#118 | Voya ICAR & The Indexed UL Illustration War

10/31/18 Update – Voya will no longer issue new policies effective 12/31/18. Also, I’ve been hearing that some people are reading this article as if I’m a big fan of ICAR – that is not the case. It is a clever and effective way to increase illustrated performance in the crazy, bizarre, non-sensical world of the Indexed UL illustration. The real world is something entirely different. ICAR and other charge-funded multipliers in IUL products increase the leverage of the product to the underlying option profit assumption. If you think option profits are reasonably 50% or higher every year forever, then you’ll love ICAR. If not (and I definitely don’t), then you should avoid it and other charge-funded multipliers like the plague and stick to simple, straightforward, purist products if you’re going to sell Indexed UL. But either way, you should definitely read this article because even though Voya is getting out of the business, other companies are already planning on copying the design and deploying it in their own products.

Straight interest bonuses. Straight indexed return multipliers. Contingent interest bonuses and index return multipliers. Combination interest and indexed return multipliers. Multipliers and bonuses that only apply to certain indexed accounts. Multipliers funded by explicit asset charges. Multipliers funded by explicit fixed charges. Multipliers funded by a hodgepodge of charges. Barely disclosed multipliers that are so opaque that no one knows how they really work. Multiple bonuses and multipliers on one product that interact with one another. Modern Indexed UL represents a paralyzing array of choices about risk, return, leverage, performance and illustration profiles. With Voya’s new Index Credit Accumulation Rider (ICAR), you can add one more to the list – but this one isn’t just another on the list. It has the potential to disrupt the entire Indexed UL market and, by extension, shake our industry.

ICAR is a new twist on the hottest ticket in town – the charge-funded index return multiplier. In its basic form, the carrier assesses a fixed or asset-based charge to fund a multiplier on earned indexed credits. PacLife PDX, the #1 selling Indexed UL product by a landslide, uses a highly complex multiplier funded (in part) by fixed policy charges. Other companies, like John Hancock and Lincoln, use asset-based charges to fund declared index return multipliers. All charge-funded index return multipliers increase leverage on index returns, but the structure of the multiplier does have an impact on how that leverage actually plays out over time. For example, John Hancock’s multiplier uses a 2% annual asset-based charge to deliver a 55% index return multiplier, so leverage is constant every year regardless of policy performance. PacLife PDX’s fixed-charge funded design means that leverage always changes based on the ratio of the fixed charge to the account value* but, generally, leverage is highest early in the policy when the account value is lower.

Whereas the leverage from PDX’s fixed-charge funded multiplier declines over time and asset-based multipliers like John Hancock’s stay constant, Voya’s ICAR allows the leverage to actually increase over time. The result is that it delivers illustrated performance from another planet. To put it in perspective on a max-funded 45 year old, both PacLife PDX and John Hancock Accumulation IUL 2018 top out at about 7% IRR on cash value at their respective maximum illustrated rates**. Voya Global Choice with ICAR? Up to 9%. Yes, 9%. No, I’m not kidding, a 9% internal rate of return on cash value at the default illustrated rate of 6.75%. Consider the bench marked.

How’d they manage to pull this off? There is one wickedly clever difference in how ICAR works relative to other charge-funded multipliers. In short, Voya uses the sum of previously credited indexed interest rather than the account value as the basis for the ICAR charges and multiplier. Voya deducts a charge as a percentage of the previously credited interest and then essentially credits the charge back to the policy at the end of the year based on the index return. On illustrations, it basically shows up as $100 coming out at the beginning of the year and $132-150 being credited back at the end of the year, depending on the index account option. In other words, it applies the illustrated option profit embedded in the base illustration to all of the charges deducted for ICAR. The bigger the charges, the bigger the illustrated option profits flowing through to the performance of the product. This is identical to every other charge-funded multiplier except that in ICAR, more performance means more credited interest, and therefore higher ICAR charges and more illustrated option profit. Whereas policy performance dilutes the leverage from PacLife PDX’s multiplier design and doesn’t affect asset-based multiplier designs, it fuels more leverage in the ICAR design. Stew on that for a second. Little wonder why a 6.75% illustrated rate can generate 9% illustrated internal rates of return on cash value.

