#152 | Lincoln WealthAccumulate IUL 2019 – Part 4

At first blush, it might seem that all of Lincoln’s creativity was poured exclusively into increasing leverage and illustrated performance in WealthAccumulate IUL 2019 and that the risk-offset feature, the Return of Premium Rider, is quite straightforward. That’s true in a limited sense. The ROPR offers a refund of all premiums paid for a 90 day window of time after the 20^th policy anniversary. What could be simpler than that? But underneath the smooth surface, the ROPR is a tangled web that presents new opportunities, and new challenges, for providing clients with tools for mitigating risk in an Indexed UL market that is hurdling towards more leverage.

In the context of a traditional Indexed UL product, an ROPR is essentially just a return of policy charges in the event that indexed returns prove to be lackluster. Let’s assume that an Indexed UL policy only earns 0% credits for the first 20 years. In that scenario, the cash value at the 20^th year will be exactly equal to the sum of the premiums paid minus policy charges. The value of the ROPR, therefore, is equal to the sum total of the policy charge deductions. If the client elected the ROPR, then the life insurer would essentially be on the hook to cover commissions, corporate overhead, cost of capital and mortality. In the event that the policy actually earned some index credits but not enough for the cash value to equal premiums paid, then the credits will serve to reduce the liability for the life insurer. In this way, an ROPR on a traditional Indexed UL doesn’t directly have index return risk because the maximum liability is the sum of the policy charges.

But an ROPR on a leveraged Indexed UL product like WA2019 is a different animal. Every leveraged Indexed UL product charges a fee from the account value that goes directly to fund an Index Credit Multiplier (ICM). This is an important distinction. Normal policy charges are deducted to make the life insurer whole for mortality coverage and expenses. Charges to fund an ICM and create more policy leverage are deducted specifically to fund more index return upside. Let’s go back to the example above where index returns are 0% for 20 years. In that scenario, a life insurer offering an ROPR on a leveraged IUL product would be on the hook not just for unrecovered costs for issuing the policy and mortality risk, but also for whatever charges were spent on ICM exposure. An ROPR on a leveraged Indexed UL introduces direct index return risk for the life insurer. The larger the charge for the ICM, the more index return risk for the life insurer in offering an ROPR.

Despite that fact, Lincoln allows the rider to apply to the product as a whole regardless of which indexed account the client chooses. The same offer of a full return of premium is available on both the Perform Plus account and the Conserve account despite the fact that the risk profile for Lincoln on these two accounts is wildly different. It seems like a free lunch. If you have an ROPR as the backstop, then why not swing for the fences by doing a full allocation to the Perform Plus account? And if every client makes that decision, isn’t Lincoln taking on quite a bit of index return risk?

To answer that question, we have to ask another one – how much does the ROPR cost? Lincoln says that it’s free but, obviously, nothing of value is free. The way that Lincoln charges for the ROPR is through the required premium to maintain it. The logic behind a premium requirement for the ROPR is straightforward even if it’s not obvious. Imagine a UL policy funded with $20,000 in cumulative premium and another policy funded with $100,000 in cumulative premium. After 20 years, let’s say that total policy charges are $19,999. With 0% credits, the value of the first policy in year 20 would be $1 and the second would be $80,001. What are the net effective crediting rates required to make the two policies whole? For the first, assuming level charges and a single premium, is about 5.25%. That’s pretty steep for a guarantee. For the second, under the same assumptions, the effective crediting rate is only 1% because the ratio of account value to policy charges was significantly higher. Timing also matters. Spreading both premiums out over 20 years results in net effective crediting rates to satisfy the ROP of just 2% for the second policy with $5,000 annual premiums and, I kid you not, an 85% crediting rate for the first policy with a $1,000 per year annual premium. The minimum premium requirement for the ROPR is the adjustment mechanism that allows Lincoln to calibrate its level of risk and the richness of the benefit for the client.

The premium requirement is based on cumulative premiums paid for the entire 20 year period leading up to the ROP exercise window just after the 20^th policy year anniversary, but Lincoln only allows catch-up premiums through the end of year 10. For a 45 year old Preferred male with a $1M death benefit, my standard benchmarking scenario and the one used for the previous analysis in this article, the annual premium requirement is $22,890. No, it’s not always Target (although below age 50 it is). No, it’s not half of the MEC premium. So where’d they get that number? The short answer is that they probably had a risk appetite based on their own internal stochastic modeling and calibrated the required premium to meet the level of risk. In other words, it just is what it is.

