#141 | My Take on Indexed UL
Over the past few months, several of my friends in the industry have encouraged me to write an article that clearly, concisely and unambiguously states my position on all things Indexed UL. Although I write about Indexed UL all the time and obviously from my particular vantage point, I’ve shied away from making my opinion the focus of any one particular piece because I think that fact-based analytics should always take center stage. But my friends make a good point – reading between the lines requires interpretation, which too often leads to misinterpretation. I’ve felt this. I’ve been labeled as both Indexed UL’s fiercest advocate and its harshest critic and everything in between. It’s time for me to come clean. This is what I think about Indexed UL.
First, and foremost, Indexed UL is a fundamentally good product that offers a worthy value proposition. Downside protection with upside potential is a powerful and intuitive story that resonates with consumers – even if the reality is that Indexed UL is just a slight modification to traditional Universal Life. To paraphrase Cannex’s 2018 report on Fixed Indexed Annuity products, Indexed UL is a “decidedly fixed” insurance product with an “arms-length” relationship to equities. It is, in other words, just a slight twist on traditional Universal Life.
But that’s not how people in our industry talk about Indexed UL. Instead, they play up its performance characteristics as if it’s something entirely different. This is immensely problematic. Whether or not clients will actually be better off buying Indexed UL than Universal Life, in the long run, is a question without an answer. Predicting that Indexed UL will outperform Universal Life requires a host of other supporting predictions that very few people, if any, are qualified to make. For starters, you’d need to make predictions about the level and sequence of equity returns, interest rates, volatility, volatility skew and insurer portfolio yields over the next 50+ years. Those are the easy ones. Much trickier is the long debated and very much unsettled question about the degree to which short-term equity call options transfer long-term equity risk premia, which is by far the most important factor in determining how Indexed UL will perform relative to Universal Life and virtually no one can agree on it. And yet, most people in the industry just take it for granted that Indexed UL will outperform Universal Life simply because the companies selling Indexed UL told them it would. We have seen this movie before and it doesn’t end well.
My position on Indexed UL performance has always and continues to be that the only unbiased baseline assumption is that Indexed UL will perform identically to Universal Life over the long run. Why? Because it is based only on the yields on the general account backing the product. Making that assumption doesn’t require any prediction other than that the yields are being used to buy call options and that the value of those call options, over the long run, is what the insurer paid for them. I’m not saying that reality will unfold this way. Indexed UL products will perform differently from one another and from Universal Life over time. What I’m saying is that it’s impossible to predict which way things will break. Impossible and arguably irresponsible as well.
This brings me to illustrations. The way we show performance in Indexed UL is with an illustration – a document that was never designed to be a performance projection and that no agent actually believes is a reliable performance projection. And yet, illustrations are so ubiquitously used to promote life insurance products, particularly Indexed UL, that illustrated performance has become the primary competitive battleground for our industry. The tragic story of Indexed UL is that a fundamentally good product has been completely hijacked by illustration warfare. Here’s my simple litmus test – if an IUL product or a sales strategy breaks when you lower the illustrated rate to what a comparable Universal Life would show, then you’re setting the client up for failure. End of story. That little litmus test sinks most of what sells in Indexed UL – indexed loans, indexed return multipliers and arbitrage-based premium financing. All of those things are predicated on the idea that Indexed UL will deliver outperformance without a commensurate increase in risk. All of them break when outperformance doesn’t happen.
What doesn’t break, though, is the core story of Indexed UL as downside protection with upside potential. That story is independent of the illustrated rate. It is independent of long-term performance projections or expectations. It does not rely on a host of predictions and assumptions about things that will unfold over the next 50 years. It endures because downside protection with upside potential is fundamentally what Indexed UL does. That – and nothing else.
And that’s why I love Indexed UL. I love the simple, beautiful story of what it does. I love the ability to creatively deliver upside potential in ways that fit with each client’s story and beliefs. I love the flexibility that the chassis offers to expand the horizons of product design to serve more customers. Man, it’s beautiful. That’s why my story with Indexed UL is a love story. It was the first product that I ever analyzed as an intern at NFP fresh out of college and I’ve been captivated by it ever since. I can’t imagine working in this industry without Indexed UL. And it’s also why I’m more than mildly annoyed that something so elegant, creative and compelling has been bastardized into an illustration weapon that is far too often ignorantly, irresponsibly or deceptively wielded by life insurers, distributors and agents alike. It’s a tragedy unfolding and intensifying right before our eyes.
In the end, the labels that people have put on me are all accurate. I am Indexed UL’s fiercest advocate, if you define Indexed UL by what it does, not by how it illustrates. I am Indexed UL’s harshest critic, if you define Indexed UL by how it illustrates, not by what it does. But regardless of what I might be labeled, I have always and will continue to advocate for a bright future for Indexed UL – a future that is not dependent on illustration wars but, instead, rests on the unique, enduring and compelling power of Indexed UL to deliver downside protection with upside potential. And I know I’m not alone.
As an aside, I think it’s worthwhile to point out that I do quite a bit of work developing new Fixed Indexed Annuity and Structured Annuity products. Those products are generally sold based on what they do, not just how they illustrate. Folks on that side of the industry usually don’t go around making aggressive performance projections. They’re realistic about the fact that FIA products are more similar to regular fixed annuities than not. One study co-authored by Roger Ibbotson concluded that FIA products may slightly outperform long-term government bonds based on historical performance going back to the 1920s. This result was celebrated as proof that FIA products are a reasonable fixed income alternative with slightly more upside under certain conditions. That same result would have been heresy for Indexed UL, where the operating assumption is that the products will blow the doors off of fixed income alternatives. See the difference? That’s why I’ve increasingly gravitated towards my work the annuity business. Over there, the story is far cleaner. It’s more pure. And it’s not like that has hurt sales either – Fixed Indexed Annuities outsell Indexed UL somewhere between 30-1 and 10-1, depending on how you look at it.