Equity-indexed life insurance, also known as EIUL, is a newer form of universal life that combines elements of variable life insurance into the mix, which can make it extremely complex.
The main difference between EIUL and traditional universal life is in how excess interest is credited. Most EIUL policies have two separate accounts that can be used to credit interest.
One account has a fixed interest rate that is declared by the insurance issuer, periodically. The second account provides an equity option, which offers you the opportunity to earn rates of interest based on positive equity/stock market returns.
However, the cash value of the EIUL policy is not exposed to losses due to negative market returns.
The amount of interest credited to your cash value is tied to the performance of the policy’s particular equity index.
Therefore, in years where the index performs well, the interest credited to the policy’s cash value rises, and in years where the index performs poorly, your interest rate falls.
EIUL policies guarantee that the interest rate will never fall below zero, so that the policy won’t lose money if the stock market index declines.
The first thing to watch out for is that these policies usually have a cap or limit on the amount of interest that can be credited to your policy.
For example, if the cap is 10 percent, and the index rate is 14 percent, you will only participate in the 10 percent return.
The reasoning is that this would offset the life insurance company’s assumption in years where there is a negative return in the stock market index. Companies use a range of indexes that include the S&P 500, Dow Jones Industrial Average, Lehman Brothers Bond Index, and FINRAAQ.
At their own discretion, insurance companies can adjust the participation rate, so that a policy owner receives a lesser percentage of the total return. This is an important thing to keep in mind.
Some companies will offer a 100 percent participation guaranteed for the life of a policy, while others will not provide such a guarantee.
Therefore, if the market returns 14 percent as mentioned above, the policy has a cap of 10 percent and the participation rate is 80 percent – the actual credited return rate on the policy is 8 percent (10 percent overall return rate times 80 percent).
There are also different indexing methods used to measure market return.
Annual Point-to-Point Method:
This is a method that compares the value of the equity index at the beginning of the term to its value at the end of the term, disregarding functions in between. Each term is one year in length.
If the ending index value is higher, the interest is credited annually subject to the participation rate and cap. If the ending value is lower, then no interest is credited, unless the policy guarantee a minimum interest credited to the cash value.
Daily Averaging Method
A method like this takes the average daily index value over the entire index term and compares this average to the beginning index value on the first day of the index term. Most index terms are one year in length.
If the average daily index value over the entire index term is greater than the beginning index value, interest is credited subject to any applicable participation rate and cap.
Monthly Averaging Method
The monthly averaging method is fairly similar to the daily averaging method, except that the index value is recorded on a particular date of each month, usually for 12 consecutive months. Which is then compared to the beginning index value on the first day of the index term.
If the average index value over the entire index term is greater than the beginning index term, interest is credited subject to the participation rate and cap, if applicable.
Steuer, author of Questions and Answers on Life Insurance: The Life Insurance Toolbook, has more than 25 years of experience and holds the Department of Insurance Analyst License (LA) as well as the Charted Life Underwriter (CLU) designation. Tony holds various leadership positions and has authored three books on the topic of life insurance.
Steuer’s work has been awarded the “Excellence in Financial Literacy (EIFLE) Award from the Institute of Financial Literacy for his The Questions and Answers on Disability Insurance Workbook and The Questions and Answers on Insurance Planner. Forbes named Questions and Answers on Life Insurance: The Life Insurance Toolbook as one of their top nine great investment books.
He’s also the founder of the Insurance Literacy Institute and creator of The Insurance Bill of Rights designed to empower consumers and to identify members of the Insurance Industry dedicated to strong professional standards.