Indexed Life insurance products have been all the rage over the past few years and the #1 life insurance product in terms of new sales. They seem to be a miracle to clients offering stock market upside with no downside if the market goes south, even if it goes really south like 2008. In many ways 2008 is a big reason for many clients turning to these products, and for moderate or conservative investors it is a great hedge on downside loss inside their life insurance.
Index products typically will allow you to invest in an index, like the S&P, Hang Seng (Hong Kong) or Euro Stoxx 50. Your life insurance policy will receive a credit, in lieu of a fixed return, of the chosen index. These credits commonly have a cap and floor. The cap is the largest amount of the return you will receive where products can range from 8-13%. So, for a basic example, if the S&P goes up 8% your policy will be credited with an 8% return. Conversely, there is a floor so if the underlying market goes down your policy will typically receive 0-2%. So again, for a basic example, if the S&P loses 30% your policy does not take a loss or in some cases may even receive a small credit.
Sounds pretty great! However, there are many complications. These products have very complicated options strategies that maintain those caps and floors, which in most cases are not guaranteed by the insurance company. Further, the insurance company limits the gains by removing the dividend component of the underlying Index, which in some years can be as much as 30% of the total return. Therefore, if you are tracking the S&P you would be looking at the Capital Appreciation, not the total return. In addition, the companies will use a ‘Point to Point’ method in crediting your policy. Depending on when you purchased the policy you will only be credited for that period. Inter-year declines may lead you to not see a gain when the index itself may have had a gain on a year-to-year basis.
Interest rates matter on these products as well. It may not seem like they would come into play, but they do. The monies invested in these products go into the insurance company’s general account. A small fraction of those dollars is invested in options. So, as interest rates are compressed, the amounts that can be invested in options are also compressed. This can lead to index options being completely removed or altered, which we have seen in 2020. Market volatility can also play a major role as the market becomes more volatile the price of options will go up. Again, not allowing the company to purchase the options to provide returns and leading to a potential drop in cap rates, which we have seen many times over the past 7-10 years.
Another major concern is that these products are not considered securities. Although they use complicated options strategies and you receive a market return, they are not monitored by FINRA or the SEC. Agents that sell these products may or may not be securities licensed and there is no prospectus for these products.
Like most life insurance products, how they are sold is critical. These products can be great alternatives to traditional universal life products and see a portion of the market return. However, there have also been many ‘miracle’ sales showing large investments made in these products with loans being taken out, showing scenarios that would be almost impossible to occur. It is important to review index products carefully and follow the old rule: ‘If it is too good to be true, it probably is’.