#325 | Penn Mutual Bucks the Trend

Quick Take

Despite the fact that the entire Indexed UL market seems to be flocking to engineered indices, Penn Mutual has made the decision to buck the trend. Its new Accumulation IUL sports a comprehensive lineup of S&P 500 crediting strategies, all of which have rich rates – but particularly the participation rate options, which are extremely attractive at today’s prices. Accumulation IUL does have slightly higher policy charges than the outgoing Accumulation Builder Flex IUL, but it also has a slightly higher all-in illustrated rate. It also swaps the 15% built-in multiplier in AB Flex IUL for a 50bps bonus, which allows for slightly exaggerated illustrated income because the 50bps is added to illustrated loan arbitrage. All of this stacks up to a highly competitive product – but not in comparison to products that leverage engineered indices to maximize illustrated performance under AG 49-A.

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In the early days of Indexed UL, two small mutual insurers suddenly bolted on to the scene and shot to the top of the sales charts, blowing past the incumbents. Those two companies, of course, were Minnesota Life (now Securian) and Penn Mutual. Both companies used the same playbook – ultra-high S&P 500 Caps, with Minnesota Life ringing in at 17% with a 0% Floor and Penn Mutual at 14% with a 2% Floor. Both companies sported illustrated rates in excess of 9% and completely upended the market, contributing significantly to the already-emerging arms race in Indexed UL. These two companies are an integral part of the history of Indexed UL.

And Indexed UL is an integral part of the history of these two companies. At Securian, for example, nearly 70% of overall Life reserves are in Indexed UL. At Penn Mutual, the breadcrumb trails are a bit harder to follow because Penn Mutual doesn’t actually categorize any product as “Indexed Life,” but it looks somewhere around 50% of overall Life reserves are Indexed UL.

Both companies may have made their name on what proved to be unsupportably high Caps and absurdly high illustrated rates, but neither company has followed the rest of the industry into the chaos that followed. Neither company has relied on manipulated lookbacks (which resulted in AG 49), aggressive buy-up caps and multipliers (which resulted in AG 49-A) or engineered indices with fixed interest bonuses (which is going to likely lead to AG 49-B). Minnesota Life and Securian are, perhaps, like two players who trade a couple of quick punches and then stop to look at each other in dismay as both benches empty into a massive brawl, the entire stadium erupts and security guards pour onto the field.

The question is always whether these two companies will get back into the fray. Securian has resolutely stayed out. Its street product, Eclipse Accumulator IUL is a clean, simple, relatively low cost product without any illustration gimmicks. The same goes for BGA IUL, the Annexus product, which has engineered indices but doesn’t illustrate better performance for those indices or artificially juice the cap on the product a la Nationwide New Heights IUL. It’s the model for how engineered indices should be incorporated into an Indexed UL product.

Penn Mutual, however, has played a bit on the fringe. Its outgoing flagship IUL, Accumulation Builder Flex IUL, has a bevy of S&P 500 options with a 15% multiplier. The multiplier gave the product just enough of an edge in the AG 49 world to compete with some of the more aggressive charge-funded multiplier products because Penn Mutual generally had higher caps. But that product lost its edge under AG 49-A and Penn Mutual’s cap reductions.

Hence, their “new” product – Accumulation Indexed UL, a mercifully simpler name for a simple product. Take a look at the available crediting strategies:

*This account is a little bit tricky. Penn Mutual applies the 3% spread first and then the 12.75% cap. For example, a 20% index return would result in a 17% return and then the cap of 12.75% is applied for a final 12.75% credit. A 15% index return would net 12% after the spread for a 12% credit. However, for option valuation purposes, this is a call spread with a 103 bottom strike and 115.75 top strike, which nets the 12.75% Cap.

A couple of things stand out. First, there are only S&P 500 strategies. Penn Mutual is not playing the engineered index game. Second, this is the first time that Penn Mutual has offered an indexed strategy with a 0% Floor. It’s a watershed moment because Penn Mutual has always marketed that its products have guaranteed positive credits. And, as you’ll see in a second, that’s still true but now in a different way.

Third, Penn Mutual is covering the full gamut of option strategies with Accumulation IUL, offering Cap, Spread (plus Cap) and Par Rate options. I included the option fair market value (as of 7/20/22) to give a little bit of insight into the relative value of the strategies and the message is clear – all of the strategies are pretty rich, but the participation rate strategies are particularly so. This is something I’ve seen in other Penn Mutual products as well (particularly Diversified Advantage VUL when it rolled out). My guess is that Penn Mutual tries to shoot for rate stability on its Par Rates, which might seem a bit counterintuitive given how high they are, but hear me out.

The reason the rates are so rich is because volatility and interest rates are both currently very high. Penn Mutual is probably setting rates based on what it thinks is “normal.” Historical S&P 500 implied volatility is more on the order of 19%, which would push the value of the 56% Par Rate on the 0% Floor strategy to 4.7%. In a normal world, a 56% Par Rate has a similar cost to a 9.5% Cap. But we’re not in a normal world right now. Consequently, the clear and obvious choice in terms of value right now is the 56% Par Rate. Take it while you can get it.

