Insurance

Indexed Universal Life Income Distributions in the Lost Decade

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Last week, we discussed the results one could get from indexed universal life insurance from 2001 to 2010.  We also looked at how this type of policy performed if the market returns from this time period were repeated over and over again every 10 years.  We wanted to evaluate how IUL behaved during a sustained period of mediocre market returns.  It turns out indexed universal life insurance does just fine.  To check our results, we also looked at the results of a passive index investment during the same time period.  Not surprisingly, the index investment performs way short of normalized expectations for stock market returns.

While recording the podcast for last week, we mentioned in passing that these results might look a little differently if we evaluated a similar scenario during an income phase versus an accumulation phase.  That’s the very task we’re accomplishing this week.

IUL and Regular Investment Income Distributions During the Lost Decade

I’m using the accumulated values from last week’s analysis as our starting point for income.  I’m taking 5.5% of the cash value generated by the indexed universal life policy that used a standard 1-year point-to-point S&P 500 index with an 8% cap as our income basis.  This means we’ll be distributing $43,466 per year from each scenario and then calculating the rate of return–expressed by internal rate of return also known as the money-weighted rate of return.  Loans for IUL scenarios are assumed indexed loans at a 6% accumulation rate in all years.

I’m going to evaluate this scenario using another 20 year test period, which will assume the same market return taking place in repeat.  So just like last week, I’m simply taking the 2001-2010 results and repeating them every 10 years.  I’m also going to add a 50/50 stock and bond scenario for the investment.  I’ll keep the Vanguard 500 Fund to represent the passive stock market investment and I’ll use the Vanguard Total Bond Index (VBMFX) to represent the bond component.

Results of the Analysis

Standard S&P 1-year Point-to-Point with 8% Cap

Year Age Premium Premium Charge Policy fee Per 1000 COI TOTAL S&P 500 Return Cash Value Loan Balance Net Cash Surrender Value

21 61 0 0 60 0 1,558 1,618 1.00% 790,308 46,074 744,234

22 62 0 0 60 0 1,487 1,547 1.00% 798,211 94,912 703,298

23 63 0 0 60 0 1,367 1,427 8.00% 862,068 146,681 715,387

24 64 0 0 60 0 1,348 1,408 8.00% 931,033 201,556 729,477

25 65 0 0 60 0 1,451 1,511 4.69% 974,698 259,723 714,975

26 66 0 0 60 0 1,540 1,600 8.00% 1,052,674 321,381 731,294

27 67 0 0 60 0 1,732 1,792 3.65% 1,091,097 386,737 704,360

28 68 0 0 60 0 1,938 1,998 1.00% 1,102,008 456,016 645,992

29 69 0 0 60 0 2,161 2,221 8.00% 1,190,169 529,450 660,718

30 70 0 0 60 0 2,408 2,468 8.00% 1,285,382 607,291 678,091

30 Year IRR 4.34%

31 71 0 0 60 0 2,682 2,742 1.00% 1,298,236 689,803 608,433

32 72 0 0 60 0 2,745 2,805 1.00% 1,311,218 777,265 533,953

33 73 0 0 60 0 2,762 2,822 8.00% 1,416,116 869,975 546,141

34 74 0 0 60 0 2,693 2,753 8.00% 1,529,405 968,247 561,158

35 75 0 0 60 0 2,493 2,553 4.69% 1,601,134 1,072,416 528,718

36 76 0 0 60 0 2,063 2,123 8.00% 1,729,225 1,182,835 546,390

37 77 0 0 60 0 2,459 2,519 3.65% 1,792,341 1,299,879 492,462

38 78 0 0 60 0 2,922 2,982 1.00% 1,810,265 1,423,946 386,319

39 79 0 0 60 0 3,465 3,525 8.00% 1,955,086 1,555,457 399,629

40 80 0 0 60 0 4,115 4,175 8.00% 2,111,493 1,694,858 416,635

40 Year IRR 4.17%

Uncapped S&P Index

Year Age Premium Premium Charge Policy fee Per 1000 COI TOTAL S&P 500 Return Cash Value Loan Balance Net Cash Surrender Value

