#131 | John Hancock Protection IUL 18
John Hancock Protection IUL 18 represents a dilemma for insurance professionals. On one hand, it has some of the lowest illustrated premiums in the industry. But, on the other hand, it is complex, over-engineered and highly leveraged in both its charges and credits. Unlike virtually every other life insurance product in the industry, Protection IUL charges dynamic NAR Rates instead of COI Rates that vary with a fairly complex calculation that pulls in several policy factors and, generally speaking, increase when product performance is weak and decrease when policy performance is strong. Protection IUL 18 also sports a 2% asset charge for a 65% guaranteed index return multiplier, further increasing leverage and complexity in the product. There are some mitigating factors to the risks in Protection IUL 18, particularly the fact that the contract details and guarantees the mechanics and that John Hancock offers next-level management capabilities courtesy of RateTrack, but a simpler product is probably a better fit for most clients.
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Constraints boost creativity – and there is no better example of how that plays out in the life insurance business than at John Hancock. Canadian accounting closes the doors to many of the strategies and markets employed by their US-based competitors. As a result, they’ve become experts in creatively engineering their way to competitiveness. When Hancock pulled out of the Guaranteed UL market in 2011, they rolled out Protection UL as a substitute. It was a highly complex, poorly disclosed, over-engineered product with mediocre guarantees and partially backed by a basket of alternative assets like timber. It should have been a flop but, instead, it came to define and dominate the market for non-guaranteed death benefit products. Why? Because all of John Hancock’s engineering prowess managed to deliver exactly what agents and distributors wanted to see. Protection UL had the lowest illustrated premiums in the industry. No one cared how the product was built. Protection UL gave agents what they wanted that was that.
Now, Indexed UL has supplanted Guaranteed UL as the next battleground in delivering low cost death benefit oriented products. John Hancock was one of the first entrants to the DB IUL space in 2013 with the Protection IUL line. The latest version of the product, Protection IUL 18, carries forward with many of the key tenants of previous products – the highest premium loads in the industry (35%), significant interest bonuses that decline over time and vary by policyholder and fixed charges that increase with large premiums. Each one of these pricing factors might seem a little bit bizarre in isolation, but that’s how John Hancock does things. If most life insurance products are pictures, then John Hancock’s Protection series products are collages. They’re made up of lots of strange looking individual parts that come together to create a cohesive whole.
One of those strange looking parts in Protection IUL is the Cost of Insurance Charges, which is an unlikely place for John Hancock to exert its engineering efforts. COI Rates are generally very straightforward. The carrier sets the guaranteed COI Rates equal to the applicable CSO table and then sets current COI Rates at a schedule less than the CSO. COI Rates are charged based on the Net Amount at Risk, which is the gap between the death benefit and the policy account value. The final COI Charge is equal to the COI Rate multiplied by the Net Amount at Risk. Simple enough.
John Hancock’s Protection IUL products don’t work that way. Rates charged for NAR, what would otherwise be called a COI Rate in any other product, are dynamic. They change based on other policy factors according to a guaranteed formula, factors and rate tables. Previous versions of the product were fairly simple, but Protection IUL 18 has an updated formula that is tougher to intuit. It references 3 separate rate tables based on 3 separate policy values in order to set the NAR Rate. It’s complicated and, in this case, I actually don’t think it makes sense for me to work through all of the details of the mechanics. The high-level steps to that Protection IUL 18 uses to set the NAR Rate is enough to get an intuition around how it plays out in the product:
- The baseline NAR Rate is a base COI Rate that averages to about 80% of the 2017 CSO Table
- The COI Rate is eligible to be discounted based on the policy Face Amount
- The portion of the discount that is actually applied to the rate depends on the account value
- When the account value increases, the NAR Rate decreases and moves towards 0% of the base COI Rate
- When the account value decreases, the NAR Rate increases and moves towards 100% of the base COI Rate
The net result is that the NAR Rate in any given year is dependent on the account value. When policy performance is strong, then the NAR Rate is lower than it otherwise would be. When policy performance is weak, then the NAR Rate is higher than it might otherwise be. The charge for NAR in Protection IUL 18 is dynamic in a way that other life insurance policies are not and exacerbates some of the natural feedback loops and leverage in any Universal Life policy. Everyone knows that if the AV of a product drops then the NAR increases and, therefore, the COI Charge goes up. I’ve heard people refer to this effect as the “double whammy” and it’s often cited as a reason why agents don’t like VUL contracts. The downside risk in VUL is exacerbated by increasing COI Charges at exactly the wrong moment. But the flipside is also true – when AV increases and NAR shrinks, the COI Charge drops and becomes a benefit relative to expectations. These changing COI Charges based on movements in NAR create leverage in performance. When performance is good, it gets better because COI Charges shrink. When performance is bad, it has a headwind because COI Charges increase.
That’s a normal life insurance policy, where the COI Rate stays the same (or, more technically, increases according to a known and fixed* schedule) and the only moving part is the NAR. But in Protection IUL 18, the scenario plays out differently. When AV drops and NAR increases, the NAR Charge and the NAR Rate increase. It’s a double-double whammy, if you will. And, on the flip side, when AV increases and NAR shrinks then the NAR Rate and NAR Charge shrink. The NAR Rate mechanism and formula in Protection IUL 18 serve to increase leverage through dynamic policy charges beyond what you’d find in a normal life insurance policy.
