What is Indexed Life Insurance? And should you consider it for your life insurance portfolio?
First, a brief history of the life insurance policy in America:
Term Life Insurance
The first life insurance policy was a Term Life policy. This is simple protection, a policy that pays a death benefit upon proof of death of the insured. The term of protection can be for one year, or for as many as 40 years.
The problem with Term Life insurance is that the premiums increase over time, and eventually become too expensive to maintain, especially during older ages when the majority of people die.
Whole Life Insurance
The solution to this increasing premium problem that Term Life insurance has was a policy with level premiums for the entire life of the insured. Today, we call that Whole Life.
Cash surrender values and other non-forfeiture options came later, and we can credit Elizur Wright as well as consumer demand during the nineteenth century for that.
Whole Life can be divided into two broad categories: Non-Participating and Participating.
Participating Whole Life insurance policies are eligible for dividends and the owners may have voting rights to elect the company’s board if the policy is issued by a mutual life insurance company, as these policy owners also enjoy ownership rights with their insurance company.
Non-participating Whole Life insurance does not pay dividends. This is the kind of Whole Life insurance that Dave Ramsey talks about. It is designed for lifetime death benefit protection with guaranteed premiums and guaranteed non-forfeiture options. It is not an investment or a place to store wealth.
There is a third type of Whole Life that’s relatively rare, called Interest Sensitive Whole Life insurance, or ISWL. It has fixed premiums like other kinds of Whole Life, but the cash values, interest credits, policy expenses, and costs of insurance are unbundled like Universal Life.
Universal Life Insurance
The concept of unbundling Whole Life, so that the cash value element and the cost of the death benefit element were transparent, premiums were flexible, and face amounts adjustable, was first thought up and written about in the 1930s. The first policy available for sale to consumers had to wait for affordable computers to reach your local agency, which started in the 1970s. Many people claim that this product was invented by E.F. Hutton, but the first company to actually issue an Adjustable Life policy was Minnesota Mutual (now Minnesota Life), followed almost immediately by Bankers Life of Iowa (now Principal National Life, part of the Principal Financial Group).
One of the problems with Universal Life, or UL, is that it was often marketed as “Whole Life for Half Price” or something similar. When interest rates were in the double digits, as they were in the 1980s, it was possible for a UL policy to have a premium about half that of a Whole Life policy, with level premiums projected for life, or even with an abbreviated premium schedule. When interest rates trended downward, UL policies became underfunded and started to lapse earlier than expected.
Today we refer to this original version of UL as Current Assumption Universal Life in order to differentiate it from the following versions.
Variable Universal Life
The idea for this product dates to the immediate time period following the de-regulation of securities Broker/Dealers in 1968. The first variable life insurance to reach the market were Variable Whole Life policies, but when Universal Life was introduced in the early 1980s, Variable Universal Life (VUL) was soon to follow. VUL was very popular in the 1990s.
Variable means that the policy owner can direct the cash values of their life insurance to be invested in sub-accounts that perform similarly to mutual funds, with similar risks and similar rewards. The potential for growth inside a policy by investing the cash value in equity sub-accounts made up for the declining interest rates, so a lot of old under-performing and under-funded UL policies were replaced with new VUL policies.
The Dot Com Bubble of the year 2000, and the Financial Crisis of 2007-2008, and the Covid-19 Crisis of 2020, exposed the potential downside risk of VUL, especially if it was underfunded, or the insured is at older ages where the costs of insurance rise dramatically.
Permanent cash value life insurance is designed to last a lifetime, usually with level premiums, or with a premium payment period of a limited number of years. For example, 10 pay, or 20 pay, or pay to 65, which is a premium schedule of 10 annual premiums, or 20 annual premiums, or premiums to age 65. If the premium schedule is based on projected returns on cash value that are similar to a bull market, then the policy will have potential problems when the bull market turns into a bear market, as it inevitably does.
Guaranteed Universal Life
One of the more recent derivatives of the Universal Life concept was Guaranteed Universal Life, commonly referred to as GUL. It is essentially a traditional UL policy, but the emphasis is on guaranteed lifetime protection with guaranteed level premiums. Cash values are incidental, and often non-existent at older ages, especially for the latest lifetime level premium designs. One way to describe a GUL policy is “lifetime level term” or “level term to age 121.”