However, I think the better way to tackle the question is to look at it through the lens of the effective cumulative crediting rate that it would take the base WA2019 chassis without any asset-based charges or bonuses to deliver a cash value exactly equal to premiums paid. Looking at it through this lens isolates the sheer policy charge risk inherent in offering the ROPR and ignores the risk of the leveraged accounts, which gets us out of the business of making performance projections or looking at return scenarios. For the 45 year old outlined above, the effective required crediting rate for a WA2019 base-chassis policy funded at the ROPR annual premium is exactly 3%. What that number is telling you is that the ROP is not so different in value at year 20 than getting 3% guaranteed minimum crediting rate in a traditional Universal Life policy with the exact same charge structure. It also tells you that allocating to riskier accounts will increase the net effective yield required to produce an account value exactly equal to premiums paid. For the Perform account, the net effective yield is closer to 4% and it’s nearly 5% for the Perform Plus account, including all charges and multiplier credits. Lincoln is certainly putting itself on the hook, especially for the Perform Plus account.

But getting a real look at the risk for the accounts that have charge-funded ICMs requires us to go back into the world of stochastic modeling. I re-ran the stochastic analysis used for the previous article to instead look at how often Lincoln’s ROPR would be in-the-money, meaning that the cash value in the 20^th year would be below the premium paid into the policy. Out of 500 scenarios, it happened less than 25 times. The reality is that, historically speaking, 20 years is generally a long enough time for the S&P 500 to deliver strong enough returns that flow through to index crediting so that the product can recover its costs. But this analysis is missing a key component – the fact that the cap can and will change. With a lower cap, the product is far likelier to deliver returns that put the ROPR in-the-money. In one respect, Lincoln is also making a bet on its option budget and option costs in order to get comfortable with providing the ROPR, but in another respect the ROPR is a check on Lincoln’s long-term management of policy caps. Lowering caps to increase profitability in the future would have the adverse effect of potentially causing more clients to trigger the ROPR and put Lincoln on the hook for the difference. I’m generally a pretty big fan of policy features that force life insurers to put their money where their mouth is and that’s what the ROPR does to some degree for Lincoln. This is, after all, the company that dropped crediting rates unilaterally and universally to the guaranteed minimum on every single Universal Life policy on the books. Forcing them to have a little bit of extra skin in the game can’t hurt.

Finally, there are some real quirks that come along with the ROPR. First, a lot of short-funded scenarios actually fail the cumulative premium test by the 20^th year. Even funding at the maximum non-MEC premium for 7 years won’t get you there in a lot of cases, especially at the older ages. It seems that they were exclusively focused on accumulation scenarios with long-term premiums. In my opinion, this is a big miss on Lincoln’s part for two reasons. First, it creates a lot of scenarios where the agent will tell the client about the ROPR and then subsequently run illustrations where the premium doesn’t satisfy the ROPR. Second, I don’t think short pays of maximum non-MEC premiums pose more risk than level 20 pays – in fact, I think it’s pretty easy to argue that they pose less risk if you’re looking at the risk through the lens of the effective required crediting rates. If I rerun the scenarios above but with 7 maximum non-MEC premiums, then the effective required crediting rates drop across the board and by a fairly significant margin. I think Lincoln was trying to keep it simple and, in the process, lost out on the chance to make the ROPR a story for all accumulation clients, not just the ones who pay level premiums for a long time.

Another quirk is that reducing the face amount any time before the 10^th year means that the cumulative premium requirement recalculates to the new specified face amount, even if the death benefit is in corridor and doesn’t actually decrease. Theoretically, a client could buy a large policy, stuff it full of money, drop the face amount to the minimum of $100,000 and get an ROP benefit they wouldn’t have otherwise gotten had they maintained their original face amount. This isn’t a particularly advantageous scenario because Lincoln assesses a partial surrender charge on face reduction, but a lot of people these days do accumulation and income solves with face reductions and they’re going to find some very unusual restatements of their cumulative premium requirements when they do.

All in, it’s hard to argue that the ROPR isn’t a benefit for most policyholders even if it’s not perfect. In my opinion, Lincoln could have achieved similar results with more client value by pursuing a similar alternative surrender value that other companies, particularly Pacific Life, use for their Indexed UL products. That methodology does not require any particular premium stream and doesn’t have a finite window to exercise the benefit before it’s lost. But the ROPR does provide a real backstop in the event that performance goes south, especially in the higher leverage accounts. It is not, however, a license to indiscriminately sell WA2019. Clients don’t buy Indexed UL, and especially not leveraged IUL products like this one, without expectations of stellar performance. Returning premiums paid is not stellar performance. No one will buy WA2019 with the expectation that they’re going to need the rider and the fact is that Lincoln doesn’t think anyone will need it either, which is exactly why they can offer it. On one hand, I’m glad that Lincoln included the ROPR because there’s a chance that it will be a real boon to some policyholders in dire straits and generally serves as a check on Lincoln for policy management. But on the other hand, I worry that producers will get clients all fired up about the potential for the product to illustrate enough income to ensure prosperity for the next 8 generations of their family and then tell them the kicker that they can simply “get their money back” if things don’t work out. It’s just not quite that simple – or beneficial – and shouldn’t be sold that way.