How Does Equity Indexed Universal Life Insurance Work?

Equity indexed life insurance is a great alternative for an individual, who is interested in participating in market returns, but does not want any downside risk. So, how does it work?

Generally, an equity indexed universal life insurance policy has 3 primary components: cap rate, participation rate, and minimum guaranteed rate.

All equity indexed universal life insurance policies have either a cap rate or participation, or in some cases both. The best way to explain a cap rate it is the maximum return you can receive under the life insurance contract.

For example, if an equity indexed universal life insurance policy has a cap rate of 12%, and the S&P 500 Index has a return of 22%, then the maximum the policy would be credited is 12%. Now, you may be thinking this is unfair, but this is where the minimum guaranteed rate comes into play. Under the same scenario, assuming the S&P 500 Index had a return of -22% then the contract would be credited the minimum guaranteed rate.

In most cases, the minimum guaranteed rate is between zero percent and two percent. This is the minimum crediting rate the life insurance carrier is required to credit if the indices performance is negative.

One other important note is an equity indexed life insurance policy may have 2 different minimum guaranteed crediting rates. The first is the minimum guaranteed crediting rate for the portion participating in the performance of the index. The second is for the portion that is sitting in the fixed account of the policy, and is not subject to the returns of the underlying indices.

The participation rate is a percentage of the return that will be credited to the policy. For example, if the S&P 500 Index returns 22%, and the participation rate is 80%, the crediting rate to the equity indexed life insurance policy will be 18% (22% S&P 500 Index Return times 80% participation rate).

As if all this wasn’t confusing enough you can have a equity indexed universal life insurance policy with a participation rate and a cap rate. All of these are functions of how the life insurance carrier is purchasing their options to cover the requirements of the contract.

To see how different crediting rates and minimums affect an indices performance check out “Understanding Equity Indexed Universal Life Insurance”.

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