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Indexed Universal Life - A Crash Course


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Power Point explains Equity Indexed Universal Life Insurance: how it works & how it's used.(Adapted from CampIUL™ with permission of Gulf States Marketing)

Published in: Economy & Finance, Business

Indexed Universal Life - A Crash Course

  1. 1. Presented by Al DeRemigis Indexed Universal Life (IUL): A Crash Course* *adapted from CampIUL™ with permission of Gulf States Marketing ©2012 ----------------------------------------------------------------------------------------------------------------
  2. 2. Equity-Indexed Universal Life insurance, or Indexed Universal Life (IUL), was developed in the late 1990’s and first introduced in 1997. Minnesota Life, Transamerica and Amerus (now Accordia) were the earliest companies to develop IUL’s as part of their product portfolios.
  3. 3. More on IUL…  Fox Business had this to say about IUL recently: “An emerging and fast-growing contract design — the indexed universal life (IUL) policy — may come very close to being the ideal contract for most consumers in today’s interest and overall market environment.”
  4. 4. Presently, there are more than 50 companies offering IUL’s. According to LIMRA, IUL sales grew by 192% from 2006-2010 and continue to lead all products in year over year premium growth. IUL’s are growing in popularity and more and more companies are adding them to their portfolio of products.
  5. 5.  Can provide flexible premiums  Provides death benefit at a possible lower cost than other types of policies  Opportunity to earn greater interest  Protection against economic downturns
  6. 6.  It is illegal to market Index Universal Life (IUL) as an "investment security", as defined by the Securities Act of 1933 & the Securities Act of 1934. However, IUL can be marketed and sold as an investment.  The single largest asset class of all but one of the largest banks in the United States is permanent cash value life insurance. IUL as investment/asset class
  7. 7.  Opportunity to “pay-up” a policy for guaranteed death benefit ◦ Policy owner may choose to pay premiums until age 65, but have the policy guaranteed to age 100 or beyond. Premiums amounts may change depending on premium schedule.  Opportunity to over-fund a policy to build cash value for future use ◦ Paying premiums in excess of the cost of the coverage can help to build cash value within the policy.
  8. 8.  Term life insurance policies provide a death benefit for specified period of time, such as ten, twenty or thirty years  Indexed Universal Life policies credit interest based off of a strategy based on an index’s performance  Universal Life credits their policies with a declared rate of interest  Variable Universal Life policies participate in the market and cash values and death benefit may increase or decrease accordingly
  9. 9.  a. Fixed accounts ◦ i. Credits a fixed rate of interest ◦ ii. Interest rate declared by insurance company  b. Indexed strategies ◦ i. A formula to calculate interest credited to the life insurance policy ◦ ii. Interest credited is linked to the performance of one or more indices but never invested directly into any market  c. What is an index? ◦ i. Statistical model that measures the growth or decline of a particular market ◦ ii. Examples of indices are the S&P 500, Nasdaq 100, The Dow Jones Industrial Average and Hang Seng Index
  10. 10. S&P 500 ◦ i. Published since 1957 ◦ ii. Regarded as the standard for broad stock market performance ◦ iii. The index focuses on U.S. based companies but there are a few legacy companies with headquarters in other countries ◦ iv. The S&P 500 is the most widely followed index of large-cap American stocks ◦ v. Represents approximately 70% of the total domestic U.S. equity market’s capitalization ◦ vi. The companies of the S&P 500 are selected by committee
  11. 11. NASDAQ 100 ◦ i. A stock market index of 100 of the largest non-financial companies listed on the NASDAQ ◦ ii. Includes many major industry groups, such as, computer hardware and software, telecommunications, retail/wholesale trade and biotechnology ◦ iii. It does not contain financial companies, and includes companies incorporated outside the United States ◦ iv. The exclusion of financial companies distinguishes it from the S&P 500 Index
