#162 | Visualizing the Indexed UL Product Landscape

This article uses analysis from the Dynamic Illustration Tool, our proprietary software system for comparing products. We attempt to keep all rates and products up-to-date, but that is sometimes not possible because products have been taken off the market and new rates are not publicly available. If you see a glaring error, let us know. Thanks!

One of the challenges facing regulators, advisors and their clients is how to concisely explain how something as arcane as an Index Credit Multiplier translates into actual expected performance and, even more importantly, the dispersion of expected performance around the average. The curious thing about Indexed UL is that the second part of the question is actually easier to answer than the first part. There is no long-term empirical data, scholarly studies, practical experience or theoretical underpinnings for determining the expected performance of an Indexed UL product. The maximum rate determined by AG49 is not a “regulator approved” expectation for performance. Instead, it’s a back-of-the-envelope way for actuaries to slap a value on the currently offered non-guaranteed element for the purposes of actuarial certifications. Figuring out the “right” average rate for Indexed UL is like filling out a March Madness bracket – no matter how rigorously analyzed or randomly selected your choices, the reality is that you have a vanishingly small chance (1 in 9.2 quintillion, apparently) of getting it right. So good luck with that.

But we actually can get a feel for how different product designs will react to different equity return patterns assuming that all non-guaranteed elements remain constant. This is a crucial assumption that allows for analytics of product return profiles, but not expected product performance because we know that the non-guaranteed elements can and do change. Instead, holding them constant allows us to see the mechanical differences between the products and how those differences interact with different return patterns. Producers are becoming increasingly aware of the fact that modern Indexed UL products are not created equally, even if the illustrations are identical. Index Credit Multipliers, Persistency Bonuses, dynamic COI charges and other non-standard product factors have created Indexed UL products that have different mechanical underpinnings. They are not the same, even though they look the same – at least, on a standard illustration. So how do we escape the restrictions of the standard illustration to see all of these different Indexed UL products under real-world return scenarios? The Dynamic Illustration Tool.

The DIT now contains 51 Indexed UL products, all for a 45 year old Preferred Male with $1MM of Death Benefit. It’s a thin but wide slice of the Indexed UL market and good enough for getting a sense of how different designs compare to one another. There are some notable absences from the list. I’ve excluded John Hancock’s Protection IUL series because they have highly complex dynamic COI charges that I can model accurately for thin funded scenarios but return some peculiar and inaccurate results in heavily funded scenarios that I can’t quite sort out (and don’t particularly feel the need to, since the product isn’t marketed for accumulation sales). Securian Orion IUL is also absent from the list because of its complex and virtually undisclosed Annual Policy Credit, but Eclipse IUL stands in as a proxy for it. For this analysis, I ran all 51 products simultaneously using 1,000 randomly generated sequences of 75 years worth of S&P 500 returns through each product’s current pricing and rates. The result – well, sometimes a picture really is worth a thousand words. Take a look. The ranked metric for this graph is cash value IRR in year 40.

This picture is actually even better than a thousand words – it tells a thousand stories. The most obvious story, the one that practically falls off the page, is that products with charge-funded Index Credit Multipliers exhibit significantly higher ranges of return than products without them. The bigger the charge/multiplier, the bigger the dispersion of returns. Just look at Lincoln WealthAccumulate IUL 2019 (4% charge), PacLife PDX 2 (7.5% charge scaling down to 3%), PacLife PDX (fixed-charge funded ICM) and Nationwide’s IUL products (2.25% charge in the Advanced Multiplier accounts). All four pop off the chart for dispersion of returns, easily breaking the trendlines on both the upside and the downside. This is the story of charge-funded Index Credit Multipliers. Yes, it’s more risk, but it’s also more return. It’s that simple, right?

