Indexed Universal Life

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Before reading this article about indexed universal life, you’ll want to read and understand the basics of my previous article titled Universal Life Insurance Premiums, which offers an explanation of how universal life works and some sample quotes.

When you read about indexed universal life, what you’re dealing with is a particular method that the interest is credited to your cash value, which may offer a greater opportunity for interest earnings. When you’re dealing with universal life, the higher your cash value grows the better, since that ultimately means you can pay less premiums down the line, or pull more cash out of the policy, whichever you want.

What is Indexed Universal Life?
Many universal life contracts now offer an interest crediting strategy that’s tied to a major equity index, like the S&P 500. For example, rather than earning a non-guaranteed 4% per year, which is set by the insurance carrier, you might elect to try your odds in an indexed strategy, where you could earn as much as 8% or 10% in a given year, depending on the performance of the stock market.

One Year Point to Point Strategy with Cap
The most common indexed strategy is a one year point to point with a cap or participation rate. Say you pay $500 into your policy this year, and only $200 is needed for policy costs, and you’ve elected the one year point to point indexed strategy with a 8% cap, tied to the S&P 500.

In this case, your company would mark the current index value of the S&P. Say it’s at 1300 today. Then a year from now, one year after the $300 was allocated to the indexed strategy, the S&P’s level is marked again. Say it went up to 1360. That’s a gain of 4.6%. Your $300 would be credited with 4.6%.

But what if the S&P went up to 1500, a gain of 15.3%. Here your cap of 8% would come into play, and your $300 would be credited with 8%.

What if the Index goes down?

In most cases, the money allocated to a strategy tracking an index that stays flat or decreases during a segment, will make 0 gains for the year (or however long the segment is).  In some cases, a minimum guaranteed interest rate, such as 1%-2%, is available for index strategies over a 5 or 6 year segment.  This is the way Aviva Life Insurance’s 1 and 2 year point to point strategies work, which currently offer a 2% guaranteed minimum during the 5 or 6 year segment, respectively.  (As of the time of this writing, 3/1/12)