In today’s complex world of insurance, annuity, and investment products, three terms are thrown about without much explanation: Fixed, Variable, and Indexed.  However, these terms simply define how interest is credited or earned on the investment or policy.

Unlike Fixed and Variable products, Indexed policies are somewhat unique to the insurance and annuity marketplaces.  An Indexed investment shares traits of both Fixed and Variable investments, but with one major difference – how interest is earned.  Unfortunately, there is still a lot of confusion amongst consumers and agents about these products and how they work.

With an Indexed investment, the underlying funds are not directly invested in the stock market or an Index, nor are they directly invested in a bond, CD, or other fixed investment.  They are, however, secured by bonds or other conservative investments which provide a minimum guaranteed interest rate similar to a fixed investment.

Generally, this minimum or fixed rate is lower than what is available in a purely fixed product. This is because Indexed products offer a higher maximum interest rate over Fixed investment products. The Indexed products determine the maximum interest earned using a formula based on three factors, all part of an option purchased by the insurance or investment company.  They are the participation rate, the cap rate, and the reset period.

The maximum interest earned provides “upside” potential, while at the same time eliminating “downside” risk.  In essence, it is like having the growth potential of a Variable investment with the “downside” protection of a Fixed investment.  There is, however, a trade-off.

An option, sometimes referred to as a call or put option, provides investment returns (interest earned) based on the growth of a specific market index like the S&P 500 or Dow Jones.  The option allows for lower initial costs, a pre-determined strategy for establishing current and future interest crediting, and ensures that money can’t be lost due to market fluctuations.  The option also caps (limits) upside potential, or growth.

Many opponents of Indexed investments point to this limiting of growth, especially in years where the Index or stock market exceeds the Index (option) cap or participation rates, as the Achilles heel of these products.  There is also some controversy over the way the Index rate is determined in future years.

While Indexed products do have a minimum cap and participation rate that is known for the entire term period, the current or maximum cap and participation rates normally reset on an annual basis.  This makes it difficult to determine what will happen in subsequent years.  Some advisors avoid these products, claiming that the difference between the current and minimum rates creates client confusion.

What are the other advantages to an indexed universal product?  With the recent decline of the stock and real estate markets, many are rethinking insurance as an asset class.  Products like whole life, universal life, and indexed universal life have maintained their values when other assets like stocks, mutual funds, variable annuities, and real estate haven’t.

Let’s recap – life insurance, while not technically an investment, provides all of the following:

  • Long-term protection via a death benefit.
  • Income-tax-free return on your investment (premiums) at death.
  • Tax-deferred growth on the internal cash values of the policy.
  • Potential for tax-free income from the policy's cash values.
  • No contribution or income limitations.
  • A minimum guaranteed interest rate on the policy's cash values.

That's a pretty nice list of benefits for any "investment," especially when it's not considered an investment by most people. Indexed products have the added potential of upside associated with market returns, but without the risk often associated with variable investments.  That additional potential for cash accumulation can provide any of the following:

  • College savings / expenditures— If your client is worried about having enough funds to send their child to college, an indexed universal life insurance policy’s cash accumulation can be used for college spending. Using this cash value keeps the liquidity of their income and savings intact.
  • Personal income— Similarly, if your client is worried about having enough funds for their own retirement years, cash value can be used as supplemental income during those non-working years.
  • Long-term health care— Studies show that nearly 70 percent of Americans will require some form of long-term care (2-3 years minimum) at some point. If they don’t have long-term care insurance, this will easily be one of the most expensive services they will incur in their lifetime. IUL’s cash value can be used for in-home care, assisted living, and more.
  • Executive bonuses— Business-owning clients can provide an awesome incentive for their top employees. By taking out key executive insurance on their top employees, they not only provide incentives and rewards, but this is also a good way to increase retention.

This is still just a glimpse of what indexed universal life products offer. If you’d like to learn more or discuss sales strategies for IUL, give us a call at (800) 823-4852 or email your Brokerage Director.