How Interest Is Calculated on an Indexed Universal Life Insurance Policy

I agreed to look at another book about retirement. Last night, the book’s author emailed me and thanked me for agreeing to give his book a look. He included a link to a YouTube video he put together that explains his strategy.

What I found is his strategy is similar to Pamela Yellen’s Bank on Yourself strategy. UH-OH…haha. What’s different is he uses Indexed Universal Life Insurance. I AM NOT an insurance expert. I won’t discuss the intricacies of the policy. What I do want to discuss is how the interest is credited to the account holder (about 5:42 into the video). NOTE: Notice that he uses the average return of 8.12% (I get 8.13% when I calculate it), and not the average annual rate of return, which is 7.98%.

So the way this particular policy works is it will credit the policy holder’s account a maximum of 13% and a minimum of 0%. So, if the market returns 10%, you get 10%. If the market returns -10%, you get 0 (you won’t lose money except for inflation). If the market returns 20%, you get 13%. Pretty straight forward.

What I found interesting is the index they use in order to calculate the annual credit.

If you look, you’ll see a column titled “Actual S&P 500 Growth %”. This column represents the PRICE return of the S&P 500 Index, NOT the TOTAL RETURN. His numbers look like this:

IUL Account Credit

Now, what would the account look like if the insurance company used the S&P 500 Total Return Index? Let’s see:

IUL Account Credit Using SPTR

That’s quite a difference.

It’s important to point out that the insurance company is only using the S&P 500 as a guide for crediting the interest that goes into the account. The problem I have with this is that’s not how it is often sold to the buyer. It’s usually sold as a “What if you could get the return of the stock market without the risk?”

My point in all of this is just to make you aware of the way interest on most of these policies is calculated. They aren’t using the entire index. That’s important to know.

I’ll review the book once I receive it and have read it. Stay tuned…

8 thoughts on “How Interest Is Calculated on an Indexed Universal Life Insurance Policy”

  1. Graphic at 7:09 says it all — another example where an insurance agent inaccurately represents the returns of the S&P 500 (by pretending that dividends do not exist).

    Maybe their insurance plans are great, but when they misrepresent returns of alternative investments, it makes it hard to believe anything else they say — are they misrepresenting the returns of their own products?

  2. Yep. I agree, BG.

    At the very least, they should mention the fact that the interest is calculated using the price return for the index rather than the total return.

  3. Let’s presume you invested $100k in VFINX (Vanguard’s S&P500 index fund) in January 1999. According to morningstar, with dividends reinvested, your account would grow to $128k by the end of 2011.

    The graphic in the video may be technically “wrong” for the S&P500 returns, but after correcting for that error, the insurance plan still comes out way ahead (with the UIL policy having a value of $220k).

    So: what is the catch? This sounds to good to be true…

    1. You are correct, BG (not that I thought you were wrong, but I wanted to run the numbers myself):

      VFINX vs IUL Policy

      The catch? I’m pretty sure there are fees associated with an account like this. In other words, I seriously doubt a person could have deposited $10,000 in 2000 and have over $26,0000 at the end of 2015. The insurance company has to make money somehow. I sent the author an email and asked about fees. We will see if he answers back.

  4. It’s sad that so many, certainly not you, discount the product because of how it is sold. I appreciate you pointing out the technicalities without discrediting the product. The best description I’ve heard of indexed products, annuities or life insurance is: a better than average chance at a better than average return with no risk of loss. 25 years in sales has taught me to always try to do right, not just always try to be right. I sell all kinds of life insurance products, both fixed, universal and variable as well as mutual funds. (My point being, I am as diverse in my offerings as possible.).

    1. Robert,

      I appreciate your comment.

      It’s unfortunate that a few bad apples spoil it for the honest people, but that’s what happens.

      What’s also unfortunate is just how complex these products are, making them virtually impossible to make an apples-to-apples comparison.

      I’m a firm believer that insurance has its place in a financial plan.

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