#184 | 2017 CSO IUL Update – Principal, Lincoln, Allianz, Zurich, PennMutual

Thanks to the deadline for updating products to the 2017 CSO table, Indexed UL launches have been fast and furious this fall. No less than six products have been rolled out in the last few weeks – AIG Max Accumulator+ 2019, Principal IUL Accumulator II, Allianz Life Pro+ Advantage, Zurich Wealth Builder IUL, Lincoln WealthAccumulate IUL 2019 PBR and PennMutual Accumulation Builder Flex. The first of the lot, AIG’s product, got a full product review highlighting the fact that AIG made material reductions to the charge structure of the product without dinging the caps or bonuses in the indexed accounts. I also took the opportunity to harp on AIG’s strategy of differentiating its bonuses based on the account selected so that illustrated performance favors the proprietary accounts. But realistically, I could have knocked the review out in much simpler terms and still gotten the point across. Fortunately, the other 5 products are close enough to their predecessors that they don’t warrant individual reviews. Instead, I’m going to take a quick look at each one and highlight the salient changes as I see them, starting with Principal.

Principal IUL Accumulator II

Principal has been trying to find its footing in the Indexed UL market since it first rolled out IUL Flex back in 2013 and IUL Accumulator II marks a slight step forward into the illustration war, but with classic Principal restraint. Whereas the old product had a 12% S&P 500 cap with a 0.25% bonus, the new product sports a 10% cap with a 0.75% bonus as the base account. On the surface, this move doesn’t make a lot of sense. The total illustrated rate drops from around 7.2% (6.96% + 0.25%) to 6.88% (6.12% + 0.75%), which is reflective of the fact that Principal basically took money out of equity call options and their presumed 35%+ annual option profits and reallocated that money to a fixed bonus, which does not have a presumed 35%+ profit payoff forever. But Principal knows what every other insurer operating in the BGA space knows – their customers weren’t illustrating at 6.96% when Principal had a 12% cap anyway. They were probably running it closer to 6%. And at 6%, the new account outperforms the old one by 0.5% simply because of the increased bonus. This is a somewhat bizarre phenomenon. If you really believed that IUL does what it illustrates, then you’d never choose the new product. You’d always want the higher option profit from the higher cap.

Which is exactly why Principal hedged its bet (pun intended) by offering a higher cap account currently set at 14% and supported by a 1% asset based charge. With an illustrated rate of 7.75% and still earning the 0.75% bonus, the net illustrated rate for that account is a whopping 7.5% – pretty strong for a product without a huge charge-funded multiplier. How does Principal do it? Well, obviously they’re paying through the nose for hedges and eating the loss until they build the business. But they’re also finding some mild relief by increasing the premium load for the product by 2% and some reshuffling of the policy charges, particularly lowering the base charge (and spreading it over 10 years) while dramatically increasing initial COI charges.

Bottom Line – Principal has reworked its account options to play better in a 6% illustrated rate comparison while still keeping a foot in the aggressively illustrated end of the market, all while still sporting one of the highest imputed option budgets in the industry, which is surely not going to last when and if they get traction. But they’ve continued to avoid introducing an indexed credit multiplier and, for that, they should be commended.

Allianz Life Pro+ Advantage

Life Pro+ Advantage continues the trend in recent Allianz product development of gradually adding new features that have better illustrated benefits while leaving the base product chassis largely unchanged. The key new feature for Life Pro+ Advantage is account options with a 40% multiplier funded by a 1% asset-based charge. If that math seems a little bit quirky to you, remember that the bonused accounts already offer a 15% multiplier at no charge, so the 1% asset-based charge is really only funding an additional 25% multiplier. Simple math shows you that Allianz’s presumed option budget, therefore, is just 4% for the bonused accounts and by extension, its option budget for the non-bonused accounts is 4.6% (4% * 1.15), which also happens to be exactly the fixed account rate in the product. Voila. That’s how it works.

Except, not quite. Life Pro+ Advantage offers a non-bonused S&P 500 account with a whopping 11.75% cap. At today’s prices, that 11.75% cap costs more – way more – than 4.6%. What’s going on here? Well, Allianz is quite obviously subsidizing its non-bonused S&P 500 cap with profits from other accounts and/or the product charges. Allianz has not been shy about the fact that very few people actually select the non-bonused S&P 500 account, so losing money on the hedge trade isn’t going to bust the product. Why does Allianz set caps this way? Simple. The non-bonused S&P 500 account sets the AG49 maximum illustrated rate for the entire product, which is 6.9%. However, Allianz also allows the bonused proprietary index accounts to illustrate up to 6.9% as long as their hypothetical historical backtest using the AG49 calculation can support it. In other words, with the 1% charge / 40% multiplier options, the proprietary index accounts can now illustrate a whopping net rate of 8.66% (6.9% * 1.4 – 1%). Yes, you read that correctly. 8.66%. Very clever, isn’t it? This little trick vaults Allianz back up the chart in terms of illustrated performance without resorting to a massive charge funded multiplier.

