James Christie | It’s a simple collar expansion conversation.
I have been asked countless times in the last 12 months to explain what is going on in the IUL space. Specifically, how to describe what is being referred to as “leveraged IUL” products being sold in the marketplace. “If zero is no longer the hero, how do I explain these products to my clients?”
It’s quite simple, especially if you have a baseline understanding of the old-school IUL products. Those products were sold using 3 main components. Cap, floor, participation rate. You would typically see a floor of 0%-2%, a cap in the range of 10%-12%, and the participation rate generally guaranteed at 100%. Keep in mind those three components interact with each other. Higher floors usually meant lower caps, higher participation rates typically meant lower caps, and lower participation rates meant higher caps, etc. But generally, policies were 0% floor/10%-12% cap/100% participation rate (usually guaranteed).
If you believed in those ingredients then you should believe in the leveraged IUL products being sold today because while the meal may be a little bit different, it has the same ingredients. Just with a little more than before.
So how do you explain this to a client?
All IUL is sold based off the idea of a “collar”. In order to get the 0% floor, you had to apply a cap to the upside, in this scenario let’s say it is 10%. So, the “collar” is 0%-10%. That “collar” provided exposure to the index but with a significantly lower standard deviation. This, amongst other things, has been why IUL has become so popular. Upside potential with downside protection and good returns with less volatility. People are generally risk averse and willing to give up some upside so they can sleep at night, it makes sense why IUL has become popular.
The new leveraged IUL’s are no different. The collar has just expanded. And frankly, it has expanded far more on the upside than it has on the downside.
There is a policy in the marketplace that offers an index account with a 4% asset-based charge (ABC). That ABC has now expanded the collar from the 0% floor to -4%. Not something to get excited about, except for the fact that those charges are not collected and kept by the insurance company. They buy more “ingredients” and provide upside potential for the client.
So, for this example, the cap was 10% previously. It is still 10%, but a guaranteed multiplier has been added of 56%. This essentially turns the cap into 15.6%, so the “collar” has expanded. This alone isn’t a bad deal. 4% expansion on the downside for a 5.6% expansion on the upside, giving you a plus 1.6% differential. But with this policy, there is also a variable multiplier that can be added on top of the guaranteed multiplier and can produce returns in excess of 20%.
So, you end up with a collar of -4% and the potential for 20%+. Same story as the 0% floor and 10% cap, just the collar has expanded. It is CRITICAL to discuss this with a client. The value proposition of leveraged IUL is the same as the old school IUL, downside protection with upside potential. Only difference is the collar has expanded and again, in most cases far more on the upside than it has on the downside.
I have had this conversation with hundreds of producers and every single time the lightbulb went off. This makes sense and can be easily translated into a client conversation to help explain the value of leveraged IUL, specifically regarding the ABC and the expansion on the downside and the various multipliers in the marketplace expanding the upside.
It is important to note that the -4% from the ABC in this example is not just the new floor. The floor is still 0% and when you have a year that is 0% or a negative return, the 4% charge is applied giving you the -4% mentioned above. The 4% ABC is applied in every single year and will essentially be subtracted from the total return. However, I will point out the math isn’t this straight forward. Some carriers take the cost out at the beginning of the year, some at the end, some equally throughout the year. But for simplicity purposes of this conversation, it is important to make sure the client is aware of the fact that the ABC comes out every single year whether you have positive or negative returns.
Something I find interesting: We started this conversation talking about old school IUL and three key components. Cap, floor, participation rate.
Leveraged IUL is essentially the same, but with different words. The cap and floor still exist, although they can be expanded due to the ABC and multipliers being added on top of the cap. But we don’t really talk about participation rates, multipliers are in vogue. Why is that? The reality is, a multiplier is essentially the same as a participation rate. It tells you how much of the index return you get to participate in. 100% means you participate 1:1, anything above that means you get a “multiple” of the index return. So why did carriers create multipliers if we already had a component built to do this? AG49 is the answer. Participation rates were a part of AG49, multipliers were not. Just some food for thought.
For more information on the product mentioned above, please see the article series written by Bobby. It can be found here.