#276 | North American Goes to (IUL) War with Builder Plus 3

By now, the strategy for optimizing Indexed UL illustrations under AG 49-A is quite clear and I wrote about it in great detail less than a month ago in #273 | The New IUL Illustration War. That article includes a table towards the end that shows the increase in illustrated income from allocating to a proprietary index with a fixed interest bonus is high as 47%. As I wrote in the last post, those percentage increases are in-line with what we saw back in 2018 when charge-funded multipliers were proliferating across the market.

By combining fixed interest bonuses with proprietary indices, life insurers have essentially figured out how to illustrate similar performance to multipliers without actually having a multiplier. Last time around, multipliers kicked off an arms race for illustrated performance between just a few companies that ultimately resulted in the much-maligned AG 49-A. Will the same thing happen with proprietary indices and fixed interest bonuses?

Undoubtedly. It’s already happening. AIG was the first company to pioneer the combination of fixed interest bonuses and proprietary indices. They were doing it prior to AG 49-A and during the AG 49 debate were quite vocal about the problems with multipliers, despite the fact that they were employing their own illustration gimmick. Under AG 49-A, AIG’s version is relatively tame – a 0.65% fixed interest bonus on the Merrill Lynch Strategic Balance index that illustrates at the same rate as the S&P 500 account with a 0.15% fixed interest bonus. The result is that selecting the MLSB generates an extra 20% in illustrated income over the S&P 500 account.

Allianz and F&G followed suit almost immediately after AG 49-A and both sport bonuses in the 1% range on their proprietary index options that produce about a 30% increase in illustrated performance over the base S&P 500 account without a bonus. A few months later, Prudential rolled out a proprietary index with a fixed interest bonus on Founders Plus, their death benefit oriented Indexed UL product. This is a rather curious decision and it stands to reason that Founders Plus was just first on the docket for an update and a similar strategy will be employed on Prudential’s accumulation product, Index Advantage IUL. But, regardless, the new account kicked the illustrated income in Founders Plus up 44%. And then Lincoln followed up not long afterwards with an update to Wealth Accumulate that strapped a fixed bonus on the Fidelity AIM Dividend Index that was already in the product, producing an extra 47% in illustrated income. If this isn’t an arms race, then I don’t know what is.

And with the newly released Builder Plus 3, North American just brought a bazooka to what was already rapidly evolving into a gunfight. The outgoing Builder Plus 2 product was already somewhat dependent on a proprietary index for competitive positioning, but in a less-than-obvious way. Builder Plus 2 had an embedded asset-based charge of 0.75% that, curiously enough, is referenced in the narrative description of the policy but doesn’t appear as a separate line item in the policy charge report (which themselves are incredibly difficult to access because they require North American’s standalone software). But it’s there, even if you can’t see it.

A few months ago, North American added the Fidelity Multifactor Yield 5% ER index to the already extensive lineup of accounts within the product and set it as the default 100% allocation. Why? Because it illustrates the best. How is that? Because North American waives the 0.75% charge for that account. Despite the fact that the Fidelity index illustrated at a lower rate than the BIA S&P 500 account, it still generated in the neighborhood of 0.3% better in terms of IRR because of the charge waiver. That 30bps translates into a modest 10% increase in illustrated income.

Builder Plus 3 reshuffles the charges and the increase in illustrated performance is absolutely massive. The base asset charge jumps to 1.25% and, rather than providing a refund for selecting the Fidelity account, Builder Plus 3 uses a more traditional fixed interest bonus schedule. For all accounts besides Fidelity, the bonus is 1% in years 11 and beyond. But for the Fidelity account, it’s 1.65% for the first 10 years and a colossal 2.65% for every year thereafter. That means the net bonus after year 11 is 1.40%, bigger than any other fixed bonus paired with a proprietary index on the market except for Prudential.

The impact on illustrated performance astounding. Compared to a 100% allocation to the base S&P 500 account, the Fidelity account generates 55% more illustrated income. Using the same scenario as I used in the previous article, Builder Plus 3 generates 33% more income than AIG, 41% more income than Allianz and 47% more income than Lincoln. The only company that still has more illustrated income than North American is F&G, which benefits from an industry-high cap. North American is essentially relying on a different technology than F&G to produce astounding income that, as I’ve written before, is entirely the function of a flawed illustration regulation, not the actual expected performance of the product or the account.