At the risk of sounding a little bit hyperbolic, Voya just invented the nuclear bomb in the Indexed UL market. They must have known it. ICAR is straight-jacketed with all sorts of arbitrary restrictions that are not requirements for the methodology to work effectively. For example, Voya caps the maximum charge for ICAR at 10% of previously credited interest, turns the rider off at age 85 and doesn’t illustrate ICAR performance as additional arbitrage for indexed loans (which virtually every other carrier would have done). A full analysis of ICAR is available in additional posts for Members of The Life Product Review, but I felt the need to write a public post on ICAR because of the new methodology of increasing leverage that it introduces. Voya’s version of the methodology embodied in ICAR is, frankly, pretty benign. They were about as conservative with it as they could have been. Yes, it will illustrate extremely well against today’s bonuses, but not nearly as well as what other companies will do once they take the ICAR technology and create their own nuclear bombs. Stripping off Voya’s restrictions on ICAR but preserving their pricing and methodology can create some truly unbelievable illustrations with cash value IRRs easily topping 25% (yes, 25%) and fully compliant with AG49, actuarial testing requirements and SEC guidelines for the definition of a security.

In other words, unlike with fixed charge and asset-based charge funded multipliers, there are no real regulatory guardrails for conservatism with the methodology introduced by ICAR. In fact, there’s even (theoretically) a client-centric story for why bigger leverage with the ICAR methodology makes sense. If the client is only gambling with previously credited gains, the logic goes, then this new methodology is less risky than multipliers with charges on account value and still generates more upside. That statement has truth to it (but not as much as you’d think) and, more importantly, it’s an excellent soundbite for a carrier leadership team trying to justify building their own version. That’s why the methodology that ICAR introduces is so clever, powerful and, ultimately, so incredibly dangerous.

Companies selling Indexed UL have already been increasingly and uncomfortably arming themselves to the teeth with multipliers in a desperate attempt to keep or gain market share. That’s why we have the arsenal of indexed bonuses and multipliers that I rattled through in the first paragraph of this article. Companies are already in the process of making those designs even more potent. Right now, the most aggressive asset-based charge in the market is 2%. What’s to stop companies from upping the ante? Nothing. In fact, just a few days ago PacLife filed a new rider called the Enhanced Performance Factor and it appears to have up to a 7.5% asset-based charge. At the implied option budget of 4.1%, their index-return multiplier could go as high as 180%. I know of several other companies that are looking at asset-based charges in the 2.25-4% range for launch early next year.

But ICAR changes everything – it is the superior solution in all the right ways, at least for generating illustrated performance. It doesn’t cost the life insurer anything. There is only a charge and a bonus to the extent there are previously credited gains, which makes it a bit more conservative than a fixed or asset-based charge. It generates fantastical illustrated returns that can be multiples of what other bonuses can do without running afoul of the guidelines. It will be extremely difficult for insurers to choose to not build a rider like ICAR.  And it will be equally as difficult for them to follow Voya’s example and choose not to make it illustrate its full potential – a situation where we are routinely seeing illustrations at 6% and cash value internal rates of return as high as 25%***.

If that sounds patently ridiculous to you and you’re shaking your head in disbelief, then let’s get real for a minute. It is not ridiculous at all. That 25% cash value IRR I quoted above is a simple function of releasing the arbitrary restrictions Voya put on ICAR as it is already built, filed, approved and priced today. I didn’t just make that up. Left unchecked, this is where the Indexed UL market is headed. We’re hurtling towards a world where a product that has theoretically low risk and theoretically limited upside can illustrate at twice the rate of VUL products. Something is seriously amiss in Indexed UL and Voya ICAR (along with virtually every other charge-funded index return multiplier) puts the spotlight on it.

