Questions to Ask Before Buying an Indexed Universal Life Insurance Policy
Key takeaways
Indexed universal life (IUL) policies promise growth tied to stock market indexes, with downside protection. But in order to achieve aggressive growth, many things need to be true (that often don’t come true).
Their high fees and complexities may limit your gains, and the money you contribute may be put into accounts without much track record.
More conventional life insurance products, like variable universal life insurance, let you allocate your cash value into market-based funds without the complexity of an IUL policy.
As you’re weighing different options to best protect your family’s financial well-being, you have likely come across various types of life insurance, including whole life, universal life and variable universal life policies. Another option is indexed universal life (IUL) insurance, which offers lifelong coverage along with cash value that can rise and fall based on the performance of a popular market index like the S&P 500 and policy expenses. A chief selling point is that IUL offers protection against negative market returns, in the form of an interest-rate floor. It also offers the opportunity for investment-like growth based on underlying indices.
However, IUL policies also have caps on gains. Their complex structure can also make it hard to understand how you might be affected based on how the market is performing. And aggressive growth is highly conditional, so you don’t often end up getting the growth that was illustrated for you or that the index actually achieved. And the illustrations themselves can be confusing and hard to decipher.
Let’s take a closer look at IUL policies to understand how they work and why there may be better options depending on your goals.
What is IUL, and how does it work?
IUL is a type of permanent life insurance—meaning it doesn’t expire after a fixed term—with cash value that can fluctuate and grow based on the performance of a market index like the S&P 500 or a synthetic manufactured index created specifically for use in an IUL policy. The policy offers flexible premiums, allowing you to pay less or more from year to year, within certain limits.
However, with IUL, your cash isn’t allocated directly to well-known stock indices. Rather, the portion of your premium that funds the policy’s cash value is divided between the company’s general account and options based on hedging strategies rather than direct equity investments.
Those complex options investments are linked to the performance of whatever index you’ve chosen as your benchmark but not directly invested in it. They can be hard to understand, and often insurers will illustrate good performance history based on today’s options strategies rather than what actually happened in the past; however, it’s important to really understand these illustrations before making decisions based on them. Moreover, the policy’s caps on gains can change according to the terms of your policy at the company’s discretion. For example, a cap on gains could be triggered by market conditions, the insurer’s own investing costs or risk management practices, the company’s general investment account performance and other hard-to-predict factors. As you might imagine, tracking all these complex trades requires active management, which typically incurs additional fees.
A key watchpoint for an over-promising illustration is to look at the dates of performance history. For example, the index may have been launched in 2018, but the illustration shows performance back to 2005. It might be a good idea to ask questions about how the illustration is calculated.
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Growth models tend to spotlight best-case scenarios
Proponents of IUL point to sales illustrations demonstrating the potential for huge growth in a policy’s cash value. In an ideal world, that could happen. But in reality, markets and interest rates go up and down—and if they fall dramatically, the cash value of an IUL policy could go down in value. In fact, even in a scenario where market returns are high and interest rates fall, an IUL policy could see minimal growth.
That might come as a surprise given the policy’s promise of a crediting-rate floor, usually set to zero. In theory the floor means even in a market crash, a policy holder’s cash contributions (from their premium payments) would be safe—even if any gains were wiped out. But the guaranteed interest floor doesn’t include policy fees, which would be taken out of the cash value even if there are no investment gains to cover them.
Unfortunately, IUL policies also have a maximum interest cap, which limits gains during a rally. In addition, the terms of many IUL policies allow insurers to adjust that cap based on market conditions, using formulas that are hard to parse, even for experts. And IUL doesn’t pay out dividends, which can represent a significant portion of the total return of owning stocks.
While the lofty gains promoted in IUL sales models are theoretically possible, the fine print is a bit like gravity.
Life insurance can help protect the legacy you've built.
Your advisor can make personalized life insurance recommendations based on your needs.
Let's get startedYour Northwestern Mutual financial advisor can help
At Northwestern Mutual, a life insurance plan is part of a larger financial plan tailored to each family and their needs. While IUL typically looks great when it’s recommended, we’ve found that carriers are showing its potential in an unrealistic way. The reality is that you can get similar or even better performance with other products with a longer track record of actual results. That’s why our financial advisors offer a suite of time-tested insurance options, including UL and VUL policies as well as whole life insurance.
Your Northwestern Mutual financial advisor can get to know your personal situation and recommend the right life insurance solutions to meet your goals. They’ll also help you understand how those solutions work with other pieces of your financial plan, showing you how growth and protection strategies work together to help you live the life you want—now and in the future.
