Inherent Dangers Hidden in Indexed Universal Life Insurance Contracts
In the 1950’s the tobacco industry exemplified what unscrupulous marketers always do. They illegitimately sold their products willfully implementing misrepresentation, altering experimental results, and disguising cases studies for the purpose of financial gain and market domination. Big Tobacco ads were highly successful and totally misleading, but Big Tobacco didn’t care, as long as it increased their financial prowess and provided them with the money to control congress and state legislatures across the country. Some of those ads such as, “Reach for a Lucky instead of a sweet”, “More doctors smoke Camels”, “Ivory tips protect your lips”, “Just a centimeter longer 101”, and the kicker targeting pregnant women; “Winston, when you are smoking for two”, sound preposterous today, but they certainly pulled in the money for Big Tobacco. Philip Morris introduced the Marlboro Man in 1955 and sales jumped by more than 3,000% over the next 12 months, bringing in a record $5 billion, $50,000,000,000 in 2023 dollars.
Today, the misrepresentation, data manipulation, and twisting of statistics, continues; all for the purpose of financial gain and control. Anyone that has been paying attention can recall when face masks were not deemed effective, then they were, and now they aren’t. The astute may have even noticed the falsified clinical trials, fake and/or conflict-of-interest case studies, concealment of side effects, bribed physicians, or denigration of formerly renowned and respected scientists. But it all paid-off because billions of dollars were made by the media, the drug companies, the hospitals, and the personal protection product providers. One company’s profits soared by 78%, about $55,000,000,000, over the previous year due to the misinformation contained in their marketing. That’s a bigger return than Philip Morris pulled off in 1955 with the introduction of the Marlboro Man.
Unfortunately, the life insurance industry has not escaped this marketing model because it does enhance the sale of its products. Specifically, the sale of Index Universal Life (IUL), has rocketed over the last few years regardless of the fact that IUL products are complex products, and are sold under false premises and deceptive marketing.
One of the biggest misrepresentations in the sale of IUL products, is the hidden costs. A typical IUL product will contain:
1. An increasing cost of premium which is typically illustrated in “cost per $1,000 of coverage per month” (This makes it nearly impossible for the average policyholder to determine the actual cost of an IUL)
2. A premium expense charge which will cost a certain percentage of every dollar paid in premium
3. A monthly percentage charge assessed on the accumulated cash value in the IUL policy
4. A monthly policy fee, and
5. An annual surrender charge
Here are some of the ways these costs are sold to the public:
1. “The premium for an IUL is flexible”, instead of, “Your premium cost will increase annually as long as you choose to continue this contract.”
2. “There are no fees after the first 10 or 15 years”, instead of, “You will lose 6% on every dollar you pay in premium for the first 10 to 15 years.”
3. “The beneficiaries will receive both the death benefit and the accumulated cash values upon the death of the insured”, instead of, “You will lose ‘X percent’ of every dollar which accumulates in an IUL policy”
4. “The interest earned in an IUL can never be less than 0%”, instead of, “You will pay a flat fee of $6 every month ($72 per year) as long as you own this IUL policy.”
5. “This IUL policy is guaranteed to stay inforce for the first 10 years”, instead of, “You will not be able to surrender this policy in the first 10 years without losing a large portion of the amount paid for it.”
Let us examine the first false promise listed here, “an IUL premium is flexible”. How can the cost of anything be flexible? The only way for this to occur is for the price to be elevated to keep the seller from losing money. For example, consider why a credit card company allows a cardholder to pay a flexible amount of money every month on their credit card balance. By paying a smaller amount than what is due, the credit card company can charge interest on the balance that remains. Thus, over time, a credit card company can greatly increase their profits. The same is true with a IUL insurance policy.
The insurance company knows upfront exactly what it will cost them to pay out the death benefit if the insured dies in any given year of the IUL contract. They know that initially the risk for them to have to pay this death benefit is very, very low. Reflectively, the cost for the insurance is also very, very low but the premium required to start an IUL policy is much higher than what the cost of insurance is. This allows the insurance company to make the premium for an IUL flexible, even though the range of flexibility in the premium is always higher than what it would cost to simply buy term insurance.
For example, a recent IUL contract that we reviewed had the initial cost of insurance at 0.22282/thousand/month. Calculated out, the initial cost of insurance was $356.51 a month for this IUL policy. By year 10, the cost of insurance had risen to $586.73 per month, which is an increase of 64.58%.
This contract’s flexible premium was $850.00 to $8,250.00 per month. But paying only $850.00 per month in premium would cause the policy to lapse in year 11. This IUL policy certainly had a flexible premium but the consequences of not paying the higher guideline premium of $8,250.00 per month was very ill advised.
Most people believe the flexible premium option of only $850.00 a month is a gift from the insurance company, because that is the way IUL is marketed in order for it to sell. Agents are trained to tell potential policyholders, “Look how much death benefit you will get for such a low monthly premium.” But what the policyholder doesn’t realize, is that paying only $850.00 a month will cause them to lose $102,000 by year 11, because the flexible premium of $850.00 per month cannot sustain the 64.58% increase in the cost of insurance which occurs over the first ten years of the policy, let alone meet all the other IUL policy fees and charges outlined above.
It is a known fact that tobacco use causes cancer. It is also a known fact that the cost of IUL premiums increased by 29% in the fourth quarter of 2021 alone. But facts don’t always keep people from being falsely mislead into doing something that isn’t in their best interest. For these reasons, and more, the nonprofit Center for Economic Justice has warned the public to “stay away from IUL.” Even the American Council of Life Insurers, which represents 280 insurance companies admits, “IUL is not for everyone.”
