features Equity-Indexed Annuities provide are shown here.

Annuity Sales Decline As Indexed Annuity Sales Rise.

When it comes to sales trends, as well, the tortoise has been outrunning the hare.

A report by Juliette Fairley of Insurance Networking News, May 21, 2012 shows that total annuity sales dropped 8% in the first three months of 2012 compared with last year. “The combination of persistent low interest rates and high volatility is a challenging environment for the annuity industry,” said Joseph Montminy, LIMRA assistant vice president of annuity research.

LIMRA, previously known as Life Insurance Marketing and Research Association, found:

  • Fixed annuities dropped 10% in the first quarter to $18 billion.
  • Variable annuity sales dropped 7% to $36.8 billion.
  • Indexed annuities jumped 14% to 8.1 billion in sales.

Living Benefits Riders Have Been Popular

The GLWB rider, which may be elected at purchase, offers the ability to receive guaranteed lifetime income without requiring the owner to annuitize the contract.  According to LIMRA data, variable annuities sustained overall sales the past eight quarters with variable annuity guaranteed lifetime withdrawal benefit (GLWB) election rates at 90% during the last six months. In the third quarter 2011, the election rate was 88%, .

Indexed Annuities Are A New Darling

Kim O’Brien, National Association for Fixed Annuities (NAFA) president and CEO explains, “Indexed annuities are just fixed annuities with a different manner of crediting interest. This potential for additional interest is increasingly important in today’s low-interest environment. The rate of interest on indexed annuities may vary depending on the index performance but can never fall below zero.

For the third-consecutive quarter, indexed annuities outperformed traditional fixed annuities, capturing 45% of the fixed annuity market and jumping 14% to 8.1 billion in sales.

Who Sells Annuities?

MetLife was the top seller of annuities with $5.5 billion in sales, while Prudential was the top seller of variable annuities with $4.9 billion in sales, followed by Allianz Life of North America, which sold $1.4 billion in fixed annuity sales.

The Top 20 Writers of U.S. Individual Annuity Sales during the first quarter of 2012 include:

  • MetLife
  • Jackson Life
  • Prudential Annuities
  • TIAA-CREF
  • AIG Companies
  • Lincoln Financial Group
  • Allianz Life of North America
  • AXA Equitable
  • New York Life
  • Riversource Life Insurance
  • Nationwide
  • Pacific Life
  • Aegon
  • AVIVA
  • American Equity Investment Life
  • Thrivent Financial for Lutherans
  • Great American
  • Protective Life
  • Fidelity & Guaranty Life
  • Principal Life Insurance.

“We believe the focus of the Presidential administration and current politicians’ positions on annuities and preparing for retirement along with the Department of Labor’s interest in annuity payout disclosure and the opening 401k market to annuities are all strong indicators that fixed annuity sales will be a growing part of America’s retirement going forward,” O’Brien said.

The Snap! principle of Equity-Indexed Annuities:

Slow and steady wins the race