by Kasey Gammons, LifeTrends Sr. Analyst
A Tale of Two Producers
This tale begins with two opposite producers, Trusting Ted and Skeptical Steve – our somewhat unlikely heroes. Trusting Ted is very confident in carrier product design, selling policies through a rose-colored lens and always at the maximum illustrated rate based on his confidence in strong future market performance. Skeptical Steve, however, is always seeking ways to recreate products from the ground up and taking every contingency against the potential negative sequence of returns based on his mistrust of product performance.
Why are Trusting Ted and Skeptical Steve heroes, albeit with obvious flaws? They both represent valuable points of view on the Indexed UL sale. Producers might have trust in a product’s ability to perform as designed, but they should temper that trust with some practical understanding that the market might very well underperform. On the other hand, some skepticism is certainly practical when talking about a product’s index performance but going too deep can place the whole endeavor in a state of counterproductive paralysis. A third mindset walks along a healthy middle ground between our two fictitious friends: a trust that carriers have produced products which will likely perform at least similarly to illustration expectations, but also a pragmatic understanding that indexed returns might not reach these expected levels. A producer taking this kind of approach can benefit from these four useful hedging strategies.
#1 Guaranteed Cash
One of the easiest ways to hedge against inherent policy risk on accumulation policies is to examine guaranteed cash value at the age of retirement. On a typical accumulation ledger, take some time to look at the guaranteed side. There are products that perform well enough that a full premium return is available at retirement age (for certain ages, typically younger clients). Other products also approach a return of premium threshold.
Now, this is certainly the worst gloom and doom imaginable scenario, but even if index returns were zero, zilch, or nada for every single in-force policy year, the client can at least bail out for their original buy-in (or close to it in many cases) with a select number of products. This can help reinforce some IUL narratives for skeptical clients and producers alike.
(For a deeper dive into the Guaranteed Cash narrative check out our POINTS blog from September)
#2 70% Window Strategy
Comparing illustrations at the regulatory maximum interest rate can be overly optimistic. On the other hand, same rate comparisons fail to take differences in caps into consideration. In both cases, projected illustrations will likely skew far from real product performance. So, what can an agent do to take both the capped nature of indexed policies into account and deal with less than optimum market performance?
One solution we inspected involves running the optimistic max rate as the top sill of our “window”, then running a more conservative 70% of this maximum rate as the bottom. Through this, we create a viable, practical range where actual performance may lie. This window of performance takes into account market fluctuations, cap changes, and other comparative product differences, granting a realistic hedge against inherent illustration inaccuracies.
(We will be expounding on this concept more in our June blog post, so stay tuned!)
#3 Interest Rate Sensitivity
One of the primary difficulties in selling Indexed UL centers around the question: what if returns are lower than expected? The unwanted scenario here is the policy lapsing well-ahead of schedule. In this study, we examined the following: a producer issues a protection policy at a 6% assumed rate; however, yearly returns are averaging to 5%, a full percent lower. We found most IUL products consistently lasted at least until life expectancy even under lower interest returns with a significant opportunity to catch up the policy to maturity as long as watchful producers are vigilant in their policy monitoring.
The catch-up period gives the producer a hedge in case of potentially hazardous lapse conditions. The policy will likely last for a significant time period anyway, but a producer who observes policy performance for these details can save a flagging policy in time.
(Read more about our findings on Interest Rate Sensitivity in our December POINTS blog)
#4 Bridge Products
Though initially framed as an alternative to GUL, bridge products and near bridge products can also serve as effective hedges against the fear of lapsing protection policies. Bridge Products contain longer primary guarantees (often to life expectancy or greater), more flexible and forgiving premiums than GUL, and significant cash accumulation which achieves at or near a return of premium level around policy year twenty.
The primary advantage to Bridge Products is the long-duration primary guarantees; the client is generally protected contractually to life-expectancy or longer, regardless of market performance. In the case of the S&P averaging around expected levels, then Bridge Products also have the additional benefit of a cash value safety net around the return of premium level thanks to their higher accumulation potential.
Looking Over the Hedges
Trusting Ted and Skeptical Steve may not have had much use for finding effective hedging strategies, but producers who find themselves somewhere in the middle can benefit from the various hedges mentioned above and their important implication: monitor the policy.
Policy monitoring will allow producers the opportunity to give timely suggestions to clients in the case of product underperformance but also overperformance. Unless things play out exactly as illustrated – an incredibly unlikely event, monitoring the policy will be vital to its continued health. Ultimately, hedging strategies can provide a safety net, further increasing confidence and helping ease some fears associated with the Indexed UL sale.
Tell us what you think, we’d love to hear from you. Do you use any of these strategies to hedge against inherent IUL risk? What other strategies do you use?