market is vastly different than the pre-1980 market.
This is not to suggest the markets will either be more
bullish or more bearish as economic factors will dictate
the market’s direction. But it is fair to say today’s market
is — and will continue to be — more instant, more emotional and more volatile than before. And this increased
volatility is one of the things that makes IUL shine
relative to the market.
The problem with the new regulations is that they
include market data for a 30-year period during which
the market was vastly different than it is today, and an
arbitrary assumption of a 25-year holding period. A more
useful approach would be to have stochastic (Monte
Carlo) modeling over a variety of holding periods. Clients
should be able to know how their IUL would have
performed during specific bull market periods as well
as specific bear market periods.
For instance, one of my favorite survivorship IULs currently offers a floor rate of 2 percent with a cap of 11. 25
percent. A prospective buyer of this product might be
60-70 years old and should probably plan on having the
policy for at least 30 years. The new regulations cap the
maximum illustrative rate at 7. 2 percent based on the average of 25-year holding periods going back to 1950. But
if we back-test 30-year holding periods back to 1980, we
see that the worst 30-year period produced an annualized return of slightly more than 7. 2 percent, an average
return of 7.88 percent and a maximum of 8.64 percent.
Is the client actually able to make an informed decision if
my “best case scenario” on the illustration is worse than
the actual “worst case” actual scenario?
More importantly, as a prospective buyer, I would want
to know what I can expect of this product during typical
bear and bull markets. Lacking an automated system to
track this, one must manually calculate this using calen-
dar year returns of the market going back 30 years.
Since 1985, there have been two five-year bear markets:
2000-2005 and 2005-2010. The annualized return of the
S&P (without dividends) during these periods was - 3.79
percent and - 1.62 percent respectively. The annualized
return on the indexed product referred to earlier during
these periods would have been 5. 17 percent and 6. 13
percent respectively. The 2000-2010 period represents
the only 10-year bear market since 1985 when the
S&P performed at an annualized rate of - 2.89 percent.
Meanwhile, my IUL would have performed at a rate of
5.65 percent. While normally I would not be thrilled with
a 5.65 percent rate, relative to the market performance I
would be ecstatic.
A very bullish five-year period would have been from
2010 to 2015 in which the S&P performed at an annualized rate of 13.02 percent. During this time, my IUL
would have delivered a respectable 9. 33 percent. The
30-year period ending 2015 would have produced an
annualized return in the market of 8.73 percent while
my IUL would have generated 7.73 percent.
Examining hypothetical performance during moderate
markets, bull markets and bear markets is far more useful than assuming a single static crediting rate over
an arbitrary time frame. It also supports my true feeling
about IUL: you will like it in a bull market, be satisfied in
a moderate market and love it in a bear market.
While it’s dangerous to assume overly optimistic
scenarios, it is equally dangerous to assume overly
pessimistic scenarios. Virtually every financial decision
we make from buying a house to starting a business
to investing for retirement requires us to examine and
weigh the worst-case scenario, the probable scenario
and the best-case scenario. AG 49 forbids us to do that
“One of my favorite survivorship IULs currently offers a floor rate of 2 percent with
a cap of 11. 25 percent. A prospective buyer of this product might be 60-70 years
old and should probably plan on having the policy for at least 30 years.”
Thomas M. Martin, CFP, CLU, ChFC has been an
insurance producer since 1989 and is the author of
“The Eight Other Advantages of Universal Life.”