Safety in Numbers: Endowment Scenarios
By Matthew Linder, LifeTrends Product Analyst
Today’s topic reminds me of an old Pulaar proverb I heard during my time in Senegal with the Peace Corps, Koɗɗe njidaa wowru ceera arsugaaji. It means that things which share the same origin have different fortunes. I used to contemplate the meaning as I roasted in the 120-degree heat, but now I finally understand they were talking about minimally funded and endowment indexed universal life scenarios! How can two different solves start so similarly but end up with vastly different fortunes in the end? While most of the market is minimally funding their policies, wouldn’t it be better to endow them for that extra cash build up as safety net? In a world of Indexed UL uncertainty, it seems smart to build more of a cash value cushion. We decided to dig into the numbers and find out if this hedge is a worthwhile approach.
The results of our study were straightforward. There was little to no premium difference between endowing the contract at the insured age 121 and stripping that cushion away to minimum fund the contract, solving for $1 at maturity. In fact, most of the products barely saw a premium increase at all, with one product increasing the premium by only 2 cents to achieve endowment. But how can that be since the ending cash value is so different? Both solves rely on sustained positive interest rate assumptions over significant accrual periods. A client at age 50 is accruing positive interest for 71 years in our scenarios, so even small amounts make a huge difference in an illustration. This means the endowment cushion may be less secure than you realize in real-world situations. If you go with a more conservative approach and endow the contract at age 100, it does increase the premiums and build cash value in the policy faster. However, policy premiums only increase by around 5%. This small hike may not do much to guarantee that the policy will stay in force in fluctuating interest rates.
Interest Rate Effect
So, among all the different targeting goals, we found there is little to no change in premiums and competitive positioning. That pushed us to find what might have a significant effect. Where we did see the largest changes were when illustrating at various interest rates. Switching from the max interest rates to the 5% assumption, the changes in premium were much more pronounced. We saw an average hike in premiums of around 15% for minimum funded scenarios, much more than the 5% increase when you consider endowing the policy at age 100.
So, is endowing a smart hedge for IUL policies? It does increase the premiums to give an extra cushion, but it may not be big enough to consider the policy safe. If security is the main concern, a better hedge would be lowering the interest return assumptions or looking for a strong primary guarantee. That way, even in a market downturn, the policy will still be able to go the distance. And if the market over performs, then the policy reaps significantly more cash value. Haa gongol (Until next time)!