#58 | Fixed versus Floating Variable Loan Rates
Nothing gets folks riled up like discussing variable loans in Indexed UL products. Believers say that it’s the best way to put the power of Indexed UL to work. Skeptics say that it’s incredibly risky and poorly disclosed. Variable loans essentially swap the indexed performance against a stated loan cost. The loan cost is typically pegged to a bond index or stated by the life insurer at a rate that roughly matches the carrier’s general account yield. Variable loans therefore expose the client to variability on both loan charges and loan credits. When it works, it works extremely well. The best scenario for a variable loan is that the cost is low (let’s say 4%) and the indexed bucket hits the cap (at 12%), so the loan is actually additive to performance to the tune of 8%. But when it’s bad, it’s pretty bad. If the index does zero, the loan cost is the fully charged rate of 4%. The alternative is fixed loans, which might set the loan charge at 4% but guarantee that the loan balance earns a credit of 3.75%, so the net cost is fixed at only 25bps. Some carriers even offer fixed wash loan provisions that guarantee that the loan charges and credits will be equivalent. Fixed loans are clearly less risky than variable loans, but what if there was an intermediate solution?