#343 | The Original IVUL – Equitable MSO II

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Quick Take

Equitable was first-to-market with Buffered crediting strategies in VUL with its 2010 release of the Market Stabilizer Option (MSO). A few weeks ago – on the same day that Prudential FlexGuard IVUL was released – Equitable launched a sorely needed up date to MSO, now dubbed the MSO II. It represents a markedly different approach than Prudential FlexGuard IVUL. Equitable offers MSO II on all of its single-life VUL products, a portfolio that spans traditional accumulation, protection, early cash value and rapid issue products. MSO II has a broader suite of Buffer strategies than FlexGuard IVUL, ranging from 10% to 25%, with the unique (but complex) Dual Direction crediting strategy. In my view, MSO II is the superior offering if the focus is purely on Buffer strategies and accumulation. Will it follow in the footsteps of its blockbuster annuity counterpart, Equitable SCS? I don’t think so. Annuities are positioned very differently to life insurance. In the end, what matters is not the Buffer – it’s the underlying product. Life insurance still has to be sold, not bought.

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If you were to just look at the recent industry press and buzz around Prudential’s new FlexGuard IVUL, you’d think that Prudential just pioneered the so-called Indexed VUL product category. It’s a testament to Prudential’s sheer scale and presence in our industry. But it’s also a testament to clever marketing – Indexed VUL wasn’t a category until Prudential defined it with FlexGuard IVUL. But the reality is that Indexed VUL, even as Prudential has defined it, isn’t new – it has been around since 2010, when then-AXA Equitable released the Market Stabilizer Option (MSO) in their Variable UL contracts.

Interestingly enough, MSO actually pre-dates AXA Equitable’s first Indexed UL product, Athena IUL, by three months. It also pre-dates Equitable’s perennially market-leading RILA, Structured Capital Strategies (SCS), by six months. Unlike SCS, MSO never really found its footing. It lacked some of the key stories that made SCS so appealing for advisors. It used a 1 year point-to-point strategy with a 25% Buffer* whereas the best-selling SCS strategies were longer-duration and with smaller buffers, such as the 5 year strategy with a 10% Buffer. On top of that, SCS baked the fees into the rates being offered – which meant it could be marketed as a “no fee” product – but MSO charged an explicit 1.15% asset-based fee. It was also on a Variable UL policy, which is obviously harder to sell and more complex than a basic Variable Annuity.

As if MSO needed more cards stacked against it, Equitable long ago stopped offering competitive rates on the strategy because, from what I understand, the company supported it with a highly liquid, short-duration portfolio, which meant that the there was essentially no option budget to spend during the dark days of ultra-low interest rates in the mid-2010s. Selling a put option at 25% out of the money (which is how the company hedges the 25% Buffer) only gets you so much budget to buy upside exposure. For a long time, Caps on MSO were lower than even Equitable’s own Indexed UL products with 0% Floors. It was almost like they were trying to kill the concept.

A few weeks ago, Equitable released a very sorely needed and very long overdue update to MSO II – ironically enough, on the same day the Prudential released FlexGuard IVUL. Why haven’t you heard the same buzz for MSO II as you’ve heard for FlexGuard IVUL? It’s not because MSO II isn’t a stellar offering. It is. Take a look at how the two compare:

Prudential FlexGuard IVULEquitable MSO II
Term1 Year1 Year
Buffers0%, -10%-10%-15%-20%
Upside ExposureCapped, Step Rate PlusCapped, Step Rate, Dual Direction
Fee“No Fee”0.40%
Current 10% Buffer Cap Rate18.00%19.50%
Available OnOne Product5 Products
Lifetime Secondary GuaranteeAvailableNot Available
Separate Account Funds950+

The reason why FlexGuard IVUL has captured so much attention compared to MSO II is due, undoubtedly, to Prudential’s all-out marketing blitz. But it’s also due to the fact that there is a fundamental difference in strategy between the two offerings.

FlexGuard IVUL is a separate and distinct product. Prudential only offers Buffer strategies on FlexGuard IVUL. They are clearly pursuing an either/or strategy. The separate account fund options in FlexGuard IVUL are very slim. The ability to use this product in traditional VUL sales processes will be hindered by the limited fund lineup. It is technically a dual-use product but, in reality, FlexGuard IVUL is really only worth considering if you want the Buffers. The caveat is that FlexGuard does what MSO II can’t do in that it offers a secondary guarantee and leverages the benefits of the Buffer strategies for better pricing than its traditional GVUL counterpart, Protector VUL.