A GUL policy is an alternative to Whole Life, where the policy owner requires lifetime protection, but does not care about cash values, or other non-forfeiture options such as Reduced Paid-Up, Extended Term Insurance, Policy Loans, Annuity options, or Cash Surrender Value. Just like Non-participating Whole Life, a GUL policy is not an investment or place to warehouse cash.
A GUL policy transfers all the risks to the insurance company, just like Whole Life, but without the interest rate risks of traditional Universal Life, or the stock market risks of Variable Universal Life.
A GUL policy can also have guaranteed limited premiums such as a 10-pay, 20-pay, or pay to age 65. While most newer versions do have not have standard non-forfeiture options like Whole Life or other types of Universal Life, a GUL policy may include a Return of Premium or Cash Out rider that enables the policy owner to bail out at pre-determined points in time, such as policy year 15, 20, or 25, and receive a specified lump sum of cash in return for surrendering their policy.
Indexed Universal Life
The latest derivative of the Universal Life concept is the Indexed Universal Life Insurance policy, or IUL for short. IUL was first introduced to the market in 1997.
Indexed Universal Life has the growth potential of interest linked to a stock market index, like the Standard & Poor’s 500, but with the added protection of a floor, so that the IUL policy’s cash value never suffers market losses.
IUL comes in several versions, but most policies fall into two broad categories: Death Benefit focused designs, and Cash Accumulation focused designs. You should know which design focus your policy has so that your policy best matches your financial objectives.
Here’s a video worth watching that helps explain it: Click Here (a popup will appear)
IUL is one of the two reasons this website was created. The other is below:
Indexed Whole Life
A couple of industry-leading progressive carriers that manufacture Participating Whole Life have introduced dividend options that allow policy owners to link their annual dividends to an index like the Standard & Poor’s 500.
Because its Whole Life, it has a guaranteed cash value ledger that is never subject to market risk. It always grows, year after year.
At the policy owners’ option, some or all of the policy’s dividends used to purchase Paid-Up Additions can be linked to an index and enjoy more upside potential, but without the market risk of loss.
Who Should Consider Purchasing Indexed Life Insurance?
- If you own term life insurance and want to convert an expense into an asset.
- If you need or want permanent death benefits for estate liquidity or to fund a business succession plan.
- If you have maxed out your IRA, Roth IRA, 401(k), 403(b), or 457 Deferred Compensation Plan, and need another place to save for retirement, and have at least 10 years before you need income from your policy.
- If you have an existing cash value policy, like Whole Life, or Universal Life, and want to see your cash values grow faster.
- If you have an existing VUL policy, and you want to limit your downside risk as you near retirement.
- If you have sold a business or other property, received an inheritance, or won the lottery, and now need a safe place to warehouse some of your cash, with growth potential, but no market risk.
- If you have a family history of longevity and want to make sure that your existing cash value life insurance can last to at least age 121.
- If you have a family history of heart attack, stroke, cancer, or a family history of needing Long Term Care.
- If you want Long Term Care insurance, but want to make sure that your family gets a death benefit if you never need to use the policy’s Long Term Care benefits.
- If you own a business and want to reward and retain your key people with a non-qualified benefit plan such as Salary Continuation, Deferred Compensation, Executive Bonus, or Split Dollar.
- If one of your goals is to create a warehouse for capital like the concept written about by R. Nelson Nash in his book Becoming Your Own Banker, known as Infinite Banking, that Pamela Yellen also wrote about in her book The Bank On Yourself Revolution, calling her system Bank On Yourself.
- If you want to participate in the Lifetime Economic Acceleration Process written about by Robert Castiglione in his book Leap: Lifetime Economic Acceleration Process.
- If one of your goals is to achieve a Zero Percent Income Tax rate during retirement.
If you want to learn more about Indexed Universal Life or Indexed Whole Life, and need some help figuring out if this type of policy belongs in your portfolio, then I can help. Call me today at (800) 680-5596, or click here.