In a previous article, I wrote about the concept of a registered indexed variable universal life (RIVUL) product and the benefits/advantages it could bring to an insurance carrier looking to innovate in the UL market. While a few carriers have entered the RIVUL market, adoption has still been pretty limited despite the continued success of registered index linked annuities (RILA). While VUL products have seen some growth recently, sales are still nowhere near what they were in the 1990s and early 2000s. The dot-com bubble and Great Recession equity market drops essentially put a permanent damper on VUL product sales. Indexed universal life (IUL) also continued to grow and take a bigger share of the life market. From both an insurance company and insurance agent perspective, IUL is easier to sell, as it has reduced licensing and filing requirements relative to VUL, and the policyholder does not have the risk of negative returns being credited on their fund value. So maybe RIVUL is not the path forward for IUL innovation, but could some of its perceived values and benefits be leveraged in the IUL market?
We’ve recently seen a couple of new innovations in the annuity market space. One of them is a new variation of fixed indexed annuities (FIA) and the other is a new variation of FIA/RILA. Could these annuity innovations be transferred over to the IUL market and give carriers an advantage in the ever-competitive IUL market?
Historically annual point-to-point caps have been the most popular index options on IUL. This has also been a popular option on FIA products. Insurance companies actively manage these caps, and many IUL and FIA policyholders have seen a decline in their caps as asset portfolio yields continued to decline until the recent rise in interest rates. Benefiting from the rise in fixed-income yields, the value proposition of multi-year guaranteed fixed annuities (MYGAs) relative to other investment offerings has increased, and as a result MYGAs have been selling like hotcakes. Policyholders value the MYGA guaranteed returns, and some FIA carriers have recently introduced multi-year guaranteed FIAs to increase the product’s appeal. For this article’s purpose, let’s call those MYFIAs.
For most FIAs, the insurance company sets a cap and then has the ability to reset the cap annually. Changes to the cap are commonly driven by changes in expected net investment yields as well as changes in expected hedging/option costs. Most FIAs are sold on a single premium basis, and companies commonly invest deposits with the expectation of a large shock lapse at the end of the surrender charge period. As a result, for FIAs the reinvestment risk can be limited, and change in the economics of the option costs is the biggest driver of policyholder cap changes once the policy is issued. How does the MYFIA work? The cap rate is locked in for a defined period of time (e.g., five or seven years), which typically coincides with the surrender charge period. The additional risk of the MYFIA is in the annual option cost fluctuating due to equity market volatility and interest rate movement, without the ability to adjust the cap to compensate.
To compensate for the additional risks taken on by the insurance company, MYFIA products have slightly lower caps than their non-guaranteed FIA counterpart, but the policyholder no longer has the risk of the company lowering their cap. Could this feature work on an IUL? It certainly could, but IUL products do introduce some additional quirks that need to be appropriately considered.
The main quirk is the multi-premium nature of IUL products. Commonly IUL companies bucket monthly premiums together and roll each monthly premium into the prior year’s maturing bucket. This works well when you are using a portfolio crediting method and the company retains the ability to manage the cap on a one-year basis so it can adjust for changing asset yields due to additional deposits. If you introduce a multi-year locked-in cap on IUL, the company now faces some additional behavior risk, as policyholders could take advantage of a higher locked-in cap.
Those additional behavior risks could be reduced by switching to a new money crediting approach and locking in the cap separately for each deposit, which could also benefit from today’s higher interest rates. A single premium IUL could also be very well suited to this feature, and this would help alleviate the challenges of multiple premiums. Companies could also limit the amount of additional premium that can be added to a maturing bucket or hedge some of the interest rate and equity risk. Companies may also see higher VM-20 reserves due to the longer cap guarantee. Presumably the company can compensate itself for the additional risk, reserve costs and/or hedging cost by having a lower guaranteed cap relative to a non-guaranteed cap because customers typically value guarantees. Though lower caps would start to hurt illustration performance, which can be critical for IUL sales, we wouldn’t expect IUL illustrations to assume 100% allocation of deposits to go to this new index option. This new multi-year cap guarantee would be an allocation option for the policyholder to consider. Despite this potential illustration impact as well as the potential additional risks, we do think there are ways a company could make this MYFIA feature work on an IUL.
We’ve recently seen a new FIA/RILA annuity product concept be introduced where a loss on original principal is not permitted but losses of prior crediting/gains are allowed. For example, if a policyholder was credited 7% in the first year, the policyholder could potentially lose all or part of the year-one 7% credit in year two if equity markets performed poorly but would not be exposed to total crediting that was less than zero. This product acts like a combination of an FIA and a RILA, as annual crediting is subject to a rolling negative floor amount, which is based on accumulated credits to date.
We think this feature could be appealing in an IUL product, as risk of loss is always a key concern of policyholders. The risk of loss of prior crediting allows for the potential for greater caps and crediting than a normal IUL indexed crediting option; however, the complexity of tracking the prior crediting across monthly buckets and with monthly deductions could be very difficult both from an administrative perspective as well as for customer understanding. As a consequence, while we think this annuity feature could work in an IUL, the additional complexity of multiple deposits and appropriately handling the buffer feature (i.e., cannot lose more than what has already been credited) in the administration system might make it too challenging to adapt to an IUL product. Though some of the risk reduction techniques suggested for the MYFIA feature (e.g., a new money crediting approach) could help to address some of those concerns, the feature might be more appropriate for single premium IUL products.
There could be questions as to whether this kind of feature, where prior credited interest is at risk of being lost, might require the product to be filed as a VUL. As we noted earlier, if a VUL product was required, this would make the feature and product less appealing from a company and agent perspective.
The IUL market continues to be ultracompetitive. Recent AG-49 updates have curtailed the appeal of certain crediting options and volatility controlled funds as well as their illustration advantages. Companies are looking for ways besides illustrations to distinguish their products from their peers to gain a sales advantage. Perhaps implementing some of these annuity features and product ideas could help distinguish them. Only time will tell.