But there’s even more going on under the hood of Builder Plus 3 to achieve those staggering results. The first and most obvious thing is that North American allowed the Fidelity account to illustrate all the way up to the hypothetical BIA rate of 6.24%, which it did not allow in Builder Plus 2. This alone – without any other changes – would have increased the policy IRR by nearly 0.8% simply because the illustrated rate for that account jumped from 5.48% to 6.24%. As I’ve written before, maximizing IUL illustrated performance under AG 49-A requires at least 2 of the following 3 things: a hypothetical BIA, a proprietary index and fixed interest bonuses. Builder Plus 3 checks every box.

North American is also up to something with illustrated income and, to be honest, I’m not exactly sure what they’re doing. The illustration clearly states that the fixed interest bonuses are not paid on policy debt. Taken at face value, that means North American isn’t doing what other life insurers are doing by adding the fixed interest bonuses on top of their illustrated arbitrage to further increase illustrated income. But just because they’re not doing that doesn’t mean they aren’t up to something else.

To get a feel for what they’re doing, I ran four illustrations all using exactly the same parameters with the only difference between the product (BP3 and BP2) and the allocations (S&P 500 and Fidelity). I used GPT so that the DB and the Account Value would equal each other by age 95, which means that the numbers thereafter are “pure” and don’t have any COI-related noise. I looked at a bunch of metrics, but the one that stood out was the simplest – the year-over-year growth of the account value. Take a look at how the four scenarios compare:

My jaw dropped when I saw these numbers and I’m somewhat at a loss for how they’re being produced. But here’s what I can say with confidence – Builder Plus 3 is playing illustration games for income that Builder Plus 2 quite clearly isn’t. My hunch is that both products essentially waive the asset-based charge on the loaned balance so that it essentially acts like a fixed interest bonus, which is why the values are more inflated for Builder Plus 3. That’s the only reasonable explanation that comes to mind. But no matter what the reason is, the fact remains that Builder Plus 3 is out for blood in the illustration war and North American is putting every possible tool to use.

Including compensation. Builder Plus 3 incorporates the new Section 7702-2% rate and, therefore, has higher premium limits per dollar of death benefit (or lower death benefit limits for the same premium). Every life insurer up until this point has chosen to maintain the same relationship between Target and Death Benefit as before the changes to Section 7702, meaning that if the DB dropped by 50% then the Target (and therefore the compensation) did as well. But not North American. Take a look at what happens to Target in the scenario below:

It appears as though North American has found a middle-ground solution by reducing what would have otherwise been a 49% reduction in compensation to a 29% reduction instead. This, however, creates problems of its own. In this same scenario, the first year surrender charge for Builder Plus 2 is $115,537 and about 1.8 times Target. This is more than enough to protect North American against premature lapses and very likely provides a meaningful source of profits (“surrender margin,” as discussed in the last post).

But for Builder Plus 3, the surrender charge is a mere $59,102 but the Target has been increased from what it should have been – $33,022 with no changes from the BP2 schedule – to $45,687, creating a new ratio of surrender charges to Target of just 1.29. This is a problem considering that North American’s total compensation is in the neighborhood of 150%. The surrender margin that was presumably positive and profitable on the outgoing product is now presumably negative and unprofitable on this product. Furthermore, it opens up North American to a host of short-term schemes designed to take advantage of the difference between the upfront compensation and the surrender charge. Most companies aren’t going to be willing to take that risk, which means North American may be in the enviable position of having both the richest compensation and most aggressive illustrated performance in the industry. Katy bar the door.

North American may be holding the bazooka for now, but there are undoubtedly equally as potent weapons on the horizon. The fact that Prudential – yes, staid and conservative Prudential – managed to get a 1.5% fixed interest bonus using a proprietary index with an even smaller option budget than North American means that there’s more blood in the stone. What’s to stop companies from pushing the envelope further towards 1.75% or even 2% fixed interest bonuses on top of 5.5% or 6% illustrated rates? Essentially nothing. Companies have proven themselves unwilling and unable to rein in this market that feeds on illustrated performance. The only thing that works is regulatory intervention and it’s hard to imagine that’s not on the horizon.