Understanding Loan Options within IUL PoliciesJulie Brooks
Indexed Universal Life (IUL) is a popular product choice for cash value accumulation because of its potential for higher interest crediting rates based on the performance of a selected index over a given period of time.
A big selling point for the IUL product line is the assurance that the client will never lose a single cent of their accumulated cash value due to poor market performance. Unlike Variable UL policies which are subject to market performance and allow for both gains and losses on your account value, IUL uses a floor rate to protect your cash value from losses when your index account allocations have negative returns.
This makes for a great story during the accumulation phase. But what about the distribution phase? What is the best way to distribute the funds from the policy?
Understanding the different options available is the key to making the best decision for your client. Most IUL policies allow for either fixed or variable loans.
The fixed loans have a stated interest rate on the outstanding loan amount so there is no question about the cost of the loan. After a certain number of years, the IUL product will often provide for a wash loan or preferred loan where the amount being charged on the loan is the same as the interest being credited to the cash value (thereby resulting in zero net cost on the loaned funds.)
The more commonly illustrated policy loan distribution is the Variable Loan
Using a positive arbitrage (the illustrated interest crediting rate for cash value is higher than the interest rate being charged on outstanding policy loans) allows an illustration to reflect a gain on the outstanding loan rather than a charge. Because this can make an illustration more attractive due to the higher cash value accumulations during the distribution phase, it’s what many producers prefer to show to their clients.
It is imperative that producers understand how these loan features work and communicate to their clients that they also have the potential for a negative arbitrage which can create considerable interest due on outstanding policy loans.
Depending on your client’s risk tolerance and whether or not they plan on paying outstanding policy loan interest as it accrues, either policy loan option can be appropriate. If you do not have an understanding of how your clients would like to approach their policy loans and simply elect the variable loans due to the potential for positive arbitrage, you may be setting yourself up for a difficult conversation if the loan interest charged exceeds the interest crediting rate for cash value and the amount available for distribution decreases well below your clients anticipated income amount.
Agents who are selling IUL products and highlighting the ability to generate an income stream from the policy should have a thorough understanding of the loan provisions and be able to help their clients to better understand which feature is in their best interest.
Insurance Advisors is here to help you navigate the various options and make the most suitable recommendations for your clients. Contact us today.