#290 | The Game’s Afoot – PacLife Horizon IUL

This title is borrowed from a line in Star Trek IV: The Undiscovered Country. In the final battle sequence, the Enterprise is rushing to stop an assassin at a secret summit and is met in orbit by a cloaked Klingon Bird of Prey hijacked by a rogue General Chang. When another starship enters the fray, Chang says “ah, the game’s afoot,” a quote from Shakespeare’s King Henry IV.

PacLife has always seemed conflicted about its role in the Indexed UL market. It has been the leading seller of Indexed UL since 2009 – and not by a narrow margin. In 2020, PacLife outsold its next closest competitor by more than 50%. PacLife is an absolute juggernaut when it comes to Indexed UL. Whatever PacLife does sends reverberations throughout the industry.

I’ve long said that PacLife is a leading indicator of where cap levels are going to go in the industry. They price their rates “pure” because their block is simply too big to do anything else. They’ve also been remarkably consistent in their pricing regime dating back to the original Pacific Indexed Accumulator product all the way through to the modern PIA 6 and PDX 2 Indexed UL variants. When PacLife lowers their caps, you know that other companies are going to follow suit, even if they go kicking and screaming. Where PacLife goes with rates, others will inevitably follow.

But when it comes to adopting certain product features that are designed to maximize illustrated performance, PacLife is usually a lagging indicator, with the notable and obvious exception of indexed multipliers and the notorious and best-selling PDX IUL. PacLife first staunchly opposed variable loans in Indexed UL and went so far as to put out a hit-piece saying why these loan structures were extremely problematic for clients, but then changed its positions and gradually went all-in on variable loans. PacLife, from my recollection, was also hesitant to get into long-dated crediting strategies designed to juice illustrated performance pre-AG 49 but ultimately released its own crop of long-dated strategies.

With PDX, PacLife stuck its neck out to – uhh – “innovate” on Indexed UL and promptly became the villainized for capturing a 20%+ market share and simultaneously unleashing the massive multiplier-driven illustration war that ultimately brought AG 49-A on the industry. Since then, PDX has become the subject of a high-profile lawsuit that I wrote about last year and is still working its way through the courts. Little wonder that internal folks talk about a new focus on Compliance and Legal oversight of the product and distribution functions.

Hence, the conflict. PacLife is huge and successful, but it has generally been a reluctant follower of trends in the Indexed UL space geared towards illustration warfare, oftentimes decrying a strategy before eventually adopting it. But when PacLife does eventually adopt a strategy, it’s seen as validation for many carriers still sitting on the sidelines, although PDX marred that perception a bit. Where PacLife goes with product features, others will inevitably follow.

As I’ve written in several articles so far, the latest trend in Indexed UL is using proprietary indices combined with a fixed interest bonus to maximize illustrated performance under AG 49-A. The effects can be astounding. Some companies are showing 50%+ increases to illustrated income from using the proprietary index account versus the base S&P 500 account with a cap. The list of life insurers that are using this strategy is long – AIG, Allianz, North American, National Life, F&G, Lincoln and Prudential. And it just got a little bit longer.

This week, PacLife entered the fray on proprietary indices with fixed interest bonuses with its new Horizon IUL product. But unlike PDX and PDX 2, where PacLife clearly came to fight, Horizon IUL is a tepid first step into the new illustration war. The maximum illustrated rate across all indices in the product is 5.71% and the Blackrock Endura Index account has an additional 0.35% fixed bonus, bringing the total to 6.06%. To put that into context, Lincoln also has a 5.7% illustrated rate in its proprietary index account (Fidelity AIM Dividend Index) but sports a 1% bonus, bringing the total to 6.7%.  The difference in illustrated income for Lincoln between the S&P 500 account and the proprietary index account is well north of 45%, depending on the scenario. For PacLife Horizon IUL, the difference between the illustrated income for the two accounts is just 10-15%. PacLife is playing the same game – just not nearly to the same degree as other carriers.

It would be a mistake, however, to assume that Horizon IUL is simply PDX 2 with a proprietary index option. There’s actually quite a bit more to the story. Horizon has the same combination of high early policy charges with a product-level Persistency Credit as PDX 2. As I wrote in the original review for PDX 2, the Persistency Credit is a fixed dollar credit, not an asset-based interest credit. In other words, there are a defined dollar policy charges that go to fund a defined future dollar payout – at least, for the policyholders who haven’t died and still own the policy. It is, in other words, a tontine-esque structure buried in the product itself. Theoretically, you could own just the Persistency Credit on its own without even buying the policy.

And if you did – and you kept the contract and didn’t die – then you’d be flat out thrilled with the results. It’s impossible to parse out which policy charges in the contract are going directly to fund the Persistency Credit, but we can do some rough and very conservative math. By fully blending PDX 2 with ARTR (Term) and then running an IRR on the remaining fixed charges and the Persistency Credit over time, the IRR is 7.77%. Compared to the base illustrated rate of 5.18%, taking money out of the policy and dumping it into this opaque Persistency Credit mechanism is a good deal. I’d take that deal all day long, every day, as long as I was dead sure I was going to keep the policy to reap the (non-guaranteed) rewards.