Companies and agents who sell IUL refer to it as a permanent life insurance product. In fact, many will improperly claim that IUL is better, less expensive, and will have a higher payout than whole life insurance. The problem with this sales pitch is that permanency is customarily associated with longevity, stability and even ownership. But IUL provides none of these for the policyholder. In fact, the policyowner NEVER owns the death benefit in an IUL policy. It is merely leased on a month-to-month basis, with the cost of that lease increasing every time a premium is due.
In a whole life insurance policy, the original permanent life insurance product, which was created due to the demands of policyholders, longevity, stability, and ownership (i.e., equity) are all inclusive in the contract. Overtime, much like paying off a mortgage or a car loan, the policyholder owns more and more of the death benefit in a whole life policy. With each payment, more of the insurance is owned, or completely paid for, by the policyholder and the remaining insurance coverage which hasn’t been fully paid for is the only cost associated with keeping the policy inforce. Thus, cash value accumulated in whole life insurance is based on the insurance which has been fully paid for, i.e., paid-up insurance, while the accumulated cash value in an IUL policy is merely the result of overpaying for the cost of insurance, minus the fees mentioned above, plus any interest earned which is below the capped interest rate (typically 10% to 12%) defined in the IUL contract.
In addition to these problems, there is a misrepresentation of the historical data concerning the interest earning potential of an IUL contract. In every IUL illustration used to sell IUL, there will be a chart which posts historical performances of the indexes the policy can mirror. These charts typically go back 20 years and show annualized returns for the different indexes such as the S&P 500, US Pacesetter, Credit Suisse, Russell 2000, etc. The chart adds up all the returns from each year and then divides the total by 5, 10, 15 and 20 to see what the average rate of return was historically for each of these indexes in years 5, 10, 15 and 20. Once these averages are calculated the assumption is made that this average rate of return is what the IUL policyholder can expect to earn in interest on the extra dollars they pay in premium, but which have not been used to lease the life insurance coverage defined in the IUL contract.
Historically, most of these average rates of return will fall somewhere between 5% and 17%. Of course, anything over the IUL interest cap rate (typically 10 or 15%) will not be credited to the policyholder but will become additional profits for the insurance company. Putting this fact aside, these average rates of return are misleading at best, at worst they’re down-right deceptive.
First of all, these historical market returns are cherry picked by the person designing the IUL illustration. For example, between January 2001 and January 2021, the S&P 500 produced an annualized return of 5.358%. But between March 2001 and March 2021, the S&P 500 returned an annualized rate of 6.148%. Waiting until November of 2001 and running through November of 2021, the average rate of return increased to 7.351%. Which one of these average rates of return do you think an illustrator of an IUL might use for a 20-year average? Which rate will the IUL policyholder actually receive?
What should be obvious from this simple example is, a different average rate of return will occur every time the initial month of the average time span is changed. Thus, the chart used in an IUL sales illustration shows a historical interest rate but NOT the actual interest rate which will be earned in an IUL policy. But the implication that historical interest rates are possible but attainable is certainly inferred. This leads an IUL policyholder to expect an average rate of return similar to the historical rate, and with the IUL interest rate floor of 0%, they further believe they will never lose money in an IUL contract.
Secondly, consider the IUL participation rates in the underlying indexes. Participation rates add another obstacle to cloud the real risks associated with entering into an IUL contract. If 50% of all overpaid premiums in an IUL policy participate in a certain index, and the cap rate on the contract is 12%, and if there is $10,000 of accumulated cash value (over paid premiums) in the policy, and the cap is actually hit then; the policy would gain only $600 instead of $1,200. Furthermore, if the participation rate is 50% but the interest rate attained is only 5% then $250 would be credited to the accumulated cash value in the IUL policy instead of $500. The combination of interest rates actually attained, the cap rate of the policy, along with the rate at which the accumulated cash value is participating in those interest rates, are literally endless. This leaves a great amount of uncertainty about what can be expected to accumulate in the cash values of an IUL policy.
Finally, remember the cost of insurance is increasing monthly in an IUL policy. The IUL contract referred to earlier, experienced a 64.58% cost increase over the first 10 years. By year 20 the cost increase had reached 341.50%, by year 30 the price increase was 1,176.55%, and by year 40 this IUL contract had an insurance cost increase of 4,003.54% over the initial cost of insurance. As accumulated cash values are used to offset the increased cost of insurance in an IUL policy, the interest earned must be significantly greater to meet the guideline premium payment, or this policy will lapse and the policyholder will lose everything they paid for the IUL policy, as well as their death benefit. As one actuarial scientist said, “Paying the minimal flexible premium on an IUL policy, the interest earned will have to average at least 10% every year or the policyholder will receive a premium call from the insurance company sooner than later.” Of course, when that premium call is made, if the policyholder cannot come up with the necessary funds to meet that premium, the policy, and everything paid for it, will be lost.
Life insurance’s primary purpose is to protect the policyholder, and their beneficiaries, from risk. Yet transferring this risk back onto the policyholder is exactly the reason why IUL products are sold. It makes the insurance companies and their agents more money.
Don’t be fooled by the sales pitch. The only life insurance product sold today that develops equity is whole life insurance. That is why it is such a valuable financial tool. Equity can be leveraged so you can use money that belongs to someone else without putting your own money at risk. Of course, everyone knows the best way to create wealth is to use other people’s money. Thus, whole life insurance becomes the financial tool wealthy people own and leverage to purchase assets. The risk associated with IUL contracts is much too high for individuals to assume. We fully concur with the Center for Economic Justice, “Stay away from IUL.”