MSO II, by contrast, is a rider available on all single-life Equitable VUL products. These products serve a wide range of applications from corporate/early cash value (COIL) to traditional accumulation (Optimizer) to protection oriented (Legacy) to levelized compensation (Advantage) and rapid issue with simplified design (Advantage Max). The existence of MSO II on all of these products also doesn’t change the full slate of other separate account funds available to policyholders, meaning that policyholders have access to more than 80 insurance dedicated mutual funds plus MSO II. Equitable is pursuing a both/and strategy.

The relative merits of the two strategies are up for debate. On one hand, you could argue that focusing marketing efforts around a product is almost always more effective than focusing them on a rider. Products get more attention and feel more distinct. There are some exceptions to the rule, particularly if the rider defines the product, such as certain LTC and secondary guarantee offerings. FlexGuard IVUL plays into that mindset. FlexGuard IVUL is defined by the existence of the Buffer strategies. Without those, there is no reason to pick it over Prudential’s traditional VUL offerings.

In my view, Prudential is playing FlexGuard IVUL to the RILA playbook. Annuities are sold as short-duration products, usually 10 years or less. In the RILA space, the typical duration is 6 years. Once that period is up, then the client can 1035 into a new annuity that offers the right strategy for that stage of their accumulation and income needs. In that mindset, it makes sense to have a product “dedicated” to Buffer strategies because that’s what’s driving the sale.

However, I think that approach doesn’t account for the fact that life insurance is a completely different deal. Life insurance products, in stark contrast to accumulation annuities, are sold for 50+ year time horizons. Accumulation, protection and income needs change a lot over 50 years. The fundamental power of a Variable UL offering is choice – the ability to calibrate the investments in the product to match the client’s current goals and objectives. Buffered strategies are a great option for an allocation at certain stages and for certain clients. They are not an end-all, be-all.

As a result, I would argue that the superior strategy for putting Buffer strategies into VUL is the one that Equitable chose, where the rider can be added to a range of base products that are built for different applications. The fact that MSO II is available on so many products with so many other fund offerings is a strength, not a weakness. It allows customers to pick the right chassis for their needs and gives them the flexibility of a full slate of separate account options for when their investment preferences change. The rider approach is the right one for the real world, even if it doesn’t lend itself to a neat and clean marketing story.

The irony is that although FlexGuard IVUL is built as something of a single-use application focused on the Buffer strategies, Equitable MSO II actually offers the broader and better slate of Buffered strategies. MSO II sports 5 strategies compared to 3 on FlexGuard IVUL. Equitable offers traditional Capped strategies at 3 Buffer levels – 10%, 15% and 20% – and a Step Rate with a 10% Buffer.

However, Equitable doesn’t offer a 0% Floor strategy like Prudential does. The closest thing Equitable offers is a 20% Buffer which, historically speaking, would protect against the vast majority of drawdowns in the S&P 500. The benefit of a 20% Buffer versus a 0% Floor is that a put option is still involved and, because of high volatility and volatility skew, is actually pretty valuable. That’s why Prudential has only an 8% Cap for their 0% Floor while Equitable’s 20% Buffer sports a 13.5% Cap. For most clients, particularly those buying VUL, the 20% Buffer is probably a better fit, at least in today’s volatility environment.

Equitable also offers Dual Direction with a 10% Buffer. The strategy is a bit of an odd duck. It has a traditional Cap for upside exposure, but also credits interest if the index return is within the Buffer equal to the absolute value of the negative index return. In other words, clients get positive credits when index returns are negative, but as soon as those negative returns push past the buffer, the positive returns disappear and the client goes back to losses (after applying the Buffer). Confused yet?

Right. That’s part of the problem with Dual Directional. It’s kind of bizarre and there’s nothing else in the investment world that works quite like it. Most people haven’t thought about “absolute values” since middle school. Even in option terms, it’s a complex strategy – a short put (Buffer) plus a long put spread (dual direction positive credits to the Buffer) plus a long call spread (for the Cap). Graphically, it looks like this:

Basically, the client is trading 2.5% of a traditional Cap (at least, for November’s rates) for the potential of earning 0-10% if the index experiences a modest decline of less than 10%. There’s a client story with Dual Direction, no doubt, but the marketing spin is (as usual) a little bit slicker than reality. And while the current tradeoff between the Cap and the Dual Direction credit might make sense right now, it’s going to bounce around quite a bit and in some kind of bizarre ways because of the complexity of the option strategy. In my view, Dual Direction is a nice thing to have, but isn’t the focus of the product – and, if you’re not careful, could end up being a real distraction and point of confusion in a client conversation.

Another big point of differentiation between the two offerings is that Prudential FlexGuard IVUL has “no fee” Buffer strategies whereas Equitable charges a 0.4% fee on assets. As I pointed out in my recent article on FlexGuard, the reality is that there are, of course, embedded fees in FlexGuard. The fact that Prudential hides them in the rates is problematic because it makes the comparison between FlexGuard and Custom Premier II very difficult when it doesn’t have to be. More pointedly, it gives an illustration advantage to FlexGuard that it doesn’t deserve simply because it doesn’t show the fees as an explicit line item in the illustrated values.

