With the amount of reoccurring volatility our stock market is experiencing, many financial professionals are taking a more conservative approach to investing. The demand for a financial vehicle that provides both protection and stability drastically increases when using this more cautious strategy.
In this episode of Money Script Monday, Marcus explains one crediting strategy that allows you to participate in stock market gains and protects you from losses.
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Video transcription
Hello, my name is Marcus Kiel, and welcome to another episode of Money Script Monday.
Today's topic is IUL crediting strategy, guarantees, credits, and how it all works.
I've talked to hundreds of advisors and clients, and one of the main questions I'm asked is, "Can you explain what an IUL is and how the crediting works, how the strategy works?"
Hopefully, after this video, you can have a better explanation as to how IUL crediting strategy works, and with a real-world example.
What is an IUL?
Fixed indexed universal life is an insurance policy, and it's permanent, and it can receive interest credits in positive years, all the while having a death benefit should your insured pass away.
The IUL can receive 65% to 80% of stock market gains with none of the losses.
It's tied to the stock market, but not in the market.
Once again, in a positive index credit year, you'd receive a positive interest credit.
In a negative year, zero, it's a floor, it's guaranteed, and that's where the phrase "Zero is Your Hero" came from.
Let's get into it.
S&P 500 Historical Rates
With the S&P 500, these are historical rates, year-end, I have 2002 and 2008, I have the year-end index change, from -23.37%, -38.29%, and in an index allocation, if you were in IUL, the annual point to point with a cap, and you see that as a zero.
In 2002, I remembered it well. I was finishing up college.
And years before, I'd gone to job fairs and employers, it was packed with employers and they were recruiting and I told them, "You know, I'm here just to practice and get better at talking to employers and recruiters and definitely looking for employment when I graduate two, three years from now."
And they said, "You got to come out now. This is a great opportunity. Come out now."
They said that year after year after year until I got to 2002 and went to the job fair and there weren't as many people.
There weren't as many employers. And instead of saying, "Come out now, let's go to work," they said, "You know what? You may want to stay a year."
I remember that, 2002. And if you had funds in the S&P 500 year in, there was a -23.37% change end of the year.
Now, the good news is, with an IUL and that index allocation, you had a 0% floor, so you didn't lose any cash accumulation to the stock market losses.
Fast forward to 2008 and the Great Recession. We all remember that. Look at the year ending historical index change of -38.29, but once again, with an IUL, you have that 0% floor.
So that's tied to the market but not in, 65%, 80% of the gains, and none of the losses.
Now, I know what you might be saying, and I've heard this too, "it sounds too good to be true. I mean, that can't be possible. How can the insurance company guarantee a 0% floor, or how can they have a 0% floor?"
Investing a Client's Premium
Let's take a look at how an insurance company invests a client's premium.
From this pie chart, you see that most of the pie, 96% to 99%, is placed in a high-quality income portfolio, so high-quality bonds, that's what makes an insurance company an A+ or an A++-rated company.
This small sliver here, 1% to 4%, is what's used for hedging instruments.
So that's what they're going to use to purchase these allocations and we hope that we can have or they hope that they can have a positive interest credit year, but know that if it doesn't return a positive number, most of their money is in a bond that's going to return 4.5% to 4.75% for the year.
That's how they're able to guarantee this floor. Most of their money is put in a high-quality fixed income portfolio. They're not risky about it.
For insurance companies that don't have A+ rating or B+ or even C, this pie looks a little bit different.
They're a little bit riskier, and they're putting more money into a hedging instrument to buy these index allocations or the options for these index allocations.
That's how they invest in the client's premium — definitely a big difference from how a bank would invest a client's money.
Hypothetical Example
Now, let's take a look at a hypothetical example.
Take a look at the numbers. Let's get to the numbers. The client uses $1000, and they paid the insurance company $1000 for their premium.
The insurance company takes $950, so they take most of it, once again this pie, large part of this pie, they take most of it, and put it into the general portfolio which is going to gain anywhere from 4.5%, 4.75% for that year.
They grow that $950 back to $1000.
There's your floor, your 0% floor, no matter what happens on this side of the board, we know that we can at least get the premium back to $1000 and guarantee that 0% floor.
Now, they take the $50 from the $1000, $50 over here, $50 over here, and they use it to purchase hedging instruments.
And these hedging instruments buy options, so let's take S&P 500 and at the end of the year, in the year policy year, we'll see if there's index credit or not, positive, great.
If it's negative, they rip off the option, 0% floor, you don't lose accumulated cash value to the market.
And if it's positive, there could be a cap S&P 500, let's say it could be 10, so the highest you can go is 10.
The index change for S&P could be +30, but you would be capped at 10.
That's how it works with real-life numbers, how insurance companies are able to guarantee that 0% floor, how they invest the premium and then using a real-world hypothetical example with actual dollars and cents.
Now, these are traditional IULs.
With the new AG49 and CSO tables, we've seen a different landscape.
You may be asking, "Well, I want higher than a 10% cap. I want a 20% cap." Or "I want a bigger bonus or a multiplier," if you have participation rates.
How can we do that?
Either you invest more into the hedging instruments, take this $950 down to $900 and put $100 into the hedging instruments, or charge a fee.
We put another column and charge maybe $50 over here. You have $50 here, maybe $900 here, that $50 fee is the ability for them to use a higher bonus or a multiplier.
You see multipliers of 200%, a participation rate. And so that's how they're able to do that.
In those instances, zero doesn't really become your hero.
That's kind of how the new landscape is changing.
Not all carriers are like this, and not all options are like that.
But the landscape is changing.
And for more information, I ask that you check out "Broker World," and my article, "Is Zero Still Your Hero?" You can check that out.
Once again, to go over, IUL crediting strategy guarantees credits and how it all works.
You see how an IUL's tied to the market but not in.
You see that zero, traditionally, is your hero, how an insurance company invests the premium, and then a hypothetical example with numbers.
That's all my time for today.
My name is Marcus Kiel.
Thanks for watching.
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