In terms of policy charges, the new Accumulation IUL is very similar in terms of structure as the outgoing Accumulation Builder Flex IUL but is more expensive. For example, in the standard Male 45 year old Preferred $1M scenario that I use to benchmark, the per thousand charges in Accumulation IUL are $52,290 over the first 10 years compared to $41,220 in Accumulation Builder Flex IUL, a 27% increase.

One reason is that Target Premium is up 17%. Penn Mutual is following the recent trend of carriers increasing their Targets, sort of finding the middle ground between where Allianz landed with compensation and the old Target rates pre-7702. But the increase in Target still doesn’t cover the increase in policy charges. In dollar amounts, the Target premium is up $3,257, but policy expenses are up $11,070 – a ratio of 3.4x. That’s pretty steep. Combine that with slightly higher COI rates in Accumulation IUL and I don’t think it’s a stretch to say that Accumulation IUL is more frontloaded than AB Flex IUL.

Where’s that extra money going? The old AB Flex IUL had, as I previously mentioned, a 15% multiplier that worked well under AG 49 because it not only increased the illustrate rate but also illustrated loan arbitrage. Accumulation IUL gets rid of the 15% multiplier in favor of a 0.5% fixed bonus and slightly higher Caps. Take a look at an apples-to-apples comparison between the old and new product on the 1% Floor account:

So while Accumulation IUL is slightly more expensive in terms of policy charges than AB Flex IUL, it also offers slightly more valuable upside potential. That flows through to illustrated rates as well. AB Flex IUL maxes out at 5.49%, which then gets the 15% multiplier for a grand total of 6.314%. Accumulation IUL, however, illustrates at 6% in the 9.5% Cap / 0% Floor strategy plus the 0.5% fixed bonus, which brings it up to 6.5%.

The net result is that AB Flex IUL has better performance in the early policy years – courtesy of lower expenses – but Accumulation IUL pulls ahead in later years courtesy of the slightly higher illustrated rate. In terms of IRR, Accumulation IUL tacks on around 15bps in IRR over the long haul for a fully funded contract. Over 40 years, the IRR differential is more like 8bps, which translates to about 3% extra cash value. However, if you run income from years 21-40, you’ll see that illustrated income is up a whopping 8% in Accumulation IUL.

How is that possible? Because the 0.5% interest bonus in Accumulation IUL is added to illustrated arbitrage whereas the 15% multiplier in AB Flex IUL isn’t. With Accumulation IUL, Penn Mutual is very tentatively dipping its toes in the same water as the companies that are using engineered indices with fixed interest bonuses. There’s just not nearly as much juice when you’re using S&P 500.

Instead, it’s about tradeoffs. Penn Mutual could have had a higher cap without the fixed interest bonus and probably comparable income. My read on the 0.5% bonus is that it’s half about optimizing illustrated income under AG 49-A and half about providing some level of guaranteed growth on the new 0% Floor strategies (although the bonus applies to all accounts). It lets Penn Mutual stick to their story about offering positive credits while giving them the ability to put more of their option budget to work to buy more upside. Penn Mutual would likely have made that same decision even without AG 49-A.

However, I wonder if Accumulation IUL isn’t missing something. Focusing entirely on the S&P 500 is certainly simple. It has that virtue. Penn Mutual has filed a slew of other S&P 500 crediting strategies that it didn’t use but could easily append to the product. But the problem with a pure S&P 500 product is that it doesn’t allow for diversification beyond strike diversification (or, in other words, dollar cost averaging). Having multiple indices, including engineered indices, is a benefit because it allows for diversification. It almost feels like Penn Mutual missed an opportunity to include other indices without the illustration gimmicks. They would have made the same point, but still been able to offer strategies to diversify.

How does Accumulation IUL stack up against peer products? That depends. On pure S&P 500 illustrated performance and income, Accumulation IUL should be one of the most competitive offerings on the market. But if you start throwing engineered indices into the mix, it doesn’t even get close, trailing some of the most aggressively illustrated products by 20% or more. The Indexed UL market is so oriented towards engineered indices at this point that it seems somewhat unlikely that Accumulation IUL will get a lot of attention, despite the fact that the fair-market value of some of the options in the product are among the highest in the market, bested only by F&G.

However, Accumulation IUL’s competitive positioning would change with a new regulation that limits the effectiveness of engineered indices. In every round of regulation, there have been new winners and losers as soon as the ink is dry (and sometimes even before). This product will very likely be a winner when the dust settles after AG 49-B – with one caveat. Penn Mutual released a new product but didn’t switch to new money rates and significantly bump up the rates. The same goes for AIG’s forthcoming Max Accumulator+ III, which has essentially the same rates as the outgoing product. There is still the lurking risk that a company will switch to new money and wreck the whole thing. But it ain’t going to be Penn Mutual.

If nothing else, we should applaud Penn Mutual for sticking to its guns on Indexed UL. It has more or less not changed its strategy for the past 15 years and has largely avoided falling prey to the various fads in the market. They’re playing the long game, it seems, and that counts for something.