  12. 12. Dow Jones Industrial Average ◦ i. One of several indices created by Wall Street Journal editor and Dow Jones and Company co-founder, Charles Dow ◦ ii. It is an index that shows how 30 large, publicly owned companies based in the United States have traded during a standard trading session ◦ iii. Accounts for approximately 29% of the investable U.S. market, as measured by the Dow Jones
  13. 13. Hang Seng ◦ i. A free float adjusted market capitalization weighted stock market index in Hong Kong ◦ ii. The 45 constituent companies represent about 60% of capitalization of the Hong Kong Stock Exchange
  14. 14.  Step one: Premium paid to the policy ◦ i. Premium goes into a basic interest strategy ◦ ii. Basic interest strategy holds the premiums to fund one year of policy charges and cost of insurance
  15. 15.  Step two: Remaining premium allocated into segments ◦ i. A segment is either one or a combination of fixed or indexed strategies that you selected for a specific segment term ◦ ii. A segment term is usually one, five or six years long depending on the strategy selected and funds cannot be redirected to different strategies until the segment term matures
  16. 16.  Step three: Segment term ends ◦ i. Segment dollars are placed back into the basic interest strategy ◦ ii. New premiums placed into basic interest strategy ◦ iii. Process begins again with funds kept in basic interest strategy to pay for policy ◦ iv. Excess funds allocated to new segment with new segment term
  17. 17.  a. Participation rate ◦ i. A percentage of the overall increase in the index ◦ ii. May vary from company to company and product to product Question: The S&P 500 increased by 10% from the beginning of the interest crediting period to the end. The participation rate of the chosen policy is 85%. What interest is credited to the policy? Answer: 8.5% because interested credited equals 10% performance times 85% participation rate.
  18. 18.  b. Cap rate ◦ i. The maximum amount of interest a company will credit a policy for a particular strategy and segment ◦ ii. Caps vary by strategy ◦ iii. Caps can be adjusted up or down at the beginning of each interest crediting period Question: The S&P 500 increased by 17% from the beginning of the interest crediting period to the end. The participation rate is 100%. The cap rate is 12.5%. What is credited to the policy?
  19. 19.  Answer: 12.5% because at 100% participation interest credited equals the lesser of the cap rate or index performance.  c. Interest crediting period ◦ i. Measured from the creation of the segment to the segment anniversary ◦ ii. The time period used to calculate the interest credited to the policy
  20. 20. Bob has an indexed universal life policy that has a two year point-to-point strategy (discussed in next section). The indexed used is the Nasdaq 100. The participation rate for his strategy is 90%. The cap for his strategy is 11.65%. The Nasdaq 100 increased by 11.95% over the interest crediting period. What is credited to the policy? Case study using all components:
  21. 21. Case Study Answer:  The index and strategy used are irrelevant. Multiply participation rate times strategy performance and crediting rate equals the lesser of this calculation or the cap rate. In this case: 90% participation rate times 11.95% strategy performance equals 10.755%. The cap for his strategy is 11.65% and 10.755% becomes the crediting rate because it is lower than the 11.65% cap rate.
  22. 22.  a. 1-year point-to-point ◦ i. The interest crediting period is one year from the creation of the segment and on each anniversary thereafter ◦ ii. Interest credited is subject to the participation rate and the cap ◦ iii. May be linked to any index, not necessarily the S&P 500
  23. 23.  b. 2 year point-to-point ◦ i. The interest crediting period is two years from the creation of the segment and on each anniversary thereafter ◦ ii. Interest credited is subject to the participation rate and the cap ◦ iii. May be linked to any index, not necessarily the S&P 500
  24. 24.  c. Multi Indexed strategies ◦ i. Takes average of multiple indices ◦ ii. May be a monthly average or annual average ◦ iii. Subject to participation rate and cap  d. One year monthly cap ◦ i. Interest measured monthly ◦ ii. Index increases capped ◦ iii. Index decreases not capped ◦ iv. 12 months of index measurements added together to determine interest credited to policy ◦ v. Subject to participation rate and cap
