#138 | Indexed UL on the Risk Spectrum – Part 3

The intuition for why a higher fee to buy more index exposure delivers better returns is pretty straightforward. The higher the fee, the more downside risk but also the more leverage on upside returns. For example, let’s just assume that the fee is 4.85% annually and that purchases a 2 multiplier on index returns for a product with a 10% cap. If the index returns are 10% or greater, then the net policy credit is 15.15%, which is 10% x 2 – 4.85%. That’s quite an upside. Running that product through the same analysis generates a standard deviation about half as much as pure equities or, in this analysis, a VUL product. The gap between the arithmetic and geometric means also widens to 33% of VUL because now we’ve introduced negative returns to the structure. No surprise, but dramatically increasing the fee to, say, 25% also dramatically increases the measures of risk. Now, both measures of risk are about twice as much as in VUL. By just this simple modification of using a fee to buy index return exposure, we’ve transformed a product that is spitting distance from Universal Life in terms of risk into something riskier than pure equities.