6 Unique Advantages of Indexed Universal Life (IUL) Insurance

The unique advantage of  Indexed Universal Life (IUL) is that it allows policyowners to earn potentially higher returns tied to the performance of equity indexes, similar to Variable Universal Life Insurance (VUL) policies, while retaining the safety afforded by the insurer’s guaranteed minimum interest crediting rate, similar to regular Universal Life (UL) policies. This advantage has several dimensions:

  1. The safety of no negative returns. Clients burned in recent years by declining values in the equity, bond, and real estate markets now understand the value of a guarantee that their annual returns will never be negative. That guarantee is precisely what IUL provides. If the index used by the product (or selected by the policyowner) declines over the period measured, the client is completely protected from that risk. The contract’s cash value will never decline due to declining values in the reference index.
  2. The insurer absorbs the investment risk. The insurance company provides interest credits to the IUL policy by investing in bonds and index options (or options on index futures). Suppose some experts expect bond defaults this year to be several times historical averages or that the counterparty to the index options defaults, like Lehman Brothers did to many insurers. How would such events affect the amounts credited to an IUL policy’s cash values? The answer is that the insurer bears the entire investment risk and protects its policyowners from this risk.
  3. The possibility of high positive returns. Safe alternatives with low investment risk currently are earning very low yields. Many are at historical lows, making them unattractive to many savers. Even if and when interest yields on safe alternatives rise, the probabilities are that returns on higher-risk equities generally will be higher. With IUL, if the index performs well over the period measured, the amount the insurer will credit on the cash values tied to the index should be quite attractive. Some IUL policies even include interest-crediting formulas that compare multiple indices and more heavily weight those that are performing better.
  4. The ability to create tax-free cash flows. Many other vehicles investors can use to save create taxation. IRAs and 401(k)s, for example, delay but do not eliminate taxation. IUL, in contrast, can create a totally tax-free cash flow. Through the use of policy loans, policyowners can completely avoid federal, state, and local income taxes, as well as the alternative minimum tax on the cash flow. And IUL, like all life insurance policies, provide a tax-free death benefit. This tax-free feature makes the IUL policies more attractive than other alternatives, even if those alternatives may create a somewhat higher pre-tax return.
  5. An ability to take advantage of the design of certain insurance products. Studies show that the interest crediting on most IUL policies is higher than the interest crediting on most index annuity products. Why? Because insurers have a second source of profit on index universal life–the spread between the insurers’ mortality charges versus the expected mortality of the people they insure. In some cases, the insurers are generating much if not all of their profits from the mortality spread. Therefore, customers who buy IUL policies and minimize the insurance coverage relative to the premium they pay get a better deal. From one perspective, this means that the many policyowners who will maximize their insurance coverage relative to the premiums they pay essentially will be subsidizing these customers’ who maximize their coverage relative to the premiums they pay.
  6. Life-long insurance without paying for a lifetime. One perhaps unexpected bonus for clients who use IUL to save for retirement is that once the clients stop paying premiums and start taking cash flows as policy loans, the insurance coverage does not end. In fact, clients often can continue to be insured for the rest of their lives without ever having to pay additional money into the contracts.
Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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