  25. 25.  e. One year monthly average ◦ i. Indexed measured on a monthly basis ◦ ii. 12 months’ average growth is calculated to determine annual interest credited to the policy ◦ iii. Subject to participation rate and cap  f. Strategy availability ◦ i. Varies by company ◦ ii. One year point-to-point is most common and often only strategy offered
  26. 26.  a. Tax free death benefits ◦ i. The recognized public benefit of life insurance has led to the favorable tax treatment of life insurance policies ◦ ii. Most life insurance death benefits are income tax free ◦ iii. If the policy is transferred for value, the portion of the death benefit that represents a gain may be taxed
  27. 27.  b. Tax advantaged loans to supplement retirement ◦ i. Must meet certain guideline premium or cash accumulation test ◦ ii. Cash accumulation test not allowed in Florida ◦ iii. Policies that fail either of these test may lose favorable tax treatment ◦ iv. Policies that fail either test are considered Modified Endowment Contracts, “MEC’s”, and are taxed as a interest first in the same fashion as annuities
  28. 28.  a. Cost of Insurance ◦ i. Actuarial calculation ◦ ii. Based on age and sex ◦ iii. Also based on risk rating  b. Other expenses ◦ i. Premium expense charge ◦ ii. Annualized policy fee ◦ iii. Policy expense charges ◦ iv. Rider expenses ◦ v. Surrender charges
  29. 29.  1. Over-funding ◦ a. Premium in excess of the requirement to keep the policy in-force ◦ b. Excess premium is allocated to the interest crediting strategies ◦ c. The purpose is to accumulate cash value within the policy
  30. 30. John wishes to pay $400 per month into an indexed universal life insurance policy. John is 30 years old and in excellent health. He needs some insurance to replace his income with the beneficiary being his wife. However, he would like only a minimal amount of death benefit with the ability for the life policy to grow cash value for future use. He wants at least $185,000 in death benefit with any remaining premium going towards building cash value. It is determined his current cost of insurance is $1.00 per thousand annually. The annual policy fee is $96 and the premium expense charge is $180. In addition there is a policy expense charge of $400. What portion of his premiums will be credited to his chosen index strategy? Case study using all components:
  31. 31. Case Study Answer:  To solve this case first convert all expenses to monthly amounts -  Cost of Insurance: ($1.00 per thousand annually) 186 X $1.00 = $186 per year/12= $15.50 per month  Policy Fee: $96.00/12 = $8.00 per month  Premium Expense Charge: $180/12 = $15.00 per month  Policy Expense Charge: $400.00/12 = $33.33 per month  Then, subtract the sum of all monthly charges from the monthly premium payment – ($400.00 less $15.50+$8.00+$15.00+$33.33) = $328.17 excess monthly premium will be credited to chosen index strategy.
  32. 32.  2. CVAT ◦ a. What is it?  i. Cash value accumulation test  ii. A relationship between the cash value of a policy and the death benefit  iii. The test will limit the amount of cash value in a policy in relation to the death benefit or, conversely, increase the death benefit to allow for the increase in cash value ◦ b. CVAT not available in Florida ◦ c. Useful for policies where cash accumulation is a concern Cash Value AccumulationCash Value Accumulation TestTest
  33. 33.  3. Guideline Premium Test (GPT) ◦ a. Determines premium amounts based on the death benefit chosen ◦ b. Limits both the premiums that can be paid in and the cash value that can accumulate ◦ c. Useful test to determine maximum death benefit per premium dollar paid Guideline Premium TestGuideline Premium Test
  34. 34.  4. Modified Endowment Contract (MEC) ◦ a. What is it?  i. A life insurance policy can be determined to be a MEC if it fails either the GPT or CVAT  ii. Uses CVAT and GPT to prevent policy owners from making large single premium payments for the purpose turning life insurance policies into tax sheltered investment vehicles ◦ b. How does it affect access to the cash value?  i. Prevents the policy owner from withdrawing cash from the policy under the more favorable cost recovery rules  ii. Cash withdrawn is considered an interest first withdrawal, as in the case of an annuity Is MEC a bad word?Is MEC a bad word?