Here’s the fundamental problem. There is no way to denounce what Voya did with ICAR, what PacLife did with PDX, what John Hancock did with Accumulation IUL 18 and what many other companies have done or are about to do with their products without denouncing the fundamental premise behind every Indexed UL illustration. Illustrated at maximum AG49 rates, every single Indexed UL shows up to 50% profits forever on the option budget. Every IUL illustration shows a magical money machine that never loses or, in the words of one IUL carrier executive I heard, a slot machine that hits the jackpot almost every time. All that these bonuses and multipliers represent is a full expression of the core premise behind every Indexed UL illustration. The entire enterprise of Indexed UL, every single part of it, is built on the premise of 50% illustrated option profits forever. If you really believe that 50% profits were reasonable, why not lever up? Why not bet it all? Why not illustrate a product with a 25% cash value internal rate of return?

It’s tragic, really, that this is where we are. A decade ago, we were selling life insurance for death benefit protection. Now, we’re selling highly complex derivative strategies that just happen to be in a life insurance wrapper on the premise of long-term financial gain, leverage and arbitrage. Nowhere else in the financial world is anyone, anywhere, making the case for sustainable long-term profits from buying equity call spreads. Just us life insurance folks. Doesn’t that seem strange? Doesn’t it seem like we would see everyone else talking about this strategy if it really worked the way it illustrates? But it doesn’t. And yet, our industry has wholesale sold out to the idea that we, of all people, have captured lightning in a bottle. Please. Let’s not forget that Indexed UL is a $2B market. It is barely a rounding error on the combined $100B+ market for Fixed Indexed Annuities and Retail Structured Products, both of which use exactly the same crediting mechanism and never talk about long-term option profits. In the huge global family of structured products, Indexed UL is the crazy Cousin Eddie. We’re not even allowed in the house.

So instead of marketing indexed crediting as leveraged financial arbitrage, perhaps we could just get back to actually selling life insurance. Wouldn’t that be a change for the better? Isn’t that what our industry is actually supposed to do? Shouldn’t we leave selling leveraged derivative strategies on the premise of financial arbitrage to people who actually know what they’re doing?

If you still want to sell Indexed UL at AG49 maximum illustrated rates but you really don’t like what’s happening with all of these new leveraged multipliers, I have bad news for you. The only way to clamp down on these leverage designs is for us, as an industry, to get real about illustrating long-term option profits. Doing so would essentially strip Indexed UL of any illustrated advantage over UL. But since there’s too much money to be made in not getting real about option profits, there’s a snowball’s chance in hell that it’s actually going to happen. I’m reminded of a quote by Upton Sinclair – “it is difficult for a man to understand something, when his salary depends on his not understanding it.” Right now, there are a lot of incomes in our industry, everyone from agents to CEOs, depending on Indexed UL illustrations. It’s certainly not the first time our industry has sold its soul to an idea that didn’t exactly pan out.

We survived tontines. We survived vanishing premium Whole Life. We survived UL illustrated at 14% from the 1980s. We survived VUL illustrated at 12% from the 1990s. We survived STOLI in the early 2000s. And we will survive Indexed UL when – not if – it comes undone.

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*Even a cursory look at PacLife PDX will show you that the Performance Factor is far more complicated than the simplistic description I use here. You can read more in the PacLife PDX Series.

**I ran PacLife PDX at 6.09%, the current rate as of this moment, recognizing that the cap is falling in a few weeks along with the maximum illustrated rate.

***You might be wondering why it’s not closer to 50%. When I released the Voya restrictions on ICAR and juiced the ICAR allocation to 90% in my Excel clone of the product, I got IRRs that peaked at about half of the baseline option profit assumption. This is was odd to me at first but I think it’s mostly related to how the accounting in ICAR works. Voya deducts the next year’s charge right alongside the current year credit, which blunts the impact of the current year credit. You can see this in their illustrations because when the ICAR rider stops at age 85, there’s a huge cash-on-cash pop in the illustration because there is no charge coming out for the next year.

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