Buyer Beware... of False Promises Appearing Real Part 2 (Hybrid Indexes)
One of my professional advantages of being the admin of one of the largest professional Facebook groups if its kind, is that I get to get a sense of what is going on out there. Something that became known to me earlier this year is the concept of 'hybrid indexes' in the way that indexed life and annuities are sold. This is a separate issue from my 'part 1' article in my blog where I discussed Index Multipliers.
Rather than have me explain, I'm going to quote Sheryl Moore, CEO of Wink Intelligence who helped to bring a great deal of clarity to the subject in my Facebook group.
Good evening everyone!
A post about indexed insurance products has been brought to my attention. I want to provide a little more information about what I refer to as “hybrid indices” on indexed annuities and indexed life.
First of all, we need to remember that 220% of 2.00% is only 4.40%. Meaning- just because the participation rate is high, doesn’t mean the product will necessarily perform.
The case that was brought to my attention features an index that was just created on 4/8/22. The index was then added to the IUL product offering on 4/30/22.
It is VERY important to understand how such an index’s historical performance is calculated. In this particular example, there truly is no historical performance because the index didn’t exist even one month before the product launched. Disclosures on indices such as this are akin to, “this index has no history, but here are some numbers we put together, assuming it does have history.”
Some hybrid indices will use the performance of the indexes CONSTITUENTS, in lieu of actual historical performance. Again- disingenuous because standalone constituents are not identical to the constructed index.
And- current options costs are almost always assumed in the backcasting of these indexes, which is disingenuous because options costs in the past are not like they are today.
In the aforementioned case, the index has an annual 0.50% index fee. This fee has the effect of drag on the index.
Also of interest is the fact that although the indexing method has a current participation rate of 220%, it could go as low as 65%, once the contract is inforce. The insurance company has to go out and buy new options every year, so the inforce participation rates WILL change. Note that many insurance companies reduce their inforce rates, even if new options costs don’t warrant it. This is a function of independent agent distribution. The insurance company wants to give you “shiny, bright objects” to sell their product; so, they boost the rates in year one, snd then adjust them downward in years 2+.
We also need to take note of the fact that the previously mentioned indexing method has an annual 1.00% annual fee, which is deducted from the IUL’s account value. This will have the effect of drag on the IUL’s performance. And it will be deducted every year, even though the policy could earn 0.00%. Plus, this fee could increase to as much as 1.50% annually, once the case hits it’s first policy anniversary.
I have been doing this for 24 years. I am an independent expert with a history in inforce policy management, illustrations, product development, research, and expert witness work. Insurance companies WILL increase charges on inforce insurance contracts. They will also reduce participation rates/caps [increase spreads] on inforce insurance contracts. And sadly, they will distribute Illustrations that are too good to be true. What they make on the sales of these products is far beyond what they would have to pay to settle a class action lawsuit.
You have to do the research for yourself. The insurance company has a vested interest in you selling their product. Your marketing organization does too. Be careful out there. [Emphasis added]
Here is the section of a given insurance company's product "Historical Look Back Rates" that is in question (as of January 15th, 2022). (For obvious reasons, I'm leaving out the company name.)
I just want to show that it's the COMPANY behind this, not just the agent who may not know better.
Why do companies engage in this practice? I believe there are many reasons.
Amateur agents rely on the printed illustration and what the company allows to be printed in order to sell their product. While an NAIC compliant illustration is required to sell cash value life insurance, it's the agent who often says that what is on the paper (including and especially the non-guaranteed elements) is what will happen in your contract. They are selling the hypothetical rate of return rather than helping their clients have reasonable expectations of their contract.
There have been various insurance laws passed regarding how indexed life and annuity contracts may be illustrated (AG49, AG49a, and others) and therefore use LEGAL means within the illustration to pump up those numbers. Again, putting the emphasis on a rate of return in a contract rather than other provisions and guarantees.
I personally have no problem with indexed insurance contracts. I like them! But I am not going to misrepresent what is possible and set unrealistic expectations with my clients even though the COMPANY ITSELF may try to do that. And companies alone aren't to blame. Agents will take this information and use it in their marketing! David McKnight, author of The Power of Zero, friend, industry mentor, and IUL advocate, created this video at the time... helping to debunk some of these company and agent claims:
This is why, for me, I never (okay rarely) compete against companies. I'm always competing against the other agent, if I'm in any kind of competition. And I would much rather be the CONSERVATIVE professional, than the one who believes he can create results that, frankly, aren't realistic.