21 61 0 0 60 0 1,558 1,618 1.00% 763,011 46,074 716,937

22 62 0 0 60 0 1,487 1,547 1.00% 770,641 94,912 675,729

23 63 0 0 60 0 1,367 1,427 8.00% 832,293 146,681 685,612

24 64 0 0 60 0 1,348 1,408 8.00% 898,876 201,556 697,320

25 65 0 0 60 0 1,451 1,511 4.69% 941,034 259,723 681,310

26 66 0 0 60 0 1,540 1,600 8.00% 1,016,316 321,381 694,936

27 67 0 0 60 0 1,732 1,792 3.65% 1,053,412 386,737 666,674

28 68 0 0 60 0 1,938 1,998 1.00% 1,063,946 456,016 607,930

29 69 0 0 60 0 2,161 2,221 8.00% 1,149,062 529,450 619,611

30 70 0 0 60 0 2,408 2,468 8.00% 1,240,986 607,291 633,695

30 Year IRR 4.14%

31 71 0 0 60 0 2,682 2,742 1.00% 1,253,396 689,803 563,593

32 72 0 0 60 0 2,745 2,805 1.00% 1,265,930 777,265 488,665

33 73 0 0 60 0 2,762 2,822 8.00% 1,367,205 869,975 497,230

34 74 0 0 60 0 2,693 2,753 8.00% 1,476,581 968,247 508,334

35 75 0 0 60 0 2,493 2,553 4.69% 1,545,833 1,072,416 473,417

36 76 0 0 60 0 2,063 2,123 8.00% 1,669,499 1,182,835 486,664

37 77 0 0 60 0 2,459 2,519 3.65% 1,730,436 1,299,879 430,557

38 78 0 0 60 0 2,922 2,982 1.00% 1,747,740 1,423,946 323,795

39 79 0 0 60 0 3,465 3,525 8.00% 1,887,560 1,555,457 332,103

40 80 0 0 60 0 4,115 4,175 8.00% 2,038,564 1,694,858 343,707

40 Year IRR 3.98%

VFINX IRR end of first 10 years = 1.82%

VFINX IRR end of next 10 years = null

VFINX Income Years 31-40

50/50 VFINX/VBMFX IRR first 10 years = 3.21%

50 50 Stock bond years 21-30

50/50 VFINX/VBMFX IRR second 10 years = 3.29%

50 50 Stock bond years 31-40

Commentary on the Results

As a reminder, income for all scenarios in all years is $43,466 per year.  This is 5.5% of the cash surrender value of the 8% cap IUL at the end of year 20 from last week’s example (i.e. the end of the accumulation period).  One could argue that I should have taken some other number from the resulting end of accumulation period results for each individual option, and this would have resulted in different endpoints for the other scenarios that weren’t the 8% capped IUL.  This is true, but ultimately, retirement planning is about creating the most amount of income for the dollar saved.  Since making this adjustment for the other scenarios would have resulted in lower-income distribution, I find whatever results from this created to be un-remarkable.

It’s interesting, though not really surprising, that the passive index investment entirely in the stock market wasn’t able to survive the entire 20 year period of the income distribution.  Now I’m well aware that customary investment advice would never recommend someone keep 100% of their portfolio in the market and never recommend taking 5.5% of the balance as income in all years.  There are two points, however, that I wish to make about this.

First, there are some internet and radio financial warriors out there who have espoused remaining 100% in the market forever or–ideally–as long as possible.  Some of them are on recorded YouTube videos making such recommendations to ladies in their elder years.  While traditional investment advising would disagree–and disagree correctly with this sentiment–there are people who will go rogue and their investment advice is horrible as it’s wildly susceptible to problems highlighted above.

Second, I want to reiterate the fact that I’m trying to suss out what benefit achieved per dollar in.  If both IUL policies are capable of sustaining the same income figure despite different beginning account balances, where does that put the market investment?

IUL is Far More Resilient in this Scenario

It’s obvious under this scenario indexed universal life insurance shows more resiliency.  It’s also extremely unlikely that this scenario will ever play out.  This isn’t a thought exercise attempting to dissuade anyone from owning stocks and bonds and persuade them to load up on life insurance.  Instead, I’m using it to highlight that cash value life insurance products have a tactical purpose for risk mitigation.

I strongly doubt we’ll see a sustained stock market period like the one in this example.  However, I believe that market corrections will take place more than once over the next several decades.  These corrections will dramatically alter the results achieved by ordinary investors who use said investment for retirement preparedness.  Incorporating fixed universal or dividend-paying whole life insurance into your retirement portfolio will shield you to varying degrees from these potentially life-altering corrections.

What’s more, the cost of insurance (COI) reporting in the IUL results is likely overstated as I did not account for the change (reduction) in the net amount at risk in years when index earnings are higher than anticipated from the illustration.

Also, just like last week, the bonus that is a part of this IUL product is still not included.  Additionally, income from the investment does not account for taxes due.

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