And, of course, it is a trick. Other companies are not so comfortable with this (very aggressive) interpretation of how to illustrate proprietary indices under AG49. A more conservative interpretation would have required Allianz to use the maximum illustrated rate for the bonused S&P 500 index to set the maximum illustrated rate for all similarly bonused proprietary indices. But Allianz chose not to do that and to their great advantage. You can bet your bottom dollar that this type of strategy is the next move for more than a few insurers looking to pick up huge illustrated performance with relatively small multipliers. But don’t be fooled – illustrating Allianz with bonused allocations to proprietary indices is a purely speculative endeavor, predicated on past performance of the proprietary index repeating itself. As I’ve written extensively in other pieces, that’s not an assumption that should be taken for granted. Proprietary indices are complicated. They are engineered specifically for backtested performance. So before you slap the multiplier on top of what is already a pretty aggressive illustrated rate, think twice and do your homework. And whatever you do, don’t just take Allianz’s word for it.

Zurich Wealth Builder IUL

Zurich’s new product has the same base cap of 12% as the outgoing product. And it has the same 0.5% charge to get a 14% cap. And the same 12% Persistency Bonus multiplier. The only thing that changed – at least, discernably so – is the charge structure. The base charge is down about 20% but COIs are quite a bit higher in the first 40 years, trade places thereafter, and then ramp up towards age 121. I think it’s fair to say that the new product is slightly more expensive than the old one but it really depends on the funding pattern. So what’s the best and most notable part about the changes to Zurich’s flagship accumulation product? Undoubtedly, it’s the new name.

Lincoln Wealth Accumulate IUL 2019 PBR

The best way to think about what Lincoln did with Wealth Accumulate IUL 2019 PBR (hereafter referred to as WAIUL 2020) is akin to a mid-cycle refresh for cars – slight changes to the exterior with essentially no modification to the underlying chassis. In the case of WAIUL 2020, Lincoln made three key changes. First, they reworked the Balanced Account to eliminate the much-maligned Positive Performance Credit (more on that in a second) and instead put the 2% asset charge to work with a 55% guaranteed Index Credit Enhancement. Second, they increased the premium load from 7.5% to 10% and slightly increased the base charges while leaving COIs unchanged.

Third, and most importantly, Lincoln added significant disclosure about the mechanics and impact of the Positive Performance Credit in a well-intentioned but long overdue attempt to provide transparency. Lincoln now describes the PPC calculation in the illustration in excruciating detail, complete with boxes, arrows, formulas and examples. You can’t fault them for trying, but you also can’t look at the new disclosure and quickly say “ah ha, now I get it.” The fact remains that the PPC is tough to wrap your head around the first, second and maybe even third time you really study it. The intuition is simple – roll option profits forward one year to buy a bigger multiplier in the second year – but the mechanics are undeniably complex. I’m not sure this new disclosure will win more fans of the PPC, but that’s beside the point. Lincoln is at least giving producers and their clients the full story and that’s worth something. Furthermore, Lincoln added a report that shows the actual dollar contributions of the Index Credit Enhancement and the PPC so the client can see where the illustrated returns are sourced. You can’t fault Lincoln for trying.

Overshadowing all of these relatively minor changes, however, is the overall story that Lincoln dropped caps after being out with this product for less than 6 months and increased policy charges as well. Is Lincoln justified in their moves? Yes, absolutely. It’s tough sledding out there. Carriers that aren’t dropping their caps are quite obviously cross-subsidizing their caps with other charges or eating reduced (or negative) profits on the block. I said on a podcast recently that I don’t trust life insurers that haven’t made adjustments to their caps commensurate with the current environment and I meant it. So kudos to Lincoln (and everyone else) for biting the bullet and passing along the real economics of hedging these products. That’s exactly how things are supposed to work and the quicker producers get used to it, the quicker they’re going to stop believing that illustrations are actual projections of performance. That’s going to be nothing but positive for the long-term viability of this product line and our business in general.

PennMutual Accumulation Builder Flex

Considering how long Accumulation Builder Select has been in market, I was a little bit surprised that PennMutual didn’t modify their formula more with Accumulation Builder Flex (AB Flex) – but if it ain’t broke, as the saying goes, then don’t fix it. Instead, PennMutual just bolted more features onto their chassis while slightly tweaking the charge and bonus structure. On the charge side, fixed charges in the first 5 years have increased by 10%+ and COIs are up slightly as well, but the COIs actually fall below the old product in middle durations before rising back to equal (or slightly exceed) in ultimate durations. To partially offset these increases in policy charges, PennMutual increased the guaranteed index credit multiplier from 10% to 15% while eliminating the old product’s 0.3% fixed interest bonus payable in year 11 and beyond. All in, these tweaks probably increase the profitability of the product while essentially netting out the illustrated performance at the maximum AG49 rate. The difference, of course, is paid for with illustrated option profits embedded in the extra 5% of index credit multiplier for the new product. Magical, isn’t it?