The easiest way to see the impact of the NAR Rate formula on policy performance is by putting it into the Dynamic Illustration Tool and running a hundred index return scenarios through the product. The relevant metric for comparison is the NAR Rate as a % of the COI Rate because that tells you how much additional leverage is being applied to performance from the NAR Rate mechanism that is unique to Protection IUL products. It’s a way to isolate this particular part of the product from the others. Again, by comparison, virtually every other life insurance product always has a 100% ratio. The rate charged on NAR is always equal to the COI Rate – but not so with Protection IUL 18, as you can see in the chart below.
Each blue line is a random series of index returns over the life of the policy and the black line is what most agents will show to their client – the steady-state AG49 Maximum Illustrated Rate every year. That scenario is pretty neat and proper. The NAR Rate starts off at about 65% of the Base COI Rate and declines over time as the policy performance consistently clicks by at the AG49 Max Rate. It’s exactly what every client and advisor wants to see on the illustration. The real world, though, doesn’t work that way. Index returns bounce around annually and their average returns can deviate significantly from the index history used to set the AG49 Max Rate. Using real-world index returns is the true measure of a product. You’d never even see the dynamic NAR Rate in Protection IUL 18 with a level illustrated rate, but it is blatantly obvious under real-world return scenarios.
Every blue line above the black line is a lapsing policy. Every blue line below the black line is a policy that over-endows by a significant margin. There is no middle ground in Protection IUL 18. Strong performance gets a tailwind from a falling NAR Rate, which in turn shrinks NAR, grows AV and sets the stage for more discounts on the NAR Rate going forward. Poor performance gets a headwind from all of those mechanisms working in reverse and results in a lapse. Just look at how slight deviations from the AG49 scenario turn into huge deviations in a very short period of time. That’s partly due to the natural compounding effect of the NAR Rate, especially in the low account value, lapsing scenarios where the NAR Rate can become huge relative to the AV.
But that’s not the only reason why Protection IUL 18 shows so much leverage to product performance and index returns in real world scenarios. John Hancock also added a charge-funded Index Return Multiplier (IRM) to PIUL18. As in Accumulation IUL 18, the charge is 2% annually, but the IRM for PIUL18 is 65%. At the maximum AG49 illustrated rate of 6.21%, the net effective illustrated rate for the product is a whopping 8.25% (calculated as: 6.21% * 1.65 – 2% = 8.25%). Higher net illustrated rates obviously benefit funding patterns where there is more account value eligible to earn the credit, such as single pay and short pay solves. It is no surprise, then, that PIUL18’s competitiveness in those scenarios is better than the outgoing product – especially once you tack on the fact that the NAR Rate also shrinks with higher funding. But, on the flip side, that IRM also adds risk and leverage to index returns. When index returns are strong, the multiplier side of the IRM generates much more benefit than the 2% cost. But in other index return scenarios, the 2% cost is a bigger drag than the benefits of the multiplier. Whether or not 2% for a 65% IRM is a “fair” trade is really tough to determine. It depends on your outlook for both the level and variability of index returns and, more importantly, how John Hancock will adjust future Caps in order to account for the cost of providing the IRM. Today’s price for a 65% multiplier on an account with a 10.25% cap is about 3.25%, which is quite a bit higher than the 2% charge that supposedly funds the 65% multiplier. Something is amiss and, over time, things are going to change from the deal you see on the illustration today**.
But one thing is for sure – a charge-funded IRM on Protection IUL 18 only adds more leverage to a product that already has an abnormal amount of leverage courtesy of the NAR Rate formula. All of this variability, risk and leverage might be appropriate in an accumulation product, where the account value itself serves as a buffer against the adjustments in the product parameters, but it’s simply not appropriate in a death benefit product. There’s no room for error. Agents will run Protection IUL 18 at the AG49 Max Rate and have literally no idea that the product they’re selling, the product that the client is relying on for protection, can change dramatically in its fundamental structure over time and in ways that can work against the policyholder. This is a double black diamond product being sold to people who have never even seen snow.
However, there are two saving graces in Protection IUL 18. First is the fact that the complexity in the product is based on mechanics and rates that are clearly defined and guaranteed in the contract. Whereas other products like PacLife PDX/PDP IUL and Securian Orion IUL are complex and opaque, Protection IUL 18 is complex and transparent. That makes a world of difference. Protection IUL 18 might have some mechanics that can cause problems for consumers, but you’ll at least know what you’re dealing with. Clients actually have the opportunity to know what they’re buying and make an informed decision. With many other IUL products these days, that’s not necessarily the case.
The second saving grace is LifeTrack, which will get its own upcoming article. LifeTrack is a John Hancock system that consistently tracks policy values and allows for on-the-fly adjustments to maintain the integrity of the policy. In theory, at least, a system like that could allow the client to materially mitigate some of the moving parts in Protection IUL 18. But the power of LifeTrack requires a different mentality when approaching any premium-focused Universal Life sale. Agents tend to pitch UL as if it is Whole Life. They talk about the premium as “the premium.” There is no premium requirement in UL. There are only charges and credits. The premium is an estimation that will absolutely, unequivocally be wrong over time – especially for a product as volatile, leveraged and complex as Protection IUL 18. But if the client buys the product under the idea that they need to make adjustments every year and they have a system like LifeTrack to help them do it, then their chance of success goes up immeasurably and the variability in product performance drops considerably.
In short, Protection IUL 18 is not for the feint of heart. It’s complicated. It has a lot of moving parts. It has an inordinate amount of leverage stemming from the NAR Rate calculation in addition to the charge-funded Index Return Multiplier. But at least it’s transparent and there might be a couple of clients who can really understand the structure and manage it properly. But for the rest of humanity, a simpler, more straightforward, easily managed and less sensitive product is a better and more sustainable solution – even if the illustrated premium is higher.