Illustrating IUL Index Performance Responsibly

If Carrier "A" uses 6.5% index performance on its indexed universal life (IUL) illustration, while Carrier "B" uses 5.5%, you should buy Carrier "A", right? Not necessarily. Even at the same return for index performance, there are many other factors that will help to determine how the policy will do. The actual markets that are tracked, Caps, Floors, Participation Rates, Cost of Insurance, Premium Load, other expenses, frequency of locking in gains, use of leverage, and policy loan provisions are on that list. But this article will focus primarily on how the carrier (and the insurance professional that markets those products) come up with those dazzling numbers.

First, nobody really knows what kind of index performance will be experienced with any index strategy. The best anyone can do is back-testing a strategy. For example, if Carrier "A" illustrates the S&P Strategy using a one-year point to point, and has a 9% cap, a 100% participation pate,  along with a zero floor, it is possible to look back over 20 or 30 years and see what returns would actually have occurred if this strategy with these limits had been in place. The most thorough way to do this is to consider each trading day from the earliest date in the study through the last trading date that would still yield a completed bucket. Such an exercise will yield thousands of hypothetical results.

For each hypothetical period in our example, buckets that show a decrease in the underlying index come in at zero. Buckets that show gains in the S&P of greater than 9% come in at 9%. All the others come in at the exact performance during its one-year lifespan.

Also, some carriers illustrate Bonus Interest Crediting after, say, the tenth policy year. This will affect performance significantly. (See article explaining Bonus Interest Crediting.)

Most carriers will take an average of all these hypothetical buckets, and then allow advisors to illustrate index returns of up to the 50-50 (50th Percentile) chance of actually getting those returns. A few carriers will insist that their illustrations show index returns no greater than those that would take place with an 80% or higher probability of success, based upon back-testing. So, which is better? An 8% return that is supported half the time, or an 8% return that has happened 80% of the time?

Of course, we do not know whether or not the next 20 or 30 years will be like the last 20 or 30 years, but the longer the study period, the more comfort we can take in the numbers. Usually if we can wait long enough, history tends to repeat itself.

This same type of process is used for all kinds of index strategies, including those that are uncapped, or draw from multiple markets. However, it would be important to know what percentile is used from back-testing to arrive at the illustrated rate. Amazingly, some carriers allow their illustrations to go out using only a percentile in the 40's, while a few more-responsible ones only allow their illustrations to assume returns supported at the 80th percentile and higher. There are various spreadsheet applications that can demonstrate these percentiles objectively between various carriers and various strategies.

Lastly, even the most exhaustive analysis won't account for chance deviations over a relatively few years. There will be times when returns are zero, unlike the smooth returns shown on most illustrations. If leverage is involved, care must be taken by the policy owner to stay out of trouble. Our affiliated company, Plan Trackers, Inc., can analyze a given product and its available index strategies using sequential back-testing to see how it would have performed using hundreds of iterations over time.

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