Equity Indexed Universal Life from a Carriers Perspective

Equity indexed universal life is a relatively new type of life insurance product that operates on the chassis of a more traditional product called universal life. For purposes of making a comparison, both products are identical with the exception of how they credit the policy cash surrender value.

The cash surrender value of an equity indexed universal life policy allows the policy holder to be credited based on the performance of a selected index. For additional information see our recent post on how equity indexed universal life insurance works.

The confusion with equity indexed universal life is how it works from a carrier perspective and what to look out for in the future. For instance, why is one carrier offering a CAP RATE of 16%, while another is only offering a CAP RATE of 12%.

Why is this and how will it affect an equity indexed policy?

First off, let me be clear, CAP RATES are not guaranteed. Just because you have a CAP RATE of 16% today it doesn’t mean you are going to have a CAP RATE of 16% a year from now or ever again. The insurance carrier reserves the right to adjust this rate at any time. So, when you look at a policy with a 16% CAP RATE versus a policy with a 12% CAP RATE, the policy with the higher CAP RATE is going to outperform the one with the lower CAP RATE every time.

How sustainable is a higher CAP RATE?

After meeting with a major U.S. life insurance carrier last week, and asking them to explain to me why there is such a discrepancy between CAP RATES I finally got some answers.

In order for a life insurance carrier to offer a guaranteed floor and CAP RATE in an equity indexed life insurance policy the carrier must purchase two options, one to cover each side of the return. This part isn’t rocket science. But, what was news to me is the carrier is not allowed to use any portion of the premium to purchase the options. The carrier can only use earnings from the premium to purchase options. As I understand it, this is the reason equity indexed life insurance is not considered to be a securities based product governed by the Securities and Exchange Commission. The carrier is not putting any of the policyholder’s premiums at risk.

What does this have to do with anything?

Well, premiums are invested in the carrier’s general account, which is made up primarily of bonds. Life insurance companies are unique in that they hold all bonds in the general account to maturity to reduce risk to policyholders. Based on the total bond portfolio the carrier is able to determine what they can earn. This means most carriers are getting a similar return on their general account.

Now, based on the earnings of the general account the carrier is able to go out and purchase the two options for the equity indexed universal life policy. Since the floor must always be at least 0% the price of the option is what is available at the time the option is purchased. So, by taking your earnings less the cost of the option to guarantee 0% you can determine what is left over to purchase the option to hedge the CAP RATE. Now, I’m going to give you a minute to think about this, what option is going to cost more the one with the higher CAP RATE (in our example 16%) or the one with the lower CAP RATE (in our example 12%)?

Think about it….

The more expensive option will be the one with the higher CAP RATE. If everything else is equal how is this possible? I have two theories on this. The first is the carrier with the lower CAP RATE is not using all earnings to purchase a higher CAP RATE. The second is the carrier with the higher CAP RATE is using this as a teaser rate and is going to have to eventually lower the rate…you decide.

Buying life insurance is important for those individuals who financially support dependents or other family members. It is also a critical asset to provide necessary liquidity for estate planning purposes. It is important to determine what your life insurance needs are, choose what type of policy will fulfill that need, and determine which life insurance carrier suits your unique situation. Click here to see how HNWLifeInsurance.com can assist you in this process.

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