MSO II thankfully doesn’t fall into that trap. Equitable is much more transparent about the economics. We know that the spread in MSO II is 0.4%. Easy enough. And that 40bps lines up perfectly to the all-in fees of the slate of index funds offered in the Equitable product, which means that illustrating with and without MSO II doesn’t require any guessing games about how to show the fee differential. MSO II isn’t improperly advantaged out of the gate in terms of illustrated performance like FlexGuard IVUL is.

You’ll also note that the two products share just one strategy – the 10% Buffer with a Cap – and that Equitable sports a 19.5% Cap whereas Prudential has an 18% Cap. One reason, clearly, is that Prudential embeds the fee whereas Equitable charges it. At this week’s option prices, the price difference between an 18% Cap and a 19.5% Cap is exactly 40bps. I laughed out loud when I ran the numbers. It’s too perfect. Surely, it won’t be this way forever. But at current pricing, it appears that Prudential and Equitable have identical option budgets of 4%.

To put that into context, most Indexed UL products have option budgets that are north of 4.5%. This phenomenon is also found in the annuity side of the world, where RILA budgets are routinely lower than their FIA counterparts. Why? There are some legitimate differences in annuities that are attributable primarily to investment restrictions and reinsurance. But on the Life side, I think it’s probably more of an effect of Equitable and Prudential feeling out the market and trying to stay conservative so that they can manage the Cap levels in a more stable way over time. We shall see.

How do rates in MSO II compare to SCS? The operative comparison for MSO II, in my opinion, is Equitable SCS Series ADV. This product doesn’t pay a commission – and MSO II doesn’t either. Why? Because it’s a rider. The commission is funded exclusively by the policy charge structure of the base VUL product. Theoretically, the rates on these two offerings are somewhat comparable. The Cap on SCS Series ADV is currently 20%, which is just 0.5% higher than in MSO II. It appears that Equitable is finally getting serious about putting MSO II on level footing with its SCS annuity counterpart, at least in terms of rates.

The real question, though, is whether Equitable will find a way to make a splash with MSO II in a way that can mirror the enormous success that the company has had with SCS. I’ve written before that I believe that the market for Buffered strategies in life insurance is naturally smaller than in annuities for the simple reason that accumulation annuities are typically sold as transactional, short-duration, single-use assets. That’s the reason why the vast majority of flows in RILA products (such as SCS) go into crediting strategies with a payout that matches the surrender charge period of the contract (usually 5-6 years). Advisors selling these contracts are looking at them as a single trade. As a result, offering a hot rate on a Buffer product in annuities is reason enough to capture a few billion dollars in premium.

Life insurance is not a single trade. It’s a complex, long-duration, multi-use financial tool. A hot rate on a Buffer strategy in a life insurance product is not enough to warrant a client getting into the product. The life insurance product still has to be sold. One aspect of the purchase is certainly the rates being offered, but it’s a (relatively) small piece of the puzzle, especially for one-year renewable strategies such as what’s being offered by MSO II and FlexGuard IVUL. Instead, the real power of Buffered strategies in life insurance is that it supports the overall narrative of choice in Variable UL. That’s it. And that’s why, in my view, MSO II is a fantastic offering. It broadens the appeal of Equitable’s VUL products and gives them a tool to tell similar stories as SCS, but within a life insurance wrapper.

Ultimately, though, the success and failure of the strategy will rest on the base contracts. If advisors don’t like Equitable’s VUL products, then Buffered strategies aren’t going to be enough to get them over the hump. I’m sure everyone in life insurance would love to think that just slapping a Buffered strategy on a product will make it fly off the shelf, which is more or less what happened with RILA. But that ain’t the way this is going to go. We still have to sell life insurance. But there is no doubt in my mind that adding Buffered strategies will make that job a bit easier, especially with advisors who are already selling truckloads of RILA, and potentially open up some new applications for MSO II against Indexed UL.

*A Buffer provides downside protection against a specified percentage loss. For example, a 10% Buffer would protect the client from the first 10% of negative performance in the index. If the index is down 5%, the client would receive 0%. But if the index is down 25%, then the client receives a -15% credit. In the world of annuities and life insurance, almost all Buffers work this way. However, in the broader world of structured notes, there are also what’s called “soft” Buffers, where the client is exposed to percentage losses if the index falls below the Buffer level all the way back to 0%. In the examples above, the client would have received 0% (just like the “hard” Buffer) if the index falls 5% and -25% if the index falls 25%.