What Horizon does is dump more money into this magical Persistency Credit mechanism. Take a look at a comparison of cumulative fixed policy charges against the cumulative Persistency Credit payout for PDX 2 and Horizon IUL using the same premiums, Targets and death benefit with a max ARTR (Term) blend:

It’s obvious that both charges and the Persistency Credit have increased dramatically in Horizon, but the effect isn’t quite as dramatic as it looks. PacLife also changed the structure of the Persistency Credit itself and pushed the start year back from 11 to 21. Take a look at the Persistency Credit for this cell for both policies:

If you run the same IRR calculation on the charges and Persistency Credit for both policies, the result is nearly identical (7.77% for PDX 2 and 7.72% for Horizon IUL). The reason for the dramatic increase in the size of the Persistency Credit in Horizon IUL is therefore twofold – higher policy charges and delayed payout. In other words, Horizon IUL puts more money into the magic money machine and makes policyholders wait longer to get it, which simultaneously increases the dollar size of the ultimate payout and decreases the population of people still holding the policy who can get it. That, assuredly, is one of the key pricing elements for the benefit.

The impact on the illustrated performance differential between PDX 2 IUL and Horizon IUL is not trivial. Running both products with the same premium, death benefit, Target and illustrated rate (5.18%), Horizon IUL tacks on about 0.2% in IRR over PDX 2. At a 4% illustrated rate, the IRR gap widens to about 0.35%. With a 100% Fixed Account allocation (2.25% rate), the gap grows to nearly 0.6%. The lower the illustrated rate, the bigger the differential.

Why? Because, remember, the Persistency Credit is a fixed dollar benefit, not an asset-based benefit. The best way to intuit the performance of Horizon IUL is to think about the Persistency Credit as a separate contract embedded into the life insurance policy. The two elements are independent, at least for illustrative purposes. That’s what makes a unified measure of performance like Cash Value IRR show some really odd results that, frankly, you don’t see in any other Indexed UL policy.

The final change to Horizon IUL is the S&P 500 Cap and maximum illustrated rate. In PDX 2, the Cap is 8% and that generates a maximum illustrated rate of 5.18%. In Horizon IUL, the Cap is 9% and has a 5.71% illustrated rate. Where did the extra 1% in Cap come from? It’s very clear that Horizon IUL has higher policy charges and that those charges are going to fund a higher Persistency Credit, but it’s also possible that some of the charges could also be going to prop up the Cap a bit. It’s also possible that PacLife may be using a slightly different and higher yielding portfolio for Horizon IUL than for PDX 2 and its crop of standard Indexed UL policies.

Or PacLife could simply cross-subsidize the S&P strategy with the proprietary index strategy, as many companies in both FIA and IUL are doing. A proprietary index is cheaper to hedge for the same illustrated performance as the S&P 500. By assuming that policyholders elect, say, 80% into the proprietary index, the lower cost to hedge can be used to prop up the S&P 500 Cap and therefore increase the maximum illustrated rate for all of the accounts. This is the Nationwide New Heights playbook and why Caps in that product are higher than in their otherwise-identical street IUL product. And this is perfectly acceptable under AG 49-A, which has a clause that life insurers managed to shoe-horn into the language at the last minute that allows actuarial testing to be done in aggregate rather than by indexed account. Voila. Feel free to cross-subsidize your accounts to your heart’s desire.

Horizon IUL is, therefore, a three-pronged strategy – larger persistency credit, higher Cap and a proprietary index option with a fixed interest bonus. Each contributes a little bit to the overall illustrated performance, but the final result is a dramatic improvement over PDX 2 IUL. Take a look at how Horizon IUL stacks up as it employs each of the strategies:

All told, Horizon IUL makes mincemeat of PDX 2, tacking on nearly 100bps in long-term illustrated IRR that translates into a nearly 35% improvement in illustrated income. These changes are enough – just enough – to put PacLife back into contention with the other companies who are using proprietary indices with fixed interest bonuses. I’ve run a couple of benchmarks and it looks like Horizon IUL is going to come in just above Lincoln Wealth Accumulate IUL II but a smidge below Allianz and well below North American, by far the most aggressive user of the prop index with interest bonus strategy.

I kicked off this article by pointing out that although PacLife is a leading indicator for Cap levels, it is a lagging indicator for aggressive product features – but when PacLife finally capitulates, it usually serves as a validation of the strategy. Other companies on the fence may follow suit to maintain competitive positioning. John Hancock has already filed to use the same strategy in an upcoming refresh of their flagship accumulation IUL product. They will hardly be the last. And what happens next? We all know how this movie ends. In fact, I think it’s fair to go ahead and say that we even know the name of the final scene: AG 49-B. It can’t come quickly enough to put an end to this latest form of illustration gimmickry afflicting Indexed UL, hopefully the last in a very long line.

One final note – there’s an interesting twist in the Horizon IUL story that is worth mentioning. The 0.35% fixed interest bonus isn’t just available on the Blackrock Endura volatility-controlled index. It’s actually available on the 3-year S&P 500 strategy as well. Why is that? Because the longer you extend the maturity of an option, the cheaper it becomes on an annualized basis. That provides the same sort of discount to a pure S&P 500 strategy as a proprietary index and, therefore, frees up option budget to provide a fixed interest bonus. North American actually pays its bonus on an uncapped S&P 500 strategy with a spread that, based on the current spread, provides a discount as well. In both situations, the lookbacks are high enough that the carrier can still illustrate the maximum AG 49-A rate while providing a bonus. This is yet another evolution of the strategy to maximize illustrated performance by exploiting the flexibility of AG 49-A when it comes to fixed interest bonuses and it blows the doors wide open to non-proprietary index gamesmanship.