  35. 35. John and Robert are brothers who have each received a $100,000 death benefit from a parent’s indexed universal life insurance policy. Seeing the value of life insurance, they both decide to purchase life insurance for themselves for the benefit of their families. John decides to over-fund an indexed universal life policy with substantial annual premiums, hoping to build cash value to use later in life while still providing a sizable death benefit to aid his family in the event of his death. John’s financial professional tells him that the life insurance policy will not be considered a MEC due to him making premium payments over time. Robert also wants to purchase an indexed universal life policy for the same reasons as John. However, Robert is adamant that he only make one lump sum payment and be done with it. His financial professional informs him that his policy will be considered a MEC. Case Study for MEC:Case Study for MEC:
  36. 36. 1.What are the possible tax consequences if John wishes to take a loan from his policy to purchase a new car? 2.What will be tax implications of the death benefit to John’s heirs in the event of his death? 3.What are the possible tax consequences if Robert wishes to take a loan from his policy to purchase a new car? 4.What will be tax implications of the death benefit to Robert’s heirs in the event of his death? Case Study Questions:Case Study Questions:
  37. 37. Case Study Answers:  1. Under current tax law loans from non-MEC cash value life insurance are tax-free distributions.  2. Under current tax law life insurance death benefit proceeds are income-tax free.  3. Under current tax law loans from MEC cash value life insurance is taxable income.  4. Under current tax law life insurance death benefit proceeds are income-tax free. (Even if it is a MEC)
  38. 38.  a. Fixed loans ◦ i. Can be taken out against the cash value of your policy ◦ ii. Charged a fixed rate of interest until paid back into the policy ◦ iii. Amount of loan is usually deducted from the interest crediting segment and will not be considered to earn interest
  39. 39.  b. Premium loans ◦ i. A type of fixed loan ◦ ii. Usually available after the policy is in effect for a certain amount of years ◦ iii. Sometimes called a “wash loan” ◦ iv. May not charge interest Loans (Continued):Loans (Continued):
  40. 40.  c. Variable loans ◦ i. Can be taken out in relation to cash value available ◦ ii. Based off of a nationally/internationally posted loan rate ◦ iii. Amount of loan remains in segment for interest crediting purposes ◦ iv. Possibility for positive arbitrage situation ◦ v. Loan will accrue interest until paid back into the policy Loans (Continued):Loans (Continued):
  41. 41.  1. Level death benefit ◦ a. Most familiar ◦ b. Provides a consistent death benefit for the life of the policy unless either CVAT or GPT require it increases  2. Increasing death benefit ◦ a. Includes a specified amount ◦ b. Plus all or a portion of the accumulated value  3. Return of premium death benefit ◦ a. Includes a specified amount ◦ b. Plus the premiums paid into the policy
  42. 42.  1. Individual/Family purpose ◦ a. Income replacement ◦ b. Spousal support ◦ c. Child support ◦ d. Charity endowment
  43. 43.  1. Accelerated Death Benefit rider ◦ a. Triggered by diagnosis of terminal illness ◦ b. Pays a portion of the death benefit while insured is alive to help with living and health expenses  2. Waiver of surrender charges due to confinement ◦ a. Can allow a policy holder to withdraw an increased amount of the cash value without incurring a surrender charge ◦ b. May require an elimination period  3. Additional insured rider ◦ a. Used primarily to cover a spouse ◦ b. Provides level term insurance to the additional insured
  44. 44.  4. Child rider ◦ a. Can be purchased on a minor child ◦ b. Provides level term coverage ◦ c. May be convertible to a permanent policy  5. Accidental death benefit rider ◦ a. Can provide policy with additional coverage ◦ b. Death must be deemed an accident by language of contract Riders (Continued):Riders (Continued):
  45. 45.  6. Waiver of specified premium ◦ a. Company will waive payment of specified premium due to disability ◦ b. May require an elimination period ◦ c. Company may credit policy with specified premium during waiver period  7. Death benefit return of premium rider ◦ a. Designed for some split dollar and premium finance cases ◦ b. Will return 3rd party financier premiums paid in while death benefit is paid to named beneficiaries Riders (Continued):Riders (Continued):
  46. 46.  1. How does an indexed universal life insurance policy accumulate cash value? ◦ a. Over-funding  i. Premiums paid into the policy exceed requirements to pay the cost of the policy  ii. Premiums must not exceed GPT or CVAT limits ◦ b. Interest crediting strategies  i. Excess premium is put into interest crediting segments  ii. Positive performance of the interest crediting strategy increases the cash value of the policy  iii. Minimum crediting guarantees within the policy help to minimize index downturns
  47. 47.  1. Helping clients provide for their loved ones and obligations in their absence.  2. Additional uses of cash value: ◦ a. Personal bridge loans ◦ b. Emergency funding ◦ c. Down payments ◦ d. Educational funding
  48. 48.  If you are ready to increase your income significantly this year and want to take the next step in your career by adding IUL to your portfolio contact: Al DeRemigis 410-905-2492