Not quite. There are a few wrinkles. The products above are ranked on their average year 40 cash value IRR across the 1,000 S&P 500 scenarios, but I’ve also included a line that shows the illustrated year 40 cash value IRR under the AG49 maximum illustrated rate. Folks in our industry have long discussed the fact that illustrations show constant returns and the real-world produces variable returns, which means that every Indexed UL and VUL illustration using a level rate is systematically over-illustrated.  In this sample, the average cash value IRR for the maximum AG49 illustrated rate scenario exceeds the average actual cash value IRR by about 0.2%. Some of that gap can be attributed to the fact that the AG49 maximum rate calculation is built on slicing historical index data into 25-year periods. Any period that is longer or shorter will naturally diverge from the AG49 maximum rate. But the rest of it is attributable to the way in which particular product designs interact with real-world performance relative to constant performance.

Take, for example, PacLife PIA 5 and PIA 6. Both products are simple and straightforward, lacking any bonuses, persistency credits or funky cost structures. The gap between the illustrated cash value IRR at the AG49 maximum illustrated rate and the average of the 1,000 scenarios is a paltry 0.05% and 0.06%, respectively. But PDX 2, which sports a persistency bonus with payouts tied to annual index returns and an asset-charge funded ICM, shows a gap of 0.66%. In layman’s terms, that means that the illustration at the maximum AG49 rate systematically over-illustrates returns to the tune of 0.66%. If dropping the illustrated rate by a single basis point can wreck the illustration for a highly leveraged product with a stream of distributions using indexed policy loans, just imagine what a 0.66% gap will do. And if you think that’s big, then there’s Lincoln Wealth Advantage IUL 2019 and its unique Positive Performance Credit – an 85 basis point gap.

Other products with large gaps tend to have odd features. For example, Peak Life uses a fixed per-thousand charge to fund a bonus that floats between a fixed rate and a multiplier depending on the index return. Securian Eclipse IUL has a bonus that pays out on a rolling average of the last 10 years of index credits. Lincoln WealthPreserve IUL shows returns based on a hypothetical Benchmark Index Account that appears to deliver slightly better returns, on average, than the actual account in the policy with a 1% floor. If nothing else, this graph shows just how much of a disconnect exists between the particular way that level-rate, AG49 maximum returns compare to the real-world mechanical returns of products with quirky, non-standard features. Traditional illustrations are simply not up to the task of showing how these products actually work – and some life insurers are arguably using that to their advantage.

This graph tells other stories, too. The most surprising one might be that the best way to generate real-world risk-adjusted performance is still to have the highest cap. For example, F&G sports a 15.5% cap (how, I don’t know) and has a dispersion of returns between the 5th and 95th percentiles of just 3.36%. In order for Lincoln to generate similar performance to F&G at the AG49 maximum illustrated rate using a 10% cap and a combination of charge-funded ICMs, the dispersion of returns increases to a whopping 7.04%. This seems to be the tradeoff at play. If a life insurer can’t afford a high cap, then they have to resort to extreme leverage in order to win on the illustration. Leverage, in other words, is being used more as a way for life insurers that would otherwise struggle to grab marketshare by illustrating returns on par with companies with higher caps. Before this analysis, I’d never really thought about it that way, but the results are just so clear. If PacLife could afford a 15% cap, would it have needed PDX? No, it wouldn’t. So when a life insurer has their back against the wall on caps, what’s the playbook? Lever up. And who takes on the extra risk? The client. But, of course, abnormally high caps have their problems too – namely, the fact that they’re not sustainable under any rational pricing or asset return model. In either case, the client thinks they’re getting one thing and they’re actually getting something else.

Fortunately, the graph also highlights products with risk-mitigation features that often go unnoticed in the midst of all of the illustration warfare. Lincoln WealthAdvantage, for example, sports a 1% floor and 0.55% fixed interest bonus, both of which go a long way in tightening the dispersion of returns between the 5th and 95th percentiles to just 2.22%, the tightest of the lot. Several other products exhibit lower-than-expected dispersions given their average returns due to a variety of factors. Here’s a quick comparison, in no particular order:

