#92 | Prudential IAUL 2018

Executive Summary

Prudential has been trying to make a run at the Indexed UL space since 2011, but with little success. Index Advantage UL 2018 brings a host of changes that put Prudential’s offering more in line with the market. Prudential reworked the geography of the charges and indexed options so that IAUL 2018 is a slight improvement over its predecessor, but also introduced the Premium Credit (or +20 Bonus in Pru marketing materials) that is a currently guaranteed 20% bonus on indexed interest if the policy meets a certain funding requirement. It’s a pretty simple and straightforward bonus that I suspect Prudential will adjust on a fairly regular basis. And don’t be lulled into thinking that it’s necessarily a good thing – the cap can easily be adjusted in the future to offset the cost of the bonus. In the end, IAUL is an acceptably good offering from a company with a sterling reputation – and that might be enough for Pru.

Aston Martin undeniably makes some of the most beautiful cars in the world but, until recently, its cars had a secret. Underneath all of that bent sheetmetal was a decades-old chassis and powertrain. Aston Martin continually built new skins – Vantage, Virage, Vanquish, DBS, Rapide – on top of old bones. All of the styling in the world couldn’t hide the fact that Aston Martin’s cars, as beautiful as they were, became increasingly heavy, slow and expensive relative to its peers because of their ancient shared underpinning. All of that changed with the DB11 in 2016 – new chassis, new turbocharged powertrains and a new interior. A new Aston Martin.

Prudential is no Aston Martin and Index Advantage UL is definitely not beautiful like the Vanquish, but the story of new skins on old bones is the same. IAUL began life as a scuttled IUL product originally designed in 2008 that was resurrected and launched, almost without alteration, in 2012. It was obsolete right out of the gate. Just as the market was splintering into clear death benefit and accumulation products, IAUL was something in between. It had a lower cap than its peers and a 0.75% asset charge to boot. It didn’t play any of the gimmicks with sexy index options like its peers. And, not surprisingly, it didn’t exactly sell well.

Subsequent iterations of IAUL continued to put new skins on old bones. The 2015 version cut the 0.75% asset fee to only the first 9 years of the product, which brought the performance of the product a bit closer to the market. The 2016 version kept the 0.75% for all years but added a 0.85% bonus beginning in year 11 and increased the base policy charge duration from 7 years to 15 years – resulting in a slightly less competitive product that Prudential attempted to paper over with the addition of an indexed account with a 115% multiplier. But the multiplier came on an indexed account with a much lower cap when many of its peers were adding multipliers to accounts with caps 1-3% higher. New skin, old bones.

Prudential finally gave IAUL a new chassis for the 2018 product. The asset charge has shrunk from 0.75% to 0.25% annually. The base charge has been reduced back to just 7 years. Prudential also reworked the COI charges so that they are meaningfully higher in the early years, sometimes 3 times as high as on IAUL 2016, but lower at the very end of the curve. This might sound like Prudential is angling IAUL 2018 for death benefit sales, but it’s actually a way to suck up more charges on accumulation sales with Option 2 DB where the NAR in early years is higher. No surprise, then, that IAUL 2018 is the only product I know that defaults to an Option 2 DB in WinFlex. How did Prudential swap out a 0.75% asset charge for a 0.25% asset charge while generating similar net illustrated benefits? Those higher COIs have more than a little bit to do with it.

On the credits side, caps have been reduced from a little under 10.5% in IAUL 2016 to 10% flat in IAUL 2018 and from 9% to 8% in the S&P 500 accounts eligible for the 1.15 multiplier. This is a bit of a curious move because it means that the maximum illustrated rate in the S&P 500 account is 5.85%, including the multiplier, which is less than the illustrated rate on the regular S&P 500 account of 6.09%. Most companies try to calibrate the two accounts so that the maximum illustrated rates are roughly identical, but not Prudential.

If that were all to the story, then IAUL 2018 would represent a slight improvement over IAUL 2016. But, of course, that’s not the end. IAUL 2018 introduces something that Prudential calls the Premium Credit. As seems to be increasingly common these days, there’s virtually no disclosure on what the Premium Credit is or how it works. The illustration (and policy contract) simply says “…after a policy has been in force for more than 10 years, we may add a premium credit. This policy will be eligible for a premium credit if the accumulated premiums…are greater than [ X ] by the end of policy year 10.” The minimum premium to trigger the credit is equal to half of the maximum non-MEC premium paid annually for 10 years. For example, if the maximum non-MEC premium is $40,320, then the minimum eligible premium is $201,600 over 10 years. In other words, you may or may not get a credit at some point after year 10 as long as you’ve satisfied the minimum premium amount. The language also goes on to say that the fixed account is not eligible to receive the premium credit, which is truly bizarre because there should be no functional distinction between the fixed account and indexed accounts for a credit like this. You can imagine that, after writing 25+ pages on PDX, I feared that the Premium Credit would be as convoluted as PDX’s Performance Factor given that the level of disclosure is pretty similar.

Fortunately, Prudential provides far more details on the Premium Credit in supplementary materials even if the illustration leaves a lot to the imagination. For example, advisor marketing pieces refer to the fact that the Premium Credit (which is called the +20 Bonus in the flyers) is guaranteed not to be less than 1.2. But, elsewhere, Prudential caveats the Premium Credit as something that may or may be paid. In the contract filing, the guaranteed minimum Premium Credit is bracketed at 1.2, which means that Pru telling the state that the number can change by policyholder. In other words, there are lots of very strange mixed messages on the Premium Credit. Why Prudential would spill the beans in marketing materials but not in the illustration is quite strange. But I have a theory.

Recall that IAUL 2016 had an interest bonus, which was referred to as the Persistency Credit, of 0.85% from year 11 to 40. Assuming that the IAUL 2018 cap of 10% cost 4.05% when the product was delivered to market a couple of months ago, you can see where Prudential got 1.2 as the multiplier – 0.85% is almost exactly 20% of 4.05%. As I’ve said in other articles, swapping a fixed interest bonus for an indexed multiplier always provides more illustrated performance. Given the maximum illustrated rate of 6.09%, the 1.2 multiplier shows illustrated benefits of 1.22%, which is obviously greater than 0.85%. Once again, this is the wild math of Indexed UL at work – putting 0.85% into the option budget delivers 1.2% of illustrated performance. Magical, right? One dollar in, one and a half dollars out.

Let’s assume that I’m right to point out that the Premium Credit in IAUL 2018 is simply a reworking of the Persistency Credit from IAUL 2016. There are some key and curious differences. First, the Premium Credit is guaranteed and the Persistency Credit is not. If the Premium Credit is really just the Persistency Credit of 0.85% as a ratio of the option budget, then Prudential is effectively guaranteeing that relationship. This creates a bit of a monster. What happens when the Persistency Credit side of the formula doesn’t play out? What about if option budgets dramatically increase? Prudential’s exit strategy is that it can always just clamp down on the non-guaranteed cap to right the ship. But that’s not really what your policyholder signed up for, is it? I’d almost have preferred that Prudential just guarantee the formula with a fully disclosed Persistency Credit and option budget so that, at least, you’d know that the cap won’t be the victim of an overly generous guaranteed Premium Credit. And by the way, yes, I do think it’s currently pretty generous. The hedge cost for a 10% cap at launch was around 4% and now it’s over 4.5%. If I’m right about the formula, then Prudential should already be putting the clamp on the Premium Credit and the Marketing department will have to come up with a slick new name like, maybe, the +17 Bonus. Yeah, nevermind, that just doesn’t have the same ring to it.

Second, the Premium Credit has a specific funding requirement whereas the Persistency Credit does not. This is quite curious because paying the multiplier on a smaller number, as is the case if the policy is underfunded, sounds like it would be a profitable proposition for Prudential – except if other parts of the policy lose money in an underfunded scenario. My suspicion is that Pru wanted to reslope the COI curve so IAUL 2018 would perform a bit better in accumulation scenarios without having to risk the product being used for death benefit solves. Prudential has always taken a pretty hard stance on lapse supported COI curves, which means they’ve never really had a competitive non-guaranteed death benefit UL product. Hence, the Premium Credit only applies for overfunded policies. This also sort of tells you that the Premium Credit is supported, at least in part, by assumptions about how the policy is funded and designed. And if those assumptions go awry, there’s going to be pressure on the Premium Credit from things that have nothing to do with your client’s policy and that pressure will have to manifest itself in pricing elements that Prudential can change, like the cap.

My gut is that the reason why the Premium Credit is so poorly disclosed in the illustration and why the marketing name of +20 Bonus only shows up on non-filed materials is because Prudential is going to fiddle with it fairly regularly. If so, then you can read into future changes in the Premium Credit as commentary on the policies already on the books. Falling Premium Credits mean that policies with higher Premium Credits will be under pressure. Recall that the current 1.2 multiplier is the minimum guaranteed credit – so if new policies are getting a higher Premium Credit, then Prudential should raise Premium Credits on in-force contracts. This looks like a fantastically asymmetrical bet for policyholders and it really would be if not for the fact that the product is chock full of other non-guaranteed elements. If I’m wrong and the Premium Credit doesn’t change fairly often, then you can kind of figure that Prudential is punting on the risk by waiting until year 10 to see how the economics of the product look then. But, remember, all of these factors and the ultimate impact of the Premium Credit will flow back through to the non-guaranteed parts of the product, particularly the caps. It’ll be very interesting to see how all of this actually plays out for clients.

In the end, though, IAUL 2018 is a marked structural improvement over the old IAUL chassis. There’s really no caveat to that. But, is it worth selling over other IUL products? That’s where I’m torn. There are other, simpler products that perform similarly and without the added variable of how the mispricing of the Premium Credit will bleed over into other parts of the product. But IAUL 2018 is worth a look, if for no other reason than the best recognized and probably most trusted name in our business finally ditched the old chassis and now has a credible Indexed UL offering.

One other note – if you’re going to sell IAUL 2018, then you would be hard pressed not to chose the S&P 500 account with the current 4.0% spread. Based on today’s volatility, the price of that hedge is well north of 5% and significantly higher than the cost of the hedge for the 10% cap account. Take advantage of it while you can.