#245 | AG 49-A and PacLife PDX 2

Pacific Life has been at the center of the controversy surrounding leveraged Indexed UL products, whether they particularly meant to be or not. The original PDX might have had copious amounts of complexity and illustrated leverage and thrown fuel onto the fire of the Indexed UL illustration war, but PacLife has been gradually making amends ever since. Although PDX’s successor PDX 2 still offered staggering amounts of illustrated leverage, it used a decidedly simpler and more transparent approach along with better disclosure of the mechanics on the illustration. During the regulatory debate leading up to AG 49-A, Pacific Life took a back-seat despite arguably having the most at stake given that it was the #1 seller of Indexed UL and the vast majority of its sales involved some level of illustrated leverage. Now, they’ve showed their cards on how they’re going to handle AG 49-A. In doing so, they’ve also made it abundantly clear that they are not going to be the primary target the next time there’s a regulatory discussion on Indexed UL. They’re playing it straight.

If last week’s post on John Hancock Accumulation IUL 20 was about how to optimize a leveraged Indexed UL product to deliver maximum illustrated performance under AG 49-A, then this week’s post on PacLife PDX 2 is about what happens if a carrier makes effectively no changes to a leveraged product and simply applies the guideline. The two strategies produce starkly different results. Take a look at the year 30 CSV IRRs for the AG 49 and AG 49-A compliant versions of the two products. The dark lines are AG 49 IRRs, the lighter lines are AG 49-A IRRs.

As I wrote last week, John Hancock incorporated numerous changes to Accumulation IUL in order to deliver similar crediting performance and enhanced product performance in the 2020 (AG 49-A compliant) version compared to the 2019 version. Most notably, they added a new hypothetical Benchmark Index Account to provide illustrated rate aircover for the multiplier accounts and reduced policy charges. Pacific Life did neither of these things and the results bear that out. The old PDX 2 product had better performance as more leverage was applied. The Classic account, which had no leverage, illustrated just above a 5% IRR in year 30 whereas the Performance Plus account, with its 7.5% asset-based charge and commensurate multiplier, delivered an IRR north of 6%. But for PDX 2 2020, the AG 49-A compliant version, adding multipliers produces reduced illustrated performance. The Classic account is similar to the previous product at a 4.87% IRR in year 30 but the Performance Plus account shows only a 4.57% IRR.

As I wrote last week, the results produced by AG 49-A are strange. One of the most obvious and notable impacts is that, all else being equal, accounts with charge-funded multipliers illustrate worse performance than accounts without them. This was not the intent of AG 49-A. There was actually a vote early in the AG 49-A process where regulators cast their ballot for options on a spectrum ranging from most aggressive (leveraged products illustrate much better than non-leveraged products) to most conservative (leveraged products illustrate much worse than non-leveraged products). The regulators voted for the middle option to have leveraged products illustrate the same as non-leveraged products. That didn’t happen. What actually happened was that the crediting is theoretically even, but the actual impact on performance isn’t.

Why is that? Well, because as Yogi Berra famously didn’t say – “In theory, there is no difference between practice and theory. In practice, there is.” That’s exactly what happened here. All of the models presented to the regulators to justify the methodology in AG 49-A were done in the equivalent of theory. They assumed that all factors were known and they also assumed no policy charges. In the real world, neither of these things are true. I wrote at length last week about the fact that many of the factors that determine the illustrated performance of a product under AG 49-A are not disclosed or declared. But for this discussion, the latter of the two is even more problematic. Crediting and policy charges are always related and always impact each other. You can’t find a solution in a theoretical world without policy charges that will apply correctly to the real world with policy charges.

At least, not when policy charges are integrally related to crediting interest as they are in the vast majority of Indexed UL products. The basic problem comes down to timing. Generally speaking, policy charges are deducted monthly and indexed credits are applied based on the average account value throughout the year. There are some exceptions for carriers that credit interest based on the beginning of year account value (Symetra) or end of year account value (Securian), but the majority use the average account value throughout the year because it produces similar results to monthly UL crediting. The problem with a charge-funded multiplier account is that those policy charges are deducted from the account value, which means that the base indexed credit at the end of the year is lower as a result. Assuming that the carrier illustrates the even-swap between multiplier charges and credits that AG 49-A seems to imply, then the illustrated performance would necessarily be lower for multiplier accounts than non-multiplier accounts. Take a look at the simple hypothetical example below.

Beginning of Year AVPolicy ChargesMultiplier ChargesEnd of Year Account ValueAverage Account ValueIndexed Crediting RateIndexed CreditMultiplier CreditFinal Account Value
Traditional IUL100,0001,000099,00099,5006.00%5,9700104,970
Leveraged IUL100,0001,0007,50091,50095,7506.00%5,7457,500104,745

The difference in this example doesn’t look huge, but it adds up over time. The net effective cash value growth with a charge-funded multiplier is 4.745% versus 4.970%, a difference of 0.225%. Look closely again at the chart comparing PDX and PDX 2. What’s the difference in IRR after 30 years between the Classic, no-leverage account and the Performance Plus leveraged account? About 0.3%. You can safely chalk that up to the phenomenon described here, which Pacific Life faithfully shows in the performance of the product. In the supplemental reports showing illustrated charges and credits, PacLife doesn’t exactly match the multiplier charge to the multiplier credit, but it also reduces the base indexed credits more than you might expect. You can see a new crediting report on the illustration that shows a reduction in the illustrated crediting rate the moment that the charge-funded multiplier kicks in. The net effect of the reduced illustrated rate is a bit more severe than what I calculated using an even swap. I’m honestly not sure why PacLife is doing it this way. Chalk it up to conservatism. Chalk it up to the complexity of AG 49-A. Chalk it up to the messiness of applying theory to practice. Chalk it up to whatever you want, but the story is the same – PDX 2 illustrates worse in the multiplier accounts than in the non-multiplier accounts. That was not supposed to happen.

The other substantive change you’ll see in PDX 2 is in the Persistency Credit, which is the part of the product that separates it from its stablemate, PIA 6. I wrote extensively about the Persistency Credit when I first reviewed the product many moons ago, but you can now safely ignore most of what I wrote because PacLife decided to simplify the illustrated benefits of the Persistency Credit in PDX 2 2020. The former version essentially provided a cash payment into the policy and then applied indexed performance. The current version just provides a cash payment regardless of indexed performance. Why the change? Because illustrating the indexed nature of the Persistency Credit would likely have been prohibitively complex under AG 49-A. I’m not even sure it would have been possible, honestly, and that must have been what PacLife determined as well. The fact that the Persistency Credit no longer illustrates indexed interest (and therefore indexed option profits) is why the Classic account in PDX 2 2020 performs slightly worse (about 20bps after 30 years) than in PDX 2.

Where do these changes leave Pacific Life, the long-time #1 seller of Indexed UL? In a pretty tough spot. I’ve long said and written extensively about the fact I think Pacific Life is the most reliable indicator of where fair-market caps should be. Right now, the cap for their flagship products is 8.5%, well below many of its competitors. PacLife’s low caps haven’t been a huge problem for them because they could essentially paper over them with illustrated leverage from multipliers. That’s no longer possible under AG 49-A. PacLife is now a strategic disadvantage, both in terms of their caps and their handling of AG 49-A. I wouldn’t be surprised if PacLife suffered a 25-30% decline in sales next year. But it seems as though they’re playing the long-game and are more concerned with what happens after AG 49-A – and I certainly can’t fault them for that.