Along with providing a death benefit in case of the insured's death, indexed universal life insurance (IUL) has the potential to generate cash value through Fixed and Indexed Accounts. While indexed accounts credit interest based in part on the performance of major stock market indices, it is important to note that neither premiums nor policy cash values are invested or directly participate in any stock or equity investments. Policy values are supported by the insurer's general account, and, like owners of other policies types, policy owners have no right to or interest in any particular asset of the insurer.
The life insurer is contractually obligated to meeting its promises to its policy owners, including Indexed Account credits and contractual guarantees, regardless of the performance of the insurer's general account portfolio. The insurer bears all of the investment risk on its general account.
Insurer's generally set guaranteed minimum crediting rates (floor), participation (par) rates, and indexed growth cap rates (cap) on each Indexed Account separately based on the anticipated rates of its general account, including the costs of any options to manage Indexed Account liabilities.
How Does The Indexed Account Hedging Process Work?
At a segment start date, a life insurer may choose to purchase an options package that takes into account its Indexed Account obligations to policy owners, including the account's floor, par, and cap rates. This kind of general account investment is intended to match an insurer's potential IUL liabilities. The insurer still bears all the investment risk on its general account and the insurer remains obligated under the terms of the IUL policy irrespective of the general account performance.
Let's walk through a simple example. If a client has requested that 100% of the value in his or her Fixed Account goes into a 1-Year Indexed Account, the insurer may purchase an options package that would cover the Indexed Account parameters - for example, 0% floor, 100% par, and 12% cap on the S&P 500 index for 12 months. The options package is held in the insurer's general account just as any other general account asset.
At the end of the 12 months, the options package matures. If the S&P 500 finishes in negative territory, the options package pays the insurer the S&P 500 rate up to the 12% cap. That rate is then available to support the indexed interest credited to the segment.
What Could Cause A Current Cap Rate Change?
Most insurer's reserve the right to change the current cap rate at any time for any reason like any other nonguaranteed pricing element. Caps are generally managed to reflect, among other things, profitability, competitiveness, and current market conditions. Current market conditions include but are not limited to : (1) yields on fixed investments, and (2) cost of the options. If yields fall or the options price rises, an insurer could potentially lower cap rates. If, on the other hand, yields increase or options price decreases, a company may be able to increase the cap rate.
Fixed account yields and options price are only two factors that might affect current cap rates.
Where Do Life Insurance Companies Buy Their Options?
Generally, insurance companies purchase their options from large investment banks.
What Does An Insurer Do With The Performance Above The Cap Rate?
While Indexed Accounts credit interest based in part on the performance of the major sock market indexes, it is important to note that neither life insurance premiums nor policy values are invested or directly participate in any stock or equity investments. Accordingly, the insurer generally does not experience performance above the cap rate or below the floor.
If an insurer decides to purchase option packages to mitigate its risks, the packages generally do not participate in index growth above the cap or losses below the floor.
Why Aren't Stock Dividends Included In Indexed Credits?
Since the stocks of the indexes are not purchased, dividends are not received. A company could theoretically tie index performance to the total rate of the index or indexes, which includes dividends. However, this method is not as recognized and widely used in the industry. More important, the cost of options purchased on an index that reflects dividends would be more expensive, which may translate into a lower cap rate.
For any illustrations or additional information on IUL please contact out office at (888)234-0532 or visit our website at www.levineadvisors.com
