Indexed Universal Life: Back Testing and Cap Rates and Averages, Oh My!
In a recent engagement, an agent trying to convince a client to enter a premium financed indexed universal life (IUL) transaction was touting returns on his own IUL policy over the past decade or so. I found a number of aspects of this peculiar. One was that he was touting the average interest rate on his own policy, which has happened to be in force during the longest bull market in U.S. history. This was supposedly a reason the product was so great and could/might actually outperform the crediting rate of the sales ledger, which I already deem to be too aggressive based on significant objective data.
Another oddity is that he evidently doesn’t understand the difference between an average interest rate and the internal rate of return (IRR), which is the difference between an arithmetic mean and a geometric mean. The geometric mean will generally be lower, and it’s the number any sensible person would use when evaluating an investment. As an example, what if you get a 0% rate of return for three years and then a 40% return in the fourth year? The average rate of return is 10% but the IRR is 8.78%. It’s respectable but not accurate. No one would reasonably look at the track record of this product as 10%.
Next, the agent was sharing past rates of return that are higher than currently possible due to falling cap rates. In an IUL product, the cap rate is the highest crediting rate possible regardless of the actual index return. On the flip side, there’s a minimum, often 0%. Therefore the product is postured as having upside potential with downside protection. This is not untrue but rather misleading without a full discussion of internal policy fees and charges and what’s going on with caps. For full post, click here…