Minimum Guarantees on Indexed Life

Indexed universal life products also differ significantly from traditional universal life products in regard to their minimum guarantees. Traditional universal life contracts offer a minimum guaranteed annual return rate that is typically around 2% - 4%. Indexed universal life products may offer the same type of guarantee, but otherwise may offer an alternative minimum guaranteed rate. Alternative minimum guaranteed rates are the most popular guarantees offered on indexed life products because they allow the insurance carrier to lower to cost of the guarantee and permit for a larger hedge budget (thus passing on improved participation rates, caps, and spreads/asset fees). Some carriers apply their alternative minimum guarantees cumulatively at the end of a specified term, such as a period of five years. Still others may offer an alternative minimum that only applies in the event that the policy is surrender, lapsed, or a death occurs. There are variations amongst the many products on the market, but the important fact to take note of is that a guaranteed annual return is the strongest type of guarantee, but it costs an insurer the most money to offer (and therefore may result in less attractive participation rates, caps, etc). If the minimum guarantee is a less important feature, and having more competitive rates is more valuable, perhaps a product with an alternative minimum guarantee may be a viable solution.

Some indexed life policies use an alternative minimum guarantee that is cumulative at the end of a five-year period. This can be somewhat confusing to those less familiar with indexed life, particularly in regard to frequency of sweeps and optional premium reallocation. Each carrier handles the provisions differently, but the following provides a guideline. The annual point-topoint strategies on these products would not expire, or mature, to be reallocated at the end of one year. These buckets sweep and measure the annual point-to-point formula five different periods (five years), prior to maturing. This does not make it a five-year point-to-point bucket, the fiveyear period merely relates to the minimum guarantee on the policy. How so? Let’s say that the annual point-to-point calculation is performed each year over the five year period on a policy with an alternative minimum guarantee of 2% at the end of a five-year period with the following results:

At the end of the five year period, the cumulative 2% minimum guarantee has not been met, so the insurance carrier will retroactively credit 2%. The likelihood of the minimum not being met is not very high, as all it takes is one year of good indexed gains to nullify the guarantee. In addition, holding off on the guarantee for a five-year period allows the carrier to offer more competitive rates. Policies with five-year terms (or six year terms) for their guarantees do not allow for reallocation of premiums until the maturity of the indexed bucket at the end of the term, rather than annual or biennially after the index calculation is performed. Alternatively, policies with a guaranteed annual return type of guarantee allow for premium reallocation annually. It is important to note that all indexed life products allow for changes in premium allocation of new premiums coming in at any time, the aforementioned rules apply to premiums already placed in the contract.

Regardless of the minimum guarantee method offered on the indexed life policy, an annual floor of 0% is always provided. Therefore, the policyholder can never receive a reduction in cash values due to a decline in the index.