Life Insurance Consumer Advocacy Center

Insurance regulators have put into effect – presumed effective after Dec. 14, 2020 – more conservative rules for illustrating the popular index-based Universal Life policies sold by dozens of life insurance carriers.  Revising illustration rules was last attempted in late Summer of 2015 via Actuarial Guideline 49 (AG49), but newer products and their illustrated projections were in some cases devised to circumvent the design of those rules intended to tamp down the attractive but aggressive assumptions contained in the policy projections.

The problem, of course, is that we don’t know how underlying stocks and their indices will behave in the future, and aggressive illustrations inevitably overstate the effect such performance will have on these policies.  Compounding the problem is that many of these policies are projected with constant earnings factors that don’t vary (even though equities are notoriously volatile).  This leaves consumers with unrealizable illustrated expectations, often initially viewed as near- promises.

At a deeper product design level, some carriers – to circumvent the spirit of AG49 – may have dramatically increased volatility risk taken on by the consumer without their full understanding of the consequences.  For example, when an IUL index return of 6% is applied over a segment year, companies with the most aggressive multipliers demonstrated via policy sales illustration a year-over-year return of 14%!  However, in a segment year when the index does not grow at all, the higher charges that come with the multipliers will generate a large negative return.  (See extended discussion of multipliers.)

It should be noted that the new rules apply ONLY to policies sold after the December 14, 2020 effective date.  Policies put into effect before that date (and sold via sales illustrations) are allowed to continue to be illustrated in the more aggressive manner, even after the new rules go into effect.  This concession to insurers with substantial amounts of pre-regulated policies is a major disappointment on behalf of the protection of consumers!

At the very least, owners of such pre-“new” rule policies are cautioned to request updated in-force illustrations at least every few years.

What the new rules require:

1. While a carrier may apply multipliers and other indexed benefits to an in-force policy (and once paid into the policy, may illustrate the result of the credits in the calculation of net cash value in an in-force illustration), sales illustrations may NOT illustrate those enhancements at a rate higher than the charges used to support them. This prevents evolving cash values from seeming to accrue at much higher rates than the “AG49” allowable illustration rate.

Note: Just because a cash value or policy loan value is shown in the illustration does not mean it will materialize in the policy!  We have repeatedly seen that projecting on the basis of an aggressive proprietary index’s historical performance is fraught with issues, especially when the index in question has been extremely volatile and immature.   Over time, as that index matures, that index is unlikely to see the spectacular results that were the reason behind utilizing that index in the first place.  It’s an example of a likely short-term illusion that generates a long-term (and largely unattainable) expectation.

2. Only one Benchmark Index Account (BIA) is allowed per policy. The original AG 49 allowed multiple BIAs, each governing the maximum illustrated rates for any accounts with the same charge structure as that particular BIA.

For example, AG49 rules with respect to look-back illustration rates might restrict a carrier’s illustration of a S&P 500 Index account to a maximum illustration rate of 5.41%.  That’s a function of their guaranteed minimum crediting rate (typically 0%) and their current cap (perhaps 8.5% in today’s marketplace) – against a 25-year rolling average look-back in index returns.  Remember that the Cap is not used in the company’s illustration; AG49 restricts how much crediting rate can be demonstrated in a policy projection (illustration) and how it might increase the cash value segment in a given timeframe. The Cap is a current reflection of the most an index’s performance will be credited to the policy in a segment period.  The Cap rate is under the sole control of the insurance company and  it is anticipated that even lower Caps will be announced as a result of the ultra-low interest rate environment.  Caps guarantees are generally in the range of 3 – 4%.

But under AG49, if the carrier also offered a 1-year “high cap” indexed S&P500 account, it might be allowed to illustrate at 6.62% because of a current 11% cap.  And the company would use the higher 25-year look-back rate to calculate their illustrated values – regardless of which index the consumer actually chose. Going forward, that sleight of hand will not be allowed under AG 49-A.  The company’s illustration rate will be controlled by just one BIA.  And it won’t arbitrarily use the highest Index because of this next restriction:

3. Charges of any kind cannot be used to increase the Benchmark Index Account cap. And High Cap Indices cost more than basic indices.
4. Such illustrations often portray cash flow coming back to the policy owner in the form of income tax-free “income” in retirement. In an inadvertent homage to Alice in Wonderland,
   policy loans have been allowed to pretend the borrowed dollars are still in the policy and growing at a rate of 1% higher than the interest rate on the policy loan. Prior to AG49, the assumption was not limited.  Under AG-49A, the illustrated policy loan “spread” is reduced from a 1% per year gain to “merely” 0.5%.  Our view is that it shouldn’t be allowed at all.

Comments:

Here’s an example of the effect on a popular “Generation 3” IUL product:

“Using PacLife’s PDX 2 as an example: Selecting the most aggressive allocation – High Cap (0.8% charge), Performance Plus EPF (7.5% charge) and the full indexed Persistency Credit – might yield an illustrated income of $92,500 and a long-term illustrated IRR of 8.21% under the older AG49 rules.  Under AG 49-A, all 3 of the indexed bonuses would be netted out against their charges and the illustrated arbitrage would drop from 1% to 0.5%. This produces an illustrated income of approximately $53,000 and a long-term IRR of about 5.7%.” ¹

That’s an illustrated reduction of 43% projected retirement cash flow and an illustrated reduction of 30% in projected IRR (internal rate of return).  The key here is that nothing changes in how the product may work over time – just in the way the outcome can be portrayed in a sales illustration.  The AG49-A projection will initially be more conservative, but it’s still likely to be an exaggerated view of the future.

The original AG49 rule restricting the projected assumptions of indexed policy illustrations had similar reductions in product projections.  But carriers quickly developed new features that met the rules (but perhaps not the spirit) in product design and the appearance of enhanced illustrations and new benefits.

“If I’m being optimistic, I’ll say that the net result is that illustrations will still be more conservative than they are today. Maybe that’s the case. But if I’m being pessimistic, I’ll say that they might be more conservative, but they’ll also be a lot more confusing.” ²

The outcome of this change won’t be known for at least several years, as we see carriers developing updated products to better illustrate under harsher new rules.  And, as lawsuits continue to proliferate against carriers and agents, illustrated constructs designed to get around illustration rules are likely to be called into question.

^{1 & 2}   Bobby Samuelson, The Life Product Review (a subscription newsletter)

• The LICAC Team