My guess, however, is that PennMutual won’t be talking about anything in the paragraph above. Instead, they’ll be talking about their new menu of indexed crediting accounts. Here’s my quick and dirty look at the new options:

Account (all S&P 500) Upside Floor Multiplier Asset Charge
Classic 10% Cap 1% 15% None
High Cap 12.75% Cap 1% 15% 0.75%
High Floor 8.5% Cap 2% 15% None
Enhanced 8.5% Cap 1% 25% None
Uncapped 6% Spread 1% 15% None

These are very savvy choices because they basically give PennMutual a weapon for whatever battle they’re fighting in the never-ending, always-changing Indexed UL illustration war. Producers who illustrate at the maximum AG49 illustrated rate? Reach for the High Cap account. Producers who illustrate all products at 6% across the board? Here’s the Classic account. Producers who illustrate all products at 5% across the board? Go for the Enhanced Account.

But to PennMutual’s credit, they didn’t just include choices for illustration warfare – they went further and built accounts that actually modify the payoff profile of the product. The High Floor account has no illustrated advantage but offers a real option to reduce the variability of returns courtesy of the 2% minimum credit. Similarly, the Uncapped account doesn’t have an illustration angle but offers clients the chance to hit a home run if the S&P 500 goes gangbusters. These last two accounts are about aligning the client’s view of the markets and their variability tolerance within their Indexed UL product with account options that make sense for them. Taken together, these 5 options are probably the savviest I’ve seen within an Indexed UL product focused just on the S&P 500. They turned one simple and very popular index into 5 different illustrate and payoff stories. Well played.

Overall Observations

I’m sure I’ll do another one of these once more 2017 CSO products hit the market, but I can’t close without making a few overall observations. First, most life insurers are taking this as an opportunity to slightly reshuffle and increase policy charges. This has nothing to do with PBR or the 2017 CSO. It is possible, I suppose, that PBR would cause pricing issues on an accumulation product but it’s not likely. I’ve spoken to plenty of actuaries about this (and obviously looked quite a bit at PBR in my time at Met/BHF) and there’s not a lot reason to believe that PBR should impact accumulation products. Instead, increasing policy charges is a recognition of the increasingly challenging economic environment and the fact that Indexed UL is an increasingly commoditized market (and by that, I mean, the illustrations are being commoditized).

Second, if you’d asked me earlier in the year what I thought the 2017 CSO refreshes would look like, I would have told you that carriers would be jumping headlong into charge-funded multipliers and I would have been wrong – very wrong, as it turns out. With a few notable exceptions (Allianz), carriers aren’t following PacLife, Lincoln, John Hancock, Nationwide and Securian (and Voya) down the highly leveraged IUL rabbit-hole. Despite the fact that these companies are taking disproportionate shares of the market, other companies have real hesitations about charge-funded multipliers and for good reason. Instead, they’ve found other and much more subtle ways to play the illustration game. Some companies are holding caps higher than they should in order to keep an edge, which is a luxury not really available to companies with big multipliers because a gap between real hedge costs and priced hedge costs is much more damaging to companies with charge funded multipliers (because more money is being spent to buy options). Other companies are playing the proprietary index game. Still other companies have increased policy charges to offer a higher cap or persistency credit. Actuaries are undeniably creative.

But by far the most successful strategy has been to find distribution that cares more about things besides illustrated performance. Hence, the growth of Network Marketing and the fact that virtually every major Indexed UL player is poking around that space if they’re not already neck deep in it. Hence, the growth of extremely edgy tax and premium financing strategies (particularly in the executive benefits and estate planning space) that are only accepted by a few life insurers. Hence, the rise of the market for foreign nationals and the concessions that carriers are making on the underwriting side to get these folks insured and store their hard-earned (ill-gotten?) capital. But there are good moves as well. More life insurers are focusing on securities-based advisors (whether registered reps or IAR/RIAs) to write Indexed UL and that has borne out fruit for those insurers.

As much as I harp on the never-ceasing illustration warfare in Indexed UL, the fact is that product and illustrated performance isn’t the whole story. The top two players are Pacific Life and National Life and let’s just say that they got there in different ways kind of life how Mark McGwire and Sammy Sosa both broke Roger Maris’s home run record in 1998 while taking different PEDs and denying it differently after the fact. There are a lot of ways to sell a lot of Indexed UL and playing illustration games is only one of them, although it is undoubtedly the easiest and safest (for the insurer, that is). The bright spot in the industry right now is that other carriers aren’t just pressing the charge-funded multiplier button to juice illustrated performance – and that’s something we should celebrate, even if the other options aren’t perfectly clean living either.