Product Y40 Average Y40 Dispersion Reason
PennMutual ABS 6.13% 2.80% 1% Floor and 0.3% fixed interest bonus
AXA BrightLife Grow 5.63% 2.59% 1% fixed interest bonus
AIG Max Accumulator+ 6.29% 3.07% 0.25% fixed interest bonus
JH Accumulation IUL 17 5.79% 2.68% Dynamic 0.85% fixed interest bonus
Symetra Accum IUL 1.0 6.71% 3.19% Relatively low charges, simple chassis
Gbl Atl LT Builder Elite 6.69% 3.19% High initial charges, 1% fixed interest bonus

Slicing the data to look at year 10 cash value IRRs rather than year 40 also makes for some interesting insights. Take a look:

Notice that the product rankings have changed dramatically. In pole position is Mutual of Omaha’s Income Advantage IUL followed by Symetra and then, well, everyone else. What’s going on? Simple – in the 10th year, policy charges are the dominant driver of performance and both of those products stand out in terms of being low cost. There is a 1.11% gap between Mutual of Omaha’s year 10 CSV IRR of 4.89% and third place PennMutual’s. In order to produce the same gap between PennMutual and a lower-ranking product, you’d have through another 24 products, finally landing on Voya Global Choice (RIP). In other words, Mutual of Omaha is simply in another planet when it comes to year 10 CSV IRR – and that should count for something, especially considering how some of the most competitive products by year 40 (Lincoln WA IUL 2019, PacLife PDX 2, Global Atlantic Lifetime Builder Elite, Nationwide IUL Accumulator II) are laggards in the early years due to heavy initial policy charges or, in Nationwide’s case, high charges and quirky index credit accounting.

You’ll also notice that John Hancock’s Accumulation IUL 18 suddenly has a dispersion profile that pops out of the graph and is befitting the fact that it has a 2% charge-funded ICM. What’s going on in year 10 that’s not happening in year 40? Accumulation IUL 18 has an 85 basis point bonus that pops up in the 20th year and goes until the 40th year. But, unlike normal bonuses, this one isn’t paid equally. Instead, it is fully paid for policies that are underperforming and virtually disappears for policies that are outperforming. The net result is that it actively works to reduce the dispersion of returns around the average. Clever, right? But my hunch is that this graph is going to significantly change when John Hancock releases their Enhanced account options with an additional 3% asset-based charge and multiplier. That should put the dispersion profile closer to similarly leveraged products.

So why are leveraged IUL products so popular? This analysis points to the fact that charge-funded multipliers must afford more benefits than just what appears on a graph like this – namely, the fact that multiplier is not a part of the AG49 calculation. This analysis has focused entirely on cash value IRR. The market, however, has moved to benchmarking Indexed UL based on illustrated distributions. Leveraged Indexed UL products tend to outperform simple IUL products on illustrated distributions even if the two products have identical cash value IRRs. How is that possible? Simple. AG49 restricts illustrated loan arbitrage to 1%. Carriers with multipliers have interpreted that restriction to only apply to the strict AG49 illustrated rate and not interest from multipliers or bonuses. As a result, they can illustrate loan arbitrage far greater than 1%. The bigger the multiplier, the bigger the illustrated loan arbitrage. And voila – illustrated income dramatically increases as well. This, of course, is silly. It’s purely a construct of the illustration and not the real-world. And yet, that’s the core reason for the popularity of these products. That and the fact that producers can sell a product with a “conservative” 6% illustrated rate that actually illustrates performance north of 8%, courtesy of multipliers. Yikes.

In the end, this analysis points to one thing more than anything else – not all Indexed UL products are created equally. Products with risk-mitigation features like 1% crediting floors, fixed bonuses (as opposed to multipliers) and low charges actually do reduce risk. Leveraged IUL products really do enhance the variability of returns and, arguably, artificially inflate their illustrated performance under the AG49 maximum rate scenario relative to real-world average performance. And, of course, simple products are still simple and comparable to one another. No simple product creates an abnormal return dispersion profile on this graph. In other words, clients actually have a shot at intuitively understanding what a simple Indexed UL product will do in the real-world – and that is a benefit unto itself that we too often forget in the face of aggressive illustrated performance in leveraged products.