A few weeks ago, I received a marketing piece from a well-known insurance company.
The piece was sent to insurance company agents and announced updated cap rates and illustrated maximum rates for their indexed universal life (IUL) products. As has been the case for many years, they are all down. This means that regardless of the growth of the S&P 500 (or any other index tracked), the maximum credit rate in good years will now be at the lower cap rate. There is no judgment here; it is, but it will reduce the future performance of IUL contracts and make it even more difficult to support past projections and achieve policy owner goals.
The copy reflects a decline in each of a few dozen indices for several different policy series, from two basis points to several hundred basis points. (Remember, I must be very fuzzy here.)
It doesn’t make this insurance company any different or worse than others; they are all in the same boat. But I’m going to pick something they related in their article, although unfortunately it’s not unique to them. Everyone knows that pretty much every company spins things, especially bad news, and this company is no different. However, when does the rotation go too far?
In light of the negative announcement, the carrier reflected on its strong history. This includes recalling the launch of their very first IUL product many years ago and the average annual credit rate since then. That’s an impressive rate for a life insurance product, especially for a non-title-based contract like an IUL policy. Of course, the gross credit rate and the actual yield are not at all the same, and the cash value premium return is probably several hundred basis points lower than the advertised credit rate in most situations.
Here is the kick. The recounted historical credit rate is significantly higher than the current cap rate on the product’s index account. Did you get that? The cap rate (the maximum rate at which the cash value of the policy can be credited) is lower than the long-term credit rate they boast. In addition, the product’s lifetime credit rate is a few hundred basis points higher than the maximum illustrated rate allowed for the product today.
The article acknowledges that the maximum illustration rate is lower than the long-term credit rate and that past performance is not a guarantee of future performance. Then they state that these long-term rates demonstrate the value of the products.
But do they?
There are two main reasons why long-term rates are as attractive as they are. First, the S&P 500 has been on a tear since the launch of the IUL policy, averaging around 15% per year. Second, cap rates throughout the life of the product were higher than today, sometimes by hundreds of basis points. Potential policy owners are now making decisions at a time when the market is high, and the policy’s cap rate is about 50% of the actual long-term return of the S&P 500 that drove the credit rates they boast. It is a definitional impossibility to move forward.
Here are the calculations using made up numbers which are nevertheless a realistic example of what I have seen a few times with different carriers. Let’s say that the long-term credit rate of a given S&P 500 Index LUI product is 8%. Then we will say that the current capitalization rate of the product is 7%. You can’t have 8% credit when your cap rate is 7%! I think it’s safe to say that everyone realizes that can’t work. Yes, I know they don’t actually say you will get 8% in the future. Still, if you try to tell me that they’re not implying something much more positive than is likely or even possible, I’ll say you’re being dishonest. The long-term story of 8% doesn’t make sense when you can’t get more than 7% now, so what’s the point of focusing on that?
You know what? I used to be able to dunk a basketball, with two hands to hold myself under the net. But guess what? I can not now. But I let you know that I was more athletic, so that should mean something to you in the future. This is further proof that I am awesome. You buy it?
Pulling those numbers up is misleading because they’re not even possible, but it’s worse than that. Based on the current cap, the modeling suggests that the actual credit rate would be in the range of 4% to 5% gross assuming the next 30 years follow the last 30 years with the current cap rate. After policy costs and mortality costs, there will be almost nothing left, even though the S&P 500 has returned 15%. That’s how it works.
It is the marketing that the insurance company sells to agents who, in turn, sell to the public. It doesn’t suit me well.
Bill Boersma is CLU, AEP and LIC. More information can be found at www.OC-LIC.com, www.BillBoersmaOnLifeInsurance.info. Call 616-456-1000 or by e-mail at [email protected].