INDEX UNIVERSAL LIFE
Cap and floor rates in action
There is a cause and effect relationship between the index and the index account. We will be using a fictional index to expound on that relationship. There are three different scenarios that could happen — the cap year, the floor year, and the between year.
Indexed Universal Life (IUL) insurance has existed since the late 1990s, and since then it has grown to be over 50% of all Universal Life insurance premium and over 20% of the total premium for individual life insurance premium. While IUL has become widely sold product, the mechanics of how IUL works are not widely understood. Where does IUL fit? Indexed universal life products are ideal for clients who have a need for death benefit coverage and also want the potential for cash value growth without market risk. It occupies the space between current assumption universal life and variable universal life insurance. Today’s low-interest rate environment has made universal life less attractive to many consumers, plus the back to-back recessions of 2000 – 2002 and 2007– 2009 have left other consumers wary of investing directly in the market. These conditions have essentially shined a spotlight on IUL.
The cap year
In the cap year, the index grows beyond the cap rate, so interest is credited at the cap rate. In this example, the
index gains 18% for the year. An interest cap of 12% applies, so although the index gained 18%, interest credited
to the index account will be 12%.
The floor year
In the floor year, the index has negative growth, so the zero percent floor rated comes into effect. At the end of this
year, we find that the index is down 11% for the year. However, because of the policy’s zero percent floor, interest
credited to the index account is 0% instead of –11%.
The between year
In the between year the index grows at a rate higher than the floor rate, but lower than the cap rate. At the end of
this year, we find that the index has grown 6%. The cap and floor do not come into effect. Interest credited to the
index account is 6%.
Putting it all together with annual reset
For the purposes of this example, we’ll assume that these years happen in the order shown below, although they can
and do occur in any order throughout the lifespan of a policy. The zero percent floor rate and the index starting value
are reset each year. Let’s take a look at what that means in the graph below