by David Lear, LifeTrends Head of Product
The initial wave of excitement of Indexed Universal Life (IUL) has crested and crashed into a decry of illustration wars! Actuarial Guideline 49 (AG49) was supposed to be the stabilizer, to calm the turbulent water. But in the years following the regulation, creativity started to emerge as we began to see a flood of product design ideas. Some focused on new features like spread death benefit options, higher cap accounts, or volatility control accounts. Others chose to develop more aggressive, complicated, and expensive designs, but coupled it to wild gains. In contrast, another group of carriers chose to stay focused on the simple and straightforward approach, with less bonuses and less complication. Each carrier searched for differentiation in the accumulation IUL space, each wave of new direction making a bigger splash than the last. All these different designs shaped IUL into a wide variety of solutions to the same common need; buying life insurance that also has powerful accumulation potential. LifeTrends looked at all the options to get our arms around this market, and we are bringing the 70% window evaluation back as the strongest, and simplest approach to riding this wave.
The New “Range” Perspective
For years, typical intelligence centered around running every product for a case to find a single solution. Unfortunately, with IUL, the single non-guaranteed illustration will virtually never perform the way it is shown. This is true whether assumptions are maximized, flat, conservative, fluctuating, or based on actual historical performance. The fact is illustrations are unreliable. So, the options are to either go with the flow of optimistic maximum assumptions or aim low and hope for the best. However, neither angle takes full advantage of the complete IUL picture because they are based on a single projection. When you move away from the single illustration mindset, and towards a range of values, there is a better chance that the actual results will fall within that window. This means you can view products on both the optimistic, and the conservative, with the realistic being somewhere in between. It takes away the unreliability of a single illustration and allows for positive outlooks with practical expectations.
Defining the “Window” by Exploring All Possibilities
AG49 gave us the top of that window. It is the most optimistic illustration of potential outcomes that can be justified using the history of the market. It is an easy answer for the upper limit. Defining the lower limit is a tougher task. I have had a hundred different conversations with folks telling me what they think is the proper way to compare like-kind rates conservatively. We explored them all.
The most basic is the flat rate comparison. It usually starts and ends like this, “It’s all getting so complicated, I just run everything at 5%.” This comparison is simple, but it assumes all products will have the same rate of return, regardless of cap amount, par rate, and multipliers. With the diverging product paths of IUL over the past five years, it does not really work as a good comparison on its own.
Historical lookbacks that use a “confidence interval” had an early start as popular estimators for conservative runs. The basic concept is, “If I run my current cap rate over the past years of actual experience, how often would my illustrated rate have succeeded?” A few carriers developed calculators to assess how likely it was, and the resulting percentage became the confidence interval. Unfortunately, the current caps, floors, etc. would not have lined up in the way that the values are being retroactively applied. This is the Achilles heel of this method. Historical values have their place, but a simple lookback does not have much weight in projecting future success.
Changing the pattern of interest rates in an illustration is often called the “Sequence of Returns,” and is another popular and useful tool to stress test assumptions. First, run many different changing interest assumptions to mimic practical examples of possible future outcomes. Then, observe the projections and how often the assumptions succeed. The more conservative the assumptions, the more protected it is against volatility and the higher the success percentage. Practical demonstrations like a sequence of returns analysis is a great approach, but it unfortunately gets difficult to explain and model across an ever-complex landscape of products. The complexity and time investment needed to run an in-depth comparison makes this impractical as a lower limit to our window.
Along the notes of stress testing practical approaches is illustrating a 0% yield every fourth or fifth year. It asks the question, “Instead of showing positive returns every year, what if we add in some negative years?” Multipliers can be wonderfully productive and expensive, so when applied in a year where the interest rate yields 0%, the result after the multiplier is still 0%, and yet the charges still apply. So, adding a zero in regular intervals attempts to model a more reasonable pattern of interest rates and can be simpler than a “Sequence of returns” approach. Most software allows the illustrative rate to be zero in any year but will not allow any value above the AG49 rate, which makes cap years out of bounds. This poses a problem when trying to show years of downside but cannot show the best upside years.
There are many other ideas on setting the best comparable lower range, but these are the most frequently mentioned. We enjoy exploring these concepts and have put work into analyzing the strategies above, along with others ranging from the simple “Run everyone at the fixed account rate,” to the complex, “for every point of cap below the highest, reduce the illustrated rate by 25 basis points.” We have reviewed them all. We encourage any deeper dives into product; education on what is being sold will always be valuable. After all our analysis, we landed on 70% of the AG49 maximum illustrated rate to be the strongest, simplest, fairest, and most encompassing lower bound.
It may seem oversimplified, but rest assured we set this value in a meaningful way. It was important to set a value that wraps in different ideas of practical evaluation so that real world examples would have a higher probability of falling within our range. The 70% value starts with the assumption that market fluctuations, both positive and negative, will affect product performance proportionally. By using a scale of the AG49 maximum rate, the caps, floors, etc. are automatically included. This means that the major flaws of the 5% flat rate are fixed when looking at the 70% window. For perspective, a product with a maximum illustrated rate of 7%, which tends to be on the higher end today, will illustrate at a similar 4.9% in the 70% window, encompassing the traditional simple version of flat conservative runs.
The practical examples showing a zero yield every four years is also wrapped in. It is a matter of doing some mid-level math, but the interest rate equivalent is just over 74% of the original rate. This means it is within the 70% window with some room for adjustments in cap rate and other fluctuations. Encircling the “Sequence of Returns” example is somewhat of a moving target as it can yield varying results depending on how it is run and what assumptions are used, but most cases we have seen demonstrated themselves to be within the 70% window.
So, choosing 70% was not by accident. It is simple to explain and illustrate, yet it also includes results of much more complex methods of stress testing.
What This Gives You
Evaluating the maximum assumption illustration next to the 70% assumption produces a third value; the difference between the two. This difference is a measure of interest sensitivity and can now be matched with a risk profile. More importantly, adding the interest rate sensitivity puts a “window” around these products. It allows them to compare on an equal playing field, giving shelf space to the more conservative products without demonizing the aggressive products. This brings all perspectives back to the same comparison. The figure below shows what this looks like in an example of 5 products under our LifeTrends standard industry assumptions. For those that are wanting and willing to take a risk to get great upside potential, they can now understand the downside associated. And those that leaned on the conservative, can feel comfortable also showing the full IUL potential.
LifeTrends sits in the unique position of being an independent third-party evaluator of these products that services both life insurance carriers and the brokerage space. This means we look for ways to convey to both parties where products fit in the most even way possible. No matter the product design, it can be matched with the correct audience. Whether it be for risk takers or penny pinchers, all products have their place. The LifeTrends 70% window brings evaluating accumulation oriented IUL products back to its basic underlying value proposition of upside potential with downside protection, while